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Hernando Today

Crisis And Bubbles

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By JOHN REINIERS, More Than Words

Hernando Today

Published: October 21, 2008

It is the nature of economics, that as night follows day, we go through these unanticipated cycles — feast or famine — followed by the other. Even without government's visible hand, there are plagues, droughts, hurricanes earthquakes — whatever — that alter economic activity.
However, when government intervenes, we add another efficient cause to the cyclical mix.
Let's start with a crisis — the savings and loan in the 1980s, for example, which was really another failure of government bank regulations. (Some dating back to the Great Depression.) S&Ls were sort of a bank, because they could take in deposits, but they could only lend money for mortgages on houses. Federal policy required that they use short-term passbook savings to fund long-term fixed-rate mortgages. They were essentially mortgage banks only.
So every time interest rates rose, they had to pay more to their depositors than they were making on the mortgage side of the business. By law, they couldn't diversify their investment portfolio into other assets, so in 1979 when Paul Volker, then Fed chairman, clamped down on the growth of money supply, short-term interest rates skyrocketed, and S&Ls lost their shirts.
By 1982 all of them combined had a negative net worth — hence the beginning of the S&L crisis. (An oversimplification, but enough to get the picture of the impact of government.)
An interesting sidelight: The secondary mortgage market created by the government with Fannie Mae and Freddie Mac (the underlying cause of today's financial unraveling, because of federal policy making sure everyone owns a home whether they can afford it or not) undercut S&L profits back then by using their federal backing to effectively reduce interest rates on all mortgages. Then Congress went into a deregulation phase allowing S&Ls to sell these loans, and guess what? Just like the current crisis, Wall Street bundled them together as "government backed" bonds and S&Ls bought them back — being charged hefty fees.
Wow! So this crisis had nothing to do with the forces of nature, but everything to do with the visible hand of government.
Congressional deregulation was necessary because of the initial misguided regulations, but that attempt was flawed also because it led to imprudent real estate lending by the banks, then insolvencies, then corruption by some bank officials followed by influence peddling with political contributions to three subsequently reprimanded Democratic senators — eerily similar to Fannie and Freddie's generous contributions to Sen. Chris Dodd, D-Conn., chairman of the Senate Banking Committee and others — including Sen. Barack Obama — and even Republicans.
Now let's go to good times — the NASDAQ bubble — driven by computer technology, which is still defining our lives in ways we don't understand and costing us more jobs than outsourcing. Technology redefined the business world and gave business a competitive edge. Applications were rolled out that were remarkable. My wife's business is an example. All of her client's records — and the data keep changing — are on-line. That was unheard of back in the early nineties. Business applications created jobs by aiding in word processing, which we now take for granted, calculating taxes and all sorts of accounting. Computers replaced TV as entertainment, video games defined the marketplace. Microsoft was king. Computers were beginning their rapid ascent in the marketplace as a business tool — which brings us to the Dot-com companies — the darling of venture capitalists. And the government obliged with easy money in 1989-99. Whatever, Dot-coms were a novelty that caught on big time as a "business," with eye-popping and foolish stock evaluations.
And then technology venture capitalists were blessed by the Y2K "switchover" phenomenon. Business spending for upgrading software programs was staggering. For five years governments and companies spent between $200 to $500 billion fixing the so-called Y2K computer bug. And as we all know the new millennium started without airplanes falling from the skies or any other disasters.
And, of course, former President Bill Clinton takes the credit for the greatest economic expansion in the history of mankind, whereas economic history records it as the "NASDAQ bubble." Once the clock struck midnight 2000, businesses and governments found themselves with all the computer equipment they needed for years to come, and the bubble burst with the NASDAQ at an astounding 5048.62, the high-water mark for the Dot-com boom. (The Dow Jones peaked on Jan. 14, 2000, just days before George Bush took the oath of office.)
Many suggest now that Alan Greenspan, former Fed chairman, bears some responsibility for permitting cheap credit with low interest rates, which in turn caused the real estate boom which then fueled the secondary mortgage market with all those trillions of dollars of leveraged anonymous derivatives. Perhaps so. But then greed always intervenes. Here was Greenspan warning Congress of the imprudence of Fannie and Freddie in 2004 — and Congress did nothing — but yet in 2003 he testified that derivatives "have been an extraordinarily useful vehicle in transferring risk ..." Sure — to the taxpayer.
It may well be that a less regulated market will do more for the economy in the long haul. But that's not going to happen so long as legislators are legislating and regulators are regulating. They do so imperfectly either because of their lack of technical or supervisory skills, injecting distortions into the natural cyclical economic rubric. And there are dishonorable people everywhere looking for campaign contributions or trying to make a buck — the crooks.
Technology, which made it possible to create these enormously complex derivative instruments, could be the answer to this latest mess by providing government with the necessary oversight tools to track the effectiveness of their own often misguided laws and regulations. The computer wizards are out there. They are probably using computer programs to work on a fix right now.
That being said, a lot of experts, politicians, and highly placed officials saw many an irrational "bubble" before its predictable bursting, but didn't have the force of will to really take dramatic action.

John Reiniers, a regular columnist for Hernando Today, lives in Spring Hill.

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