Back in the 1990s, when books like Dow 36,000 were being published, the stock market was supposed to be the great liberator, equalizer, and prosperity machine.
The Internet had created a New Economy. The globalized market was rational, self-correcting, the best allocator of resources. The stock market, once the province of a tiny moneyed class, was being democratized. In 1980, five million households owned mutual funds; by the 1990s, it was 50 million. Cabbies were buying tech funds. We would all be rich. A New Era had arrived.
That faux prosperity was inflated by bubbles. First came the stock-market bubble of 1995-99, led by dot-coms. Internet start-up companies with no profits, no earnings, and no sales were launched publicly and sent to the moon. Backed by venture capital, someone would put up a Web site, an initial public offering would ensue, and boom—the share price would hit $100. Instant millionaires were minted. Never mind that the Internet actually adds competitive pressure, making profit more difficult, in many cases. Delusions were fed by those who were supposed to provide independent assessment. Henry Blodget, a Merrill Lynch analyst, rated many Internet stocks as a buy, including Excite@Home and Infoseek.com, referring to them in his private e-mails as a “piece of junk,” a “dog,” and a “piece of crap,” among other technical descriptors. Not much later, their value vaporized.
During the crash of 2000-2, dirty tricks were exposed at Enron, Tyco, Global Crossing, and WorldCom, where obsession with stock prices, encouraged by executive pay in stock options, led to short-term quarterly thinking and fraud, including off-balance-sheet financing. Once again the grown-ups had exited the room. The accounting firm Arthur Andersen helped Enron cook the books rather than exert oversight as auditor. Implosion followed.
Then came 2002-8. Onward sloshed the global pile of money into the latest American bubble: collateralized debt obligations and mortgage-backed securities. The Fed chairman, Alan Greenspan, kept interest rates exceptionally low, a stance made possible by China’s purchase of billions of dollars of U.S. Treasury bonds. The cheap money was lent hand-over-fist by mortgage brokers to anyone willing to buy a home, including buyers with no income and no assets. Since the mortgages were often adjustable-rate, the result was sure to be heavy defaults among American low-income borrowers, with no collateral to soften the blow.
But the brokers happily collected fees and sold the mortgages en masse to Wall Street, where they became Somebody Else’s Problem. Wall Street repackaged the dicey loans as fixed-income securities; ratings agencies like Standard & Poor’s called them AAA—as safe as cash—and insurers like AIG sold credit-default swaps, a fancy name for insurance, on them. Away they went, sold to pension funds in Oregon and Iceland, whose leaders thought they were buying safe and conservative investments.
When interest rates finally rose, the housing bubble burst. Home prices plummeted, foreclosures skyrocketed, many mortgage-backed securities were worthless, big banks and insurers began to teeter and fold, and in 2008 the stock market collapsed. Nest eggs became omelets. Down went the real economy.
That succinct history of 15 years of folly is occasioned by Pennywise’s cantankerousness. My house finally sold last month, at 18 percent less than what I bought it for, in 1999. Despite its being in beautiful condition after many upgrades, it was a toxic asset, foreclosures down the block having tanked its appraisal value.
That has left me more than a little grouchy about those who turned our residences, our havens in a heartless world, into a Vegas baccarat table.
I have made matters worse for myself by whiling away some summer hours with films like the brilliant documentary Enron: The Smartest Guys in the Room (2005), which somehow I missed on its first release, and books like the smug Diary of a Very Bad Year: Confessions of a Hedge Fund Manager (2010). Both movie and book were vivid reminders of the culture of arrogance and shortsightedness that brought us to this impasse. Intelligence was never lacking. Wisdom was.
Today unemployment hovers at about 10 percent. In some states, the rate is much higher. Each data point holds a human story. My brother-in-law lost his job a year ago, just after my sister gave birth to their boy. He still hasn’t found employment. No wonder, despite statistical indications of an economic recovery, the Great American Consumer isn’t spending. For the average American, now, not October 2008, is the scariest moment in the Great Recession. Who doesn’t know someone who has lost a job? What workplace hasn’t suffered cuts? How many people’s mortgages are underwater? Who wants to take on a new monthly car payment or mortgage, given the precariousness?
All of which points to a critical, though neglected, aspect of the crisis: the long-term flatlining of median household income, accounting for the failure of aggregate demand, or “excess capacity.” The gutting of American manufacturing, destruction of labor unions, and massive upward transfer of wealth via tax reduction since the 1970s and 1980s has created a gulf between rich and poor at levels unknown since the 1920s. Wal-Mart greeters and Burger King workers have a circumscribed purchasing power—even if extended, temporarily, by credit cards and no-money-down auto loans.
What does the economic future hold? There are, roughly, two schools of thought, neither rosy.
One is that the recent economic stimulus and bank bailouts—which transferred the debt bubble from corporate America to taxpayers’ ledger—when combined with military spending and tax cuts from the Reagan-Bush eras, have resulted in enormous federal deficits and debt, which will lead inexorably to higher interest rates and inflation.
The other is that we aren’t even close to the end of this crisis, unless more stimulus is injected. This view holds that the air is still expiring from the financial bubble, like a big inner tube left on the dock for a week during summer vacation. A downward spiral of joblessness, cash hoarding by banks and businesses, and low consumer confidence may well bring on prolonged stagnation, if not a double dip or catastrophic global depression.
Each side in this debate can find ample evidence in support of its argument, which is what makes the moment so uncertain. Many observers now split the difference, saying a short-term deflationary threat will eventually give way, as growth and employment are restored, to inflation.
Who is right?
Nobody knows. But clearly Pennywise is not optimistic. He is skeptical about the stability of a world economy in which one pole, the United States, consumes and finances, while the other, China-India, saves and produces. He sees radical inequalities in income and wealth as a serious constraint on expansion. Finally, despite financial-reform legislation that will result in derivatives like default swaps being traded transparently, the corporate culture of short-term myopia and greed is intact. Witness the recent grotesque bonuses on Wall Street. The Vast Bubble Machine may soon gear up again, and there are few obvious safe havens. (Long-term U.S. government bonds—once as conservative as, say, residential real estate—are looking very bubbly to Pennywise. So is gold.)
Over the next few months, I’ll attempt to lay out a rational, cautious investment approach suitable to our unstable epoch. There are no easy answers. But let me leave you with the one unquestionable, definite, practical opportunity presented by this Great Recession: Free money.
The Fed funds rate, the price the central banking system puts on money, has been reduced to near zero. That is unprecedented. Never before has the rate been set this low, and never again will it be, most likely. Not in our lifetimes, anyway. It is where it is because of a worldwide flight to safety in U.S. bonds and because Washington and Wall Street are terrified by the prospect of deflation.
What does that mean for you? If you carry any debt, now is a superb time to refinance. Consider combining your debt—home mortgage, home-equity line of credit, auto loan, credit card—into one new fixed-rate loan (the 15-year rate is about 4 percent, exceptionally low). Do the math and see if refinancing makes sense for you. It is a rare sure thing in a post-bubble age of uncertainty.