How Capitalism Will Save Us (16 page)

One fundamental problem was that not all assets on a balance sheet are necessarily saleable at a given moment. For example, what if you had to state the value of your home based on what you would get if you had to sell it today? That number might be zero. But if you sold it under normal conditions, the house’s ordinary value might be $400,000.

In much the same way, mark-to-market accounting forced banks and insurers to adjust their capital accounts to reflect what their financial assets were worth, as though they suddenly had to be sold on the open market. During the financial crisis, it encouraged undervaluation of assets—including perfectly good loans.

Yet regulators and lawsuit-fearing auditors insisted that solvent financial institutions drastically write down the value of their entire mortgage portfolios, the good loans as well as the bad. This meant banks had to raise more capital, sending distress signals to the market that forced down their stock prices. Result: hedge funds smelling blood started shorting financial stocks.

The frenzy of short selling sent financial stocks into a death spiral. Companies saw their credit ratings downgraded by agencies that had lurched from easy indulgence to mindless overreaction.

Of the $600 billion financial institutions wrote off between the summer of 2007 and the fall of 2008, almost all were book—or artificial—losses and not actual cash losses. If the mark-to-market rule had been in
effect during the banking crisis of the early 1990s, almost every major commercial bank in the country would have gone under. There would have been a second Great Depression.

Tragically, the Bush administration did not comprehend the damage caused by mark-to-market. Not only banks but also life insurers had to raise capital to cover the supposed decline in the value of their financial reserves, even though those assets had little or no relation to their day-today operations or viability. They were intended to cover liabilities arising from future claims. No matter. Otherwise healthy companies such as Hartford Financial found themselves in a near death spiral. Hartford saw its stock plunge from $72 a share in 2008 to a low of $3 before state insurance regulators stepped in with their own accounting relief that reduced pressure on life insurers.

The maniacal short selling that helped drive down both insurance and banking stocks was made possible by still another governmental misstep—removal of the uptick rule that had provided a critical speed bump to slow short selling.

The uptick rule was enacted back in 1938 to stop the bear raids that devastated companies in the 1920s and ’30s. Raiders would pick a stock, spread rumors that it was in trouble, and sell it short relentlessly, hoping to create panic. In this way they would force the price into a downward “death spiral,” then they would buy the stock back at a considerably lower price and make a profit. Allowing a short sale only after a stock went up from its previous price, the uptick rule had served as a critical speed bump, preventing or slowing bear raids. Suspending it heated up volatility, deepening the atmosphere of anxiety and uncertainty.

The 2008 economic meltdown precipitated by these mistakes is just the latest economic catastrophe caused by the less-than-invisible hand of government.

Missteps of a different kind helped produce the Great Inflation of the 1970s. Contrary to what many believe, neither oil speculators nor OPEC caused the soaring fuel prices of that era. The true culprits were the Federal Reserve and Washington politicians like President Richard Nixon, who weakened the dollar by severing its anchor to gold. That set off massive printing of money not only in this country but around the world, causing three ever-more-debilitating bouts of inflation and stagnation.

The most powerful example by far is the Great Depression. More and more people are becoming aware of the government’s role in that disaster, brought on in the fall of 1929 by the introduction in Congress of the Smoot-Hawley Tariff. That protectionist bill was designed to shield American farmers from foreign competition, keeping out or restricting agricultural goods from Canada and elsewhere. It was later expanded to protect a vast array of industrial products. Even imported olive oil was hit with huge taxes, although the U.S. was not a producer. Markets try to anticipate the future, and with this disaster looming, the stock market crashed. When Smoot-Hawley looked as though it would be sidetracked, the stock market rallied and ended the year almost where it had begun.

The bill reemerged in 1930 and stocks plunged again. When President Hoover finally signed it that June, decline turned to disaster. Countries retaliated and trade shriveled. International flows of money dried up, severely damaging countries’ financial systems.

Then, President Herbert Hoover proposed and Congress passed a gargantuan tax increase in 1932. The top income-tax rate was boosted from 25 percent to 63 percent. There was even an excise tax on checks. You had to pay a tax each time you wrote a check! The intention was to “restore confidence” by balancing the budget. Not surprisingly, confidence was anything but restored. Strapped consumers responded by using more cash. These withdrawals from banks nearly broke the financial system, forcing the new president, Franklin Roosevelt, in 1933 to close every bank in America for several days.

Roosevelt then made numerous mistakes of his own—such as instituting industrial codes that tried to micromanage prices, wages, and even selling practices throughout virtually every sector of the economy—that further retarded economic recovery. Yet it was the “economic royalists” and “plutocrats”—the selfish rich people—who were blamed for the miseries of the 1930s.

True, there had been excesses in the private sector in the heady precrash days of the 1920s. But these alone could never have caused a decade-long catastrophe that encompassed the entire economy.

Stock market breaks in and of themselves do not bring economic downturns. In spring of 1962, Wall Street had the biggest stock market bust since 1929. But no depression followed. Unlike Roosevelt, President John F. Kennedy backed off some of his earlier antibusiness actions, such
as the raids by his attorney-general brother on steel company executives. JFK actually introduced major tax cuts, which helped make the 1960s the most prosperous decade up until that time in American history.

And why was there no depression or even recession in 1987 after stocks had their worst one-day crash in history—down 23 percent? That’s because President Ronald Reagan did not respond to that crash with tariffs or taxes. Nor did he enact obese stimulus packages. Instead he allowed his scheduled tax cuts to take effect. Stocks recovered. And the economy continued to grow.

People blame the private sector during economic disasters. Yet government policy causes the worst instances of economic brutality.

One final example: the momentous government blunders—again in monetary policy—that were made in Germany during and after World War I. Instead of paying for the war through a judicious mix of taxes and borrowing, Berlin simply turned on the printing press. The resulting flood of money into the economy created raging inflation that was blamed initially on the need to pay for the war—and later on the need to raise money to pay reparations to the Allies. Instead of fully comprehending the cause, the public as always sought scapegoats. Blame shifted to Jewish financiers, “speculators” who “stabbed” Germany in the back. After catastrophic inflation wiped out the foundations of the middle class, Germany became ripe for both Nazism and communism when the Great Depression hit in 1929.

L
osing a job is painful. But it is particularly scary in a down economy. Media headlines such as “Job Losses Worst Since 1974” and “Worst Financial Crisis Since the Great Depression” convey the impression that things are only going to go downhill. That you’ll never get another job.
Even during the period of growth that preceded the 2008 crisis, when unemployment was barely 5 percent, gloom sayers complained about a “jobless recovery;” others complained that the jobs being destroyed were being replaced by low-wage, menial jobs like chain-store cashiers and burger flippers.

Media stories characteristically focus on mass layoffs and jobless statistics. This is not only an immense disservice, but also a distortion of what is taking place in the Real World economy.

The Real World truth is that even in the worst recessions, jobs are being created as well as lost. And most people find new employment, sooner rather than later.

At the end of 2008 the median amount of time a person was unemployed was ten weeks or two and a half months, according to the Bureau of Labor Statistics. That means half the people were jobless for less than that amount of time.
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In 2009 the length of joblessness increased because government blunders—like the Federal Reserve’s failure to revive credit markets—seriously hobbled the normal forces of recovery. Even so, only a little more than a fifth of those jobless were classified as long-term unemployed, that is, out of a job for twenty-seven weeks or more.

During the severe 1980–82 recession, when unemployment reached nearly 11 percent, most people found new jobs in a relatively short period of time. Most, in fact, found jobs as good as or better than the ones they had lost. Unlike the administration today, Ronald Reagan enacted pro-growth tax cuts.

In addition to jobless statistics, the Bureau of Labor Statistics recently has started measuring what it calls Business Employment Dynamics—the number of jobs both created and lost in the economy. During the second quarter of 2008, when the country had slid into what was believed to be the worst downturn since the Great Depression, 7.8 million jobs were lost. But at the same time some 7.3 million were created.
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