The American Transformation IV

Our current economic predicament

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Last night I was listening to C-Span and was particularly impressed with an address given by Barney Frank, who is becoming quite a household word these days. He put our current economic predicament in perspective and I will paraphrase some of what he said hereunder.

1. In the late nineteenth century business began to form powerful trusts.

Cf.: Trust law - Wikipedia, the free encyclopedia.

In common law legal systems, a trust is an arrangement whereby property (including real, tangible and intangible) is managed by one person (or persons, or organizations) for the benefit of another. A trust is created by a settlor, who entrusts some or all of his or her property to people of his choice (the trustees). The trustees hold legal title to the trust property (or trust corpus), but they are obliged to hold the property for the benefit of one or more individuals or organizations (the beneficiary, a.k.a. cestui que use or cestui que trust), usually specified by the settlor, who hold equitable title. The trustees owe a fiduciary duty to the beneficiaries, who are the "beneficial" owners of the trust property.

This was a novel form of economic organization which had both its good side and its bad side. The good side was that trusts made it possible to create more powerful enterprises to accomplish greater projects. The bad side was that they were unregulated because they were a relatively new development.  That caused an economic crisis at the end of the 19th century and antitrust regulation was imposed to maintain a level playing field.

Cf.: The Sherman Anti-Trust Act of 1890

In 1890, the United States pioneered competition law and significantly strengthened the future of free markets in the American system by adopting a new federal statute: the Sherman Anti-Trust Act. For the first time in history, a national government had taken responsibility to investigate and, if necessary, prosecute monopolies and price-fixing cartels. Over time, the results of this act, denounced by captains of industry at the time of its passage, would become clear. By limiting a business's ability to dominate its competitors in the marketplace, the new law made the American economic system more dynamic and more open to new competitors and new technologies. The next century saw great economic expansion and heightened living standards in the United States.

2. With the development of large corporations modern stock market operations became necessary so that a larger public could invest and greater amounts of capital could be accumulated to finance large enterprises.

They were not a new development: Cf. Stock market - Wikipedia, the free encyclopedia

Historian Fernand Braudel suggests that in Cairo in the 11th century, Muslim and Jewish merchants had already set up every form of trade association and had knowledge of many methods of credit and payment, disproving the belief that these were originally invented later by Italians. In 12th century France the courratiers de change were concerned with managing and regulating the debts of agricultural communities on behalf of the banks. Because these men also traded with debts, they could be called the first brokers. A common misbelief is that in late 13th century Bruges commodity traders gathered inside the house of a man called Van der Beurze, and in 1309 they became the "Brugse Beurse", institutionalizing what had been, until then, an informal meeting, but actually, the family Van der Beurze had a building in Antwerp where those gatherings occurred [2]; the Van der Beurze had Antwerp, as most of the merchants of that period, as their primary place for trading. The idea quickly spread around Flanders and neighboring counties and "Beurzen" soon opened in Ghent and Amsterdam.

In the middle of the 13th century, Venetian bankers began to trade in government securities. In 1351 the Venetian government outlawed spreading rumors intended to lower the price of government funds. Bankers in Pisa, Verona, Genoa and Florence also began trading in government securities during the 14th century. This was only possible because these were independent city states not ruled by a duke but a council of influential citizens. The Dutch later started joint stock companies, which let shareholders invest in business ventures and get a share of their profits - or losses. In 1602, the Dutch East India Company issued the first shares on the Amsterdam Stock Exchange. It was the first company to issue stocks and bonds.

The Amsterdam Stock Exchange (or Amsterdam Beurs) is also said to have been the first stock exchange to introduce continuous trade in the early 17th century. The Dutch "pioneered short selling, option trading, debt-equity swaps, merchant banking, unit trusts and other speculative instruments, much as we know them" (Murray Sayle, "Japan Goes Dutch", London Review of Books XXIII.7, April 5, 2001). There are now stock markets in virtually every developed and most developing economies, with the world's biggest markets being in the United States, Canada, China (Hongkong), India, UK, Germany, France and Japan.[2

In America however, the stock market really came into its own with the New York Stock Exchange. Hereunder is a timeline of events in its history:

  • 1792 - The NYSE acquires its first traded securities [1] [2]
  • 1817 - The constitution of the New York Stock and Exchange Board is adopted [3]
  • 1867 - The First Stock Ticker [4]
  • 1896 - Dow Jones Industrial Average first published in The Wall Street Journal [5]
  • 1903 - NYSE moves into new quarters at 18 Broad Street
  • 1906 - Dow exceeds 100 on January 12
  • 1907 - Panic of 1907
  • 1914 - World War I causes the longest exchange shutdown: four months, two weeks; re-opening December 12 brings the largest one-day percentage drop in the DJIA (24.4%)
  • 1915 - Market price is given in dollars
  • 1929 - Central quote system established; Black Thursday, October 24 and Black Tuesday, October 29 signal the end of the Roaring Twenties bull market
  • 1943 - Trading floor is opened to women[14]
  • 1949 - Longest (eight-year) bull market begins [6]
  • 1954 - Dow surpasses its 1929 peak in inflation-adjusted dollars
  • 1956 - Dow closes above 500 for the first time on March 12
  • 1966 - NYSE creates the Common Stock Index; floor data fully automated [7]
  • 1967 - Protesters led by Abbie Hoffman throw mostly fake dollar bills at traders from gallery, leading to the installation of bullet-proof glass
  • 1970 - Securities Investor Protection Corporation established
  • 1971 - NYSE recognized as Not-for-Profit organization [8]
  • 1972 - Dow closes above 1,000 for the first time on November 14
  • 1977 - Foreign brokers are admitted to NYSE
  • 1979 - New York Futures Exchange  stablished
  • 1982 - Longest bull market in DJIA history begins
  • 1987 - Black Monday, October 19, sees the second-largest one-day DJIA percentage drop (22.6%) in history
  • 1991 - Dow exceeds 3,000
  • 1995 - Dow exceeds 5,000
  • 1996 - Real-time ticker introduced [9]
  • 1999 - Dow exceeds 10,000 on March 29
  • 2000 - Dow peaks at 11,722.98 on January 14; first NYSE global index is launched under the ticker NYIID
  • 2001 - Trading in fractions (n/16) ends, replaced by decimals (increments of $.01, see Decimalisation); September 11, 2001 attacks occur, closing NYSE for 4 sessions
  • 2003 - NYSE Composite Index relaunched and value set equal to 5,000 points
  • 2006 - NYSE and ArcaEx merge, creating NYSE Arca and forming the publicly owned, for-profit NYSE Group, Inc.; in turn, NYSE Group merges with Euronext, creating the first trans-Atlantic stock exchange group; DJIA tops 12,000 on October 19
  • 2007 - US President George W. Bush shows up unannounced to the Floor about an hour and a half before a Federal Open Market Committee interest-rate decision on January 31.[15] NYSE announces its merger with the American Stock Exchange; NYSE Composite closes above 10,000 on June 1; DJIA exceeds 14,000 on July 19 and closes at a peak of 14,164.53 on October 9.
  • 2008 - On September 15, also known as "Ugly Monday" [10], the DJIA loses more than 500 points amid fears of bank failures, resulting in a permanent prohibition of naked short selling and a three-week temporary ban on all short selling of financial stocks; "Dark Monday", September 29 brings the largest daily point drop on the Dow (777.68, almost 7%); the DJIA closes below 10,000 on October 6 for the first time since 2003; October 10 brings record volatility with an intra-day 1,018 point swing; "Manic Monday", October 13 brings the largest one-day Dow point gain ever (936.42) and biggest percentage gain (more than 11%) since 1933; October 15 reverses this with the biggest percentage loss (7.87%) since 1987; "Terrific Tuesday", October 28 rockets the DJIA back over 9,000 with another gain of more than 10%; fresh six-year lows on the NYSE Composite are reached on November 20 near the 4,600 level as Citigroup plummets below the $5 mark

Stock markets too had its good and its bad side. Because  many modern stockmarket operations were relatively new, they remained largely unregulated and this caused the stock market crash of October 1929. During the New Deal regulations were imposed that were aimed at preventing the bad effects of under-regulated stock markets from causing similar problems in the future.

3. Then came the novel economic tool of mortgage Securitization - Wikipedia, the free encyclopedia, in which mortgages would no longer be kept by the original lenders, but packaged and sold as securities on the open market. That also had it good and its bad side. 

It was good to the extent that it gave lenders the opportunity to realize cash from the sale of their mortgages so they could make more loans,  repeating the process ad infinitem.  It was bad because this novel economic tool was still largely unregulated. 

Banks could lend money secured by mortgages that were badly underwitten, because the risk they incurred was so minimal. As soon as the papers had been signed in escrow, the mortgage could be packaged and sold by the thousands.  Brokers, like myself at the time, had incentive to push the envelope of who qualified under ever more relaxed  underwriting standards,  since everyone engaged in mortgage origination would paid up front and the long term monthly payments were not the concern of anyone in particular anymore. 

Accountability went out the window--because of far too lax regulation.

Bad mortgages could not easily be traced since they simply disappeared in the securitized package.  Though hard to trace, they did affect the quality of the total package. This is where the rating problem comes in.

Cf. Credit rating agency - Wikipedia, the free encyclopedia

Securitized mortgage packages were sold without having been properly  rated, i.e. evaluated for their risk worthiness. And anyway, who cared anymore? The packages would pass from hand to hand so fast.

Think of these secuitized assets  as ostensibly fine-looking properties with invisible termite problems. You could buy the property and flip it in a week with no one ever finding out about the termites--or any other problems or violations--because no one really checked very carefully, no one had the incentive to do so. 

So just how bad is it? The problem is that no one really knows.

Someone compared the situation to fighting a wildfire: it will be necesary to establish a fireline, abandon what is beyond it that cannot be saved and insulate what can be saved from the rest. What started in the housing market is slowly spreading through the rest of the ecomomy. Boundaries need to be drawn and defensive positions established to prevent the fire from spreading.

Personally I was amazed a few weeks ago that Bush and Pelosi were both so intransigeant in the positions they took with respect to the used of the TARP [Troubled Assets Relief Program - Wikipedia, the free encyclopedia] funds for the car industry. Bush dragged his feet on that.

On the other hand, Pelosi dragged her feet on allowing funds already allocated for developing green car technologies to be used as a bridge loan to Detroit--with the clear understanding that upon taking office the new Administration would have the power to reinstate these green funds in full, with the approval of a largely Democratic legislature. It seemed like a no-brainer to me when the issue came up.

So why did they have to waste so much time?

Now it looks like some 15 billion (give or take a billion!) may be made available at last to Detroit, which is sinking fast.  This was not Pelosi's finest hour. Bush never had a better hour of course, and it was still the pitts, as usual. The man is a joke and he may have as his last accomplishment the destruction of the American manufacturing base.

How are we going to compete on the world market (if there still continues to be one) or even fight wars in the future if we will have to buy all our equipment from foreign, often unfriendly sources? The prospect of large scale insurrections and uprisings across the globe is all but guaranteed if we don't get our act together--for as America goes down the drain, so surely, and even faster, will the rest of the world.  

You think we have an immigration problem now? Hang on to your cowboy hats! The next century may see mass migrations of desperation the likes we have not seen since the Irish potato famine--but on a world wide scale. The climate permitting,  that is--and it may not be so clement.

I wonder:  would Bush let the American air plane manufacturers go down as well? Our weapons industry? Our space industry? And what would we do with all the unemployed people? Give them all food stamps and cash hand-outs? How are we going to incentivize young people to invest in their education when the prospects for jobs are so bleak for the foreseeable future?  And how will we deal with seven million undocumented aliens that may loose their jobs--without eligibility to any benefits whatsoever--and financially unable even to return to their countries of origin?  It is a bleak picture.

But like I said--we are still fortunate that Bush will soon be our ex-president and that president-elect Obama is zooming into office with the relentless efficiency and cool determination he has so far exhibited.

Keep your fingers crossed.