“…Policy mistakes will be brought into the spotlight in Part 2. Addressing its effects on the US housing & equity markets. Additionally, drawing attention to the decisions of the US Federal Reserve during the period of 1988 to 2009.”
Questions begin to emerge as to how policy decisions can be implemented to bring about ideal effects on market-based economies. A policy designed to alleviate shocks, and to not allow the market to reach such lows as seen during 1929 and the Great Depression. The extend of globalisation relative to the early 20th century has brought about greater degrees of financial market integration with instantaneous transactions around payments, lending and borrowing for economic agents. Financial regulation is a fiercely contested topic and the book; Money, Information and Uncertainty, sheds light on the economic climate leading up the 1980’s. Theoretical critique for the use of regulation was commonplace, ‘… regulation distorts, misallocates, and restricts competition and raises prices to the consumer as a generality – is widely represented.’ (Goodhart 1989, p. 195) (1).
A slew of key regulation was repealed and introduced during the 1980’s. Glass-Steagall Act of 1933 restricted banks from dealing with profitable activities. Eventually, in 1987 the Federal Reserve authorised one of the first subsidiaries to create a structured investment vehicle (SIV) which generated up to five percent in net earnings from its activities. The Basel Accord of 1988, and the Gramm-Leach-Bliley Act of 1999, were instrumental in allowing bank-holding companies to explore all avenues of financial activities which were not viable nor possible under an originate and hold banking model, and previous regulatory confinements.
The tectonic shift to the originate and distribute banking model, was pivotal in bringing about speculative behaviour in the US realty market (refer Chart 2) which additionally ran into equities (refer Chart 3), and the affects thereof seen at their peaks in 2006 to 2007. Banks now had less pressure to raise capital in their liabilities, as they sold their securitised loans to their special purpose entities (SPE), which in turn reduced their loan books and increased cash assets on the balance sheet. Government sponsored agencies (GSE) such as Fannie Mae and Freddie Mac were incentivised into buying mortgage backed securities, with Taylor (2008) writing that these agencies and the list of government interventions were intrinsic to, and the hallmark of the GFC.
Chart 2 – US Housing Starts per Month – (1990-2010)
Chart 2 (Macrotrends 2016) (2); brings to life the extent of housing starts per month in the US from the key period between 1988 to 2010. The peak of the housing starts boom is 2,273 in January 2006. By March of 2009, housing starts fell to 478, down by almost 80 percent.
The policies pursued provided the extra spice needed for the housing boom to continue to its peak, and cannot be any more clearly shown, than in Chart 2.
Chart 3 – S&P500 Index (1988-2010)
Chart 3 (Yahoo! Finance 2016) (3); portrays the S&P500 index peaking at $1,518 in August 2000, then again at $1,550 in October 2007.
It is without doubt that the repealing and introducing of new financial reform was at the forefront of producing such amplified booms and busts, seen in Chart’s 2 and 3, during the period of 1988 to 2010. Additionally, it can be further propounded that the policy pursued by the US monetary authorities, was immensely inflationary and incorrect, given hindsight. Further, these policies left economies post-GFC with a new issue to deal with, in the form of zero lower bound and stagflation. Exploring the low climate of global interest rates is beyond the scope of this full feature article, yet addressing it is imperative to obtaining a richer understanding of the GFC. Near zero interest rates cause a liquidity trap for central banks and renders stimulative monetary policy impotent.
Chart 4 – US Fed Funds Rate (1988-2010)
Chart 4 (TradingEconomics 2016) (4); illustrates how drastically loose monetary policy was after the dotcom bubble up until mid-2004. The excess liquidity can be seen inflating both the US realty market and the equities market in Chart’s 2 and 3 respectively.
Chart’s 2 and 3 vividly depict the US housing and equity markets over heating, Chart 4, shows the audience that the FED under Bernanke were in damage control. Policy makers could see that the post-dotcom bubble stimulus only added wind to the sails of the impending housing market collapse in 2007.
(1) Goodhart, C. 1989, Money, Information and Uncertainty, 2nd edition, pp.195.
(2) Macrotrends 2016, US Housing Starts per Month, <http://www.macrotrends.net/1314/housing-starts-historical-chart>.
(3) Yahoo! Finance 2016, ‘S&P500 Index: 1988-2010’.
(4) TradingEconomics 2016, ‘Fed Future Funds Rate: 1988-2010′, <http://www.tradingeconomics.com/united-states/interest-rate>.