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Recessionary Storm Looms for '88

December 06, 1987|Irwin L. Kellner | IRWIN L. KELLNER is chief economist at Manufacturers Hanover in New York

The steep plunge in stock prices that occurred during October points the way to a recession in 1988--but nothing more. Although there may seem to be some similarities in the behavior of stock prices today to 1929, I would like to stress that, when it comes to the economy, there is a world of differences.

For one thing, the government is a much bigger factor today than it was in the 1920s and 1930s. And, while many might complain about big government, at times like these it will help stabilize economic activity since it is a major employer--not to mention a sizable disburser of funds to companies in the private sector.

In addition, other income maintenance programs can keep consumers' purchasing power from collapsing as it did in the 1930s. Such programs as Social Security and unemployment insurance exist today, whereas they were not around during the 1929-33 slide.

To keep confidence in our financial system, there are many legal and regulatory changes and safeguards. For one, the banks are now covered by Federal Deposit Insurance on accounts up to $100,000, thereby guaranteeing, for all practical purposes, the typical family's savings. Investors are protected by the Securities Investor Protection Corp. from losses up to $500,000 if their brokerage firm should go bankrupt.

As far as the stock market is concerned, there are several critical differences this time around. For one, margin requirements are 50% today, compared to 10% in the 1920s. This means that individuals are not as heavily leveraged today as they were then and thus are less likely to be wiped out--even by declines of this year's magnitudes.

Computers Worsened Decline

Also, relatively fewer people have been buying stock on margin in this era; most have paid full price. In any event, the market these days is dominated by large institutions--not individuals, as was the case 60 years ago--who are better able to withstand steep market declines.

This brings me to the causes of the October, 1987, market crash. The dominance of large institutions has increased market volatility, because it means that fewer players are making decisions about buying and selling stocks. Since they have attended the same schools, talked to the same people, read the same reports and run the same computer programs, it stands to reason that, when one wants to buy, they all do; but when one wants to sell, the others do, too.

On the subject of computers, it is becoming apparent that program trading and portfolio insurance, aided and abetted by computers and such new vehicles as stock index futures and options, exacerbated the market's decline. Again, it's a question of everyone getting the same signal, and, in effect, wanting to get out at the same time.

The most important thing to remember, however, is that October's plunge in stock prices did not represent a sudden reversal in the market's direction. Indeed, stock prices actually peaked two months earlier, on Aug. 25.

Cutbacks Would Spread

The slide that got under way last summer reflected fundamental changes in the economic outlook. Earlier this year, it became evident that the U.S. economy was embarking on the road to recession. Inflation had flared up, depleting buying power, while interest rates had risen, cutting into borrowing power. "Big ticket" durable goods, such as autos and housing, had been declining all year--carrying many industries down with them.

Since no recession in modern times has begun without a drop in stock prices occurring first, the decline in stock prices that began late last summer was not a surprise. What October's plunge did was make the recession more likely.

Clearly, the wealth of those who own stocks has been slashed--whether in actual fact or on paper. These people will restrain their spending, as will corporations, whose access to funds via selling stocks is now constrained. Business will also suffer from the cut in spending--not only by investors--but also by the great majority of people who don't own stocks, but whose confidence in their own financial situation has been much reduced by Wall Street's plunge.

Until October's share price collapse, we were looking for 1988's recession to be mild by historical standards. Compared to an 11-month average length, we thought this one would turn out to be only nine months long. And the decline was expected to be only about half the average 2% drop in the real gross national product.

We have now modified our thinking. We now think that the recession will be at least as long and as deep as average and that it will strike sooner (around year-end), instead of next spring.

The first effects of the market's plunge have already begun to show up at luxury car dealers, high-priced stores and in sales of real estate. The rest of retail trade will feel it at the worst possible time--the onset of the important holiday buying season.

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