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Commentary & Analysis

Hard Times

History offers hints, if not a crystal ball, for the course of our current financial crisis

July 28, 2002|KEVIN PHILLIPS | Kevin Phillips' new book, "Wealth and Democracy: A Political History of the American Rich," was published in May.

WASHINGTON — All last year and well into this one, Americans dismissed the bear market in stocks as little more than a playful and frisky cub pawing through the picnic litter. Only in the last 10 weeks have people begun to see him as an angry 800-pound grizzly, capable of lacerating national economic hopes and individual portfolios alike.

The trouble, to paraphrase Winston Churchill, is that this belated-realism stage is not the end. It is not necessarily even the beginning of the end. Finally taking the bear seriously--along with pondering the lessons of 1929, the Japanese doldrums and all the other financial crises that preceded it--may only be the end of the beginning, with a larger financial crisis still to unfold.

Washington leadership itself calls up unhappy precedents. The Bush administration, with its second-rate economic advisors and its cheerleader mentality, is caught in a maelstrom it can't understand. Under the strain, it has begun to show unnerving resemblances to the ineffectual Hoover team of 70 years ago. Federal Reserve Chairman Alan Greenspan, whose place in economic history is also teetering, has few stimulative weapons left and seems to be worried about the United States having a decade of doldrums like the one that Japan experienced after its stock market crash in the early 1990s.

It's also possible that the economic recovery that began in the fourth quarter of 2001 will wind down this autumn or winter as the fiscal and monetary stimulus that was pumped into the economy after Sept. 11 wears off. Beleaguered stock owners and overextended consumers could snap their wallets and checkbooks shut.

My guess is that we are halfway through a three-stage financial crisis. Over the course of the '80s and '90s, the finance, insurance and real estate sector of the economy grew so notably that it moved ahead of the manufacturing sector in the gross domestic product numbers. We are now being tossed by the wake of its over-ambition. Indeed, given the way finance and technology teamed to create the recent tech stock bubble, one can argue that boom-and-bust was a product of finance as much as of technology.

Much of our current crisis of confidence in corporations and the legitimacy of their stock prices also derives from the financialization of business--dishonest accounting, faked earnings, derivatives, off-the-books partnerships, run-amok stock options--rather than the old corporate bugaboos of price-fixing, polluting, bribery and restraint of trade. The big corporate crimes and transgressions now have little to do with a company's product: They are financial, with chief financial officers the frequent masterminds. The United States has become a financial society.

If the first stage of the financial crisis, in 2000 and 2001, was bubble-related, the second stage, in 2002, is about the integrity of financial markets, institutions and valuations in the aftermath of two decades of mammoth expansions and hubris. The large investment firms of Wall Street earlier pressured corporations into looking at quarterly earnings as an end in themselves and, more recently, fleeced investors with corrupt stock research and ratings. Too many accounting firms, in turn, played along with corporate financial gimmickry for high consulting fees. Big banks like Citigroup and J.P. Morgan Chase, it now appears, helped the Enrons and other hungry raptors to set up financial flimflams. Enron shareholders are now suing nine of the big banking and investment conglomerates.

Out of this warped financialization have come competitions between huge industries like telecommunications and energy over who can stage the world's biggest bankruptcies--first Enron, now WorldCom--and the destruction of hundreds of billions in stock and bond market capitalization as phony profits evaporate and Wall Street "buy" ratings implode.

Finance, too, is reeling as congressional hearings multiply and mutual-fund assets shrivel. Between 1980 and 2000, mutual-fund assets rose from $138 billion to $7.8 trillion as the stock market soared. Since 2000, however, the total value of U.S. stocks, as measured by the Wilshire 5000 Index, has fallen from a peak of more than $14 trillion to $7 trillion to $8 trillion.

There is absolutely no precedent for measuring what effect this crash--the largest assets collapse in history--will have on the U.S. economy and consumers. Straight dollar comparisons with the 1929 crash are meaningless because of inflation. However, as a percentage of U.S. gross domestic product, the loss of equity wealth between 2000 and 2002 is somewhat higher than during the same period after 1929. This time, however, more of the loss has hit the middle class. Thank you again, financialization.

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