The Great Depression
The world suffered a financial crisis similar to the one going on these days; a
long time ago, at the end of the second decade of the previous century, economist
called that period the Great Depression.
The great depression was a global economic slump starting in the US during 1929,
and continued throughout the 1930’s and early 1940’s. The Great Depression started;
as most historians describe, by a crash in stock markets on October 29, 1929 which
was named Black Tuesday
Black Tuesday, Also Known As “the Great Crash”, was the most devastating market
crash in the history of the United States, the initial crash started on October
24, 1929, but the major crash came in on Monday and Tuesday, 28 and 29 of the year
1929, lasting a month respectively.
The crash initiated by heavy investments in the stock indices, encouraged investors
to borrow more money to buy more stocks, but by August 1929 brokers were lending
small investors more than two third of the stock’s face value they were buying.
Causing the entire amount of currency traded in the stock market to reach $8.5 billion
in which most of it was from loans, and exceeded the entire amount of currency circulating
in the US market.
Prices continued to incline, appealing to smaller investors; causing the Dow Jones
index to reach its peak of 381.17 by September 3, 1929, and then the market started
to head south and sink over the upcoming month.
On October 24, panic caused a huge number of investors to start selling their stocks;
12.894,650 shares were traded in a single day, causing the market to crash; thus
leading the U.S. nation into the Great Depression.
With more investors selling shares, the market continued to slide; causing the market
to plunge 13% on Monday, and by the following day, almost 16 million shares were
traded; causing the DJ to drop an additional 12% that day. The market lost almost
$14 billion alone that day, causing the total amount of losses to reach $30 billion,
which was ten times higher than the whole US budget and bigger than what the United
States spent during the First World War.
|
Date |
Change |
%Change |
Closing |
|
October 28,1929 |
-38.33 |
-12.82 |
260.64 |
|
October 29,1929 |
-30.57 |
-11.73 |
230.07 |
The Depression had greater effects over the economy in the United States, and the
aftermath spilled over to the rest of the world. The US trade balance was slashed
in half and so did personal income, tax revenue, prices and profits.
Major countries that were dependent on construction and heavy industry were halted,
and crop prices dropped by more than half reaching 60%; forcing countries to present
self relief programs such as bailout and stimulus plans.
The US faced severe deflation, and credit became available at low rates. Meanwhile,
banks stopped lending causing a drop of prices, especially in the farming sectors.
The auto industry sales declined 30% as commodity prices dropped, and unemployment
reached record highs.
Statistics of the Great Depression by numbers:
US GDP in (current) USD
In 1929: $103.6 billion
In 1939: $76.5
In 1931: $76.5
In 1932: $58.7
In 1933: $56.4 |
US Unemployment
In 1929: 3.2%
In 1930: 8.9%
In 1931: 16.3%
In 1932: 24.1%
In 1933: 24.9%
In 1934: 21.7%
In 1935: 20.1%
In 1936: 16.9%
In 1937: 14.3%
In 1938: 19.0%
In 1939: 17.2% |
The Dow Jones Industrial Average
Peaked in September 1929: 381.17
Trough in July 1932: 41.22
The index dropped the following four years of gains from the start of the depression
in 1929, causing the stock markets to surge by 90%, amid 1929-1932; the DJIA didn’t
reach the September peak, until almost quarter of a century later in November 23,
1954.
The current Chairman of the Federal Reserve, Ben Bernanke, commented on the matter
and said tight monetary policy by the Fed is what caused the crash in the stock
markets and contributed to a longer global depression. The Chairman stated that
the Fed took five basic steps that contributed in worsening the recession back then.
- The Fed started to raise interest rates in the spring of 1928, and continued to
do so during the recession, which led to the market crash of 1929.
- The Dollar was backed by gold during that period of time, so when investors saw
the market crash they turned to gold instead of the currency, causing a shortage
of dollar in the country.
- The Fed DID NOT INCREASE MONEY SUPPLY during the recession, which was the major
factor of currency shortage in the circulation inside the US.
- Finally, investors and consumers withdrew their money from banks; causing a shortage
in bank’s capital, and stashing them; causing a reduction in spending and resulting
in further currency withdrawal from the market, draining the markets from the currency.
At the end, the Feds didn’t provide the proper funding and didn’t increase money
supply in currency circulation; to fight deflation and recession, the Fed allowed
the money supply to drop by more than 30% in that period.
The United States economy faced severe deflation, either on products or in share
prices; poverty inclined and unemployment reached record highs from 3% to reach
almost 25% in three years, leaving more than 15 million Americans without a job.
The most sector suffering of all was the farming sector, as America was highly dependent
on the farming sector before the start of WWI; farmers who obtained loans from banks
couldn’t pay back their loans, due to poverty that surged as demand dropped rapidly,
with farmers unable to pay as well as common investors and companies, banks started
to fail one by one. By the time of 1932 and 1933, the banking system was on the
verge of nearly collapsing, and almost five thousand banks announced their bankruptcy,
wiping out savings for millions of people.
The Initial Governmental Response
President Hoover at that time insisted that the economy will soon prosper again,
and urged manufacturers to produce more, but productivity did not incline because
unsold goods continued to stack, and accordingly inventories inclined, so by 1932
investment dropped by 5%; following that, Hoover slashed government spending in
order to balance the Federal Budget and increase taxes, but that back fired on the
economy; causing demand to drop even further. Finally, the President started protective
measures through imposing “tariffs” on foreign goods, which blocked imports in order
to stimulate the economy and increase the number of sales American made on products,
however foreign nations did the same which had affected international trade deeply
and led it to decline further, amid the ongoing global recession at the time.
The year 1932 brought a new President to the United States, Franklin Delano Roosevelt
(FDR); who declared the most famous inaugural speech “the only thing we have to
fear is fear itself”. The new President took matters into hand, quickly announcing
a national bank holiday to prevent people from withdrawing more cash and drain liquidity
from markets.
FDR presented “THE NEW DEAL” which generated a wide variety of programs, in order
to reduce unemployment and help the crashing financial system. The basic idea was
to lower the supply of goods to meet the slump in demand.
The government provided farmers with payments in order to raise farm prices under
the Agricultural Adjustment Act of 1933, also the National Industrial Recovery Act
created regulations, to the weak industrial sector and synchronized competition
and limited minimum workers’ wages and maximum working hours.
The NEW DEAL only delayed recession instead of curing it, and helped the economy
to stand back on its feet; the United States established the Social Security program
and Labor Unions, which are still standing till today.
The End of the Depression came 10 years later
America’s conditions improved slightly but unemployment continued in double figures
(15%) by the year 1939, but the outbreak of the Second World War in Europe triggered
arms trades in the United States, and weapon productivity increased and the government
started expanding the defense system by producing more ships, aircrafts and other
war materials. Unemployment declined severely and by 1941, the United States entered
the War forcing all sectors in the economy to focus on supporting the nation at
winning the war.
The Aftermath of WWII
The Great Depression hammered the US economy and forced it to the ground, the war
helped the US economy to survive the economic slump and revived the US economy by
forcing manufacturers to produce war related materials; all industries and manufacturing
companies started producing tanks, planes, and weapons which brought up the demand
on labor and forcing unemployment lower.
The destroyed European cities opened the path for the US to become the world’s leader
during and after the war; as the United States became stronger, the European nations
were hammered by the war and needed a fresh start, so they focused on rebuilding
their countries that were left settled to the ground, by the end of the war.
The US Nominal Gross Product (NGP) in 1938 reached $84.7 billion, in which one billion
were set for defense expenditure, but by the year 1944 the NGP reached $210.1 billion
in which $87.4 billion of it went to defense expenditures. Full employment was achieved
by the year 1943, and wages increased rapidly, leading manufacturers to produce
more.
The war was financed in the US by taxes, printing money and commandeering resources;
taxes reached around 47% of total spending, and money printing formed 26% and 27%of
what was borrowed from the public. The war total cost on America reached $304 billion,
while taxes only provided $136.8 billion, thus the remaining money was collected
throughout national debt and bond expanded programs.
Overall the WWII helped drag the US economy from the worst economic crisis they
faced during the 20th century; since economic objectives were production oriented
and the involvement of the government during the war helped the US to survive the
economic turmoil and the war that swept its shadow all around the globe.
Oil Crisis 1973
Before the Crisis (1960-1972)
Oil is the bloodline for every nation because of the variety of usage such as cars,
planes, fertilizers, drugs and much more; oil companies before the sixties used
to control the flow of oil, but by the year 1960 many of the oil producing nations
agreed to form an alliance to protect their interests.
The Result was OPEC; the Organization of Petroleum Exporting Countries which currently
consists of (Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi
Arabia, United Arab Emirates and Venezuela).
OPEC’s basic goal was to protect exporting countries’ interests and negotiations
with giant oil companies, but the influence of OPEC was weak since main exporting
countries controlled the functions of the organization as desired, but by the year
1973 everything changed and had marked a new turning point for the entire globe.
On august 1971, the United States pulled out of the “Bretton Woods Accord”, lifting
the Gold Exchange Standard of the US dollar, thus allowing the dollar value to float,
and heavily increased their money reserves (Printing money); causing the depreciation
the US dollar’s value.
Because oil prices is denominated by the dollar (the barrel of oil is priced in
Dollars), and since the increased printing of dollars is leading the dollar’s value
to depreciate, oil exporters were effected by the decline in the value of the price
of oil, where they seized less true value than what the price of a barrel was, subjecting
them to losses.
At one point, OPEC discussed shifting oil prices pegging with the dollar, and start
pricing oil with gold. But the change was not completed, and the proposal was rejected
where the price of oil is still priced in dollar, till this current day.
With the depreciation of the dollar, OPEC lacked fast price adjustments causing
it to suffer lower prices for several years, the price increase between the years
1973-1974 was substantial and caught up fast, with real market conditions; thus
exporting countries of oil benefited faster than they had before, throughout the
previous years.
The Start of the Crisis and Effects
By the year 1973, the industrialized nations pace of growth was rapid, and inflation
became the most important issue to control; demand on energy inclined from those
industrialized nations, since they produced more, built more and consumed more.
Thus OPEC grew stronger and stronger everyday, and had opened the path for it to
control the price of oil and determine it, the way they want.
It all started on October 6, 1973 when Egypt and Syria attacked Israel on their
Jewish Holy day of Yom Kippur, where the Egyptians attacked from the south throughout
Sinai desert and the Syrians attacked from the north, throughout the Golan Heights.
The war lasted six days, and Israel helped the United States manage to reverse the
attack as both Egypt and Syria retreated, and the war was finalized by a seize of
fire concluding in November; but on October 16, 1973 OPEC decided to raise oil prices
by more than 70%, thus oil prices reached $5.11 a barrel from the previous $3; meanwhile,
throughout the next day OPEC decided to force an embargo and slashed almost 5% of
their production, compared with September’s production.
OPEC halted exports to the United States and the Netherlands, since they supported
Israel with the war; and prices shot from $3 a barrel to $12 a barrel.
Industrial nations were struck by the rapid increase of oil prices, nearly 85% of
Americans used to drive to their work, and with the embargo from OPEC, President
Nixon at that time stood no chance but to try to reduce the vast shortage in oil;
thus he called upon homeowners to reduce their usage of oil by shutting down their
thermostats, while companies were forced to reduce working hours, and gas stations
were asked to stop all kind of sales on Sunday’s and narrow sales to 10 gallons
per consumer.
Daylight saving time was invented to reduce electrical use, thus causing the reduction
of electrical use by consumers to lower their fuel usage, Detroit; which is considered
the heart of the auto sector in the United States, was struck deeply by the recession
that hit the economy in the 1970’s.
The effect pressured the U.S automakers to change their perspective about old models
that had big engines and consumed huge amounts of fuel; thus, automakers shifted
to manufacture more efficient fuel cars, with lighter body weight; on the contrary,
Japanese cars that were produced at that time had all the American standards the
U.S cars lacked. Therefore, car imports rose in that period and domestic car sales
dropped in the U.S.
Trade balance in the year 1970, was showing a $2.254 million surplus but the deficit
rose in the upcoming two years, reaching $-5.443 million by the year 1972; and narrowed
to $-4.293 million by 1974.
Even though total exports rose in the year 1973, from $91.242 million to $120.897
million in 1974; it was outrun by the fast incline in imports, during the same period
from $89.342 million to $125.190 million.
Ever since that time the U.S trade deficit continued to expand further and further,
reaching in 2007 a total of $-708.515 million.
The embargo mostly affected the European Commission Market and Japan; as 25% of
oil exports were reduced by oil exporting countries, however the embargoed countries
policies did not change and they continued to support Israel with the Israel-Arab
Conflict.
As for the United States, the effect was Macro on the economy with higher oil prices
coming in at high inflation levels, and less productivity; lowering economic growth,
and eventually the US ending up with recession at hand by the year 1974.
The unemployment rate surged from 4.9% in the fourth quarter of 1973, to reach 9.0%
by May 1975; before starting to drop again, which was shown clearly on the Nonfarm
payrolls, as it dropped in August 1974 to a minus 15 thousand to reach -270 thousand
jobs lost by March 1975. Stagflation (high unemployment along with high inflation
rates) was ignited, putting more pressures on the already defaulted U.S economy,
back then.
The Real GDP in the United States, started to decline by the fourth quarter of 1973
throughout 1975 from $1241 billion (4th quarter GDP) to $1168 billion (2nd quarter
GDP); the percentage of the decline reached a catastrophic 6.8%, investment purchases
were also hit by the embargo as it declined from almost $200 billion to less than
$150 billion in the same period.
Accordingly, it is obvious why the GDP declined; first, the rising unemployment
rate and lack of investments in the economy, inflation and interest rates pressured
investments to drop the way they did; as interest rates jumped in the first quarter
of 1974 from 8.4% to 11.2% by the third quarter. Inflation also followed the same
path, as it inclined during the first quarter of 1974 from 1.2% to 12.2%, by the
end of the year.
The effect on stock markets was vast and rapid, oil companies’ shares performed
well, as prices inclined while other sectors suffered the most; thus leading to
stocks losing almost $94 billion in value, throughout the following six weeks of
the embargo. By March 1974, the embargo was lifted after negotiations took place
at the Washington Oil Summit but the embargo’s ripple effect lasted throughout the
1970s.
The impact on the rapid incline in oil prices profited oil exporting nations and
delivered vast wealth to them; the result of using such measure was later known
as “the Oil Weapon”, the targeted industrial nations by the embargo were; the United
States, Great Britain, Canada, Japan and Netherland.
Ever since the embargo, the United States has been working hard to reduce oil imports
from the Middle East and become an energy dependant country, looking for different
sources of alternative energy.
Recession 1980-1982
In the beginning of the eighth decade in the 20th century, The United States suffered
a severe recession. Starting in July 1981, and lasting 16 months before ending in
November 1982; the concretionary monetary policy that the federal bank established
during that time was the main reason for the deepest recession since World War II,
at that time.
Due to the previous oil Arab embargo that was performed by OPEC in early 70’s, stagflation
caused unemployment to remain at record high during that time, with inflation also
getting higher each day.
Unemployment surged in July 1973; from 4.8% to 9.0% by May 1975, but even as unemployment
sank during 1975 till 1979; it remained at record highs during that time, ranging
between 5% and nearly 8% by 1980.
The economy continued to grow during the 80’s, but unemployment caused severe problems
to the economy at those levels; meanwhile, inflation spiked from 2.7% in June 1972
to reach 14.8% in March 1980, thus stagflation became the issue to handle during
that time.
With those figures, recession occurred during early 1980’s; the housing, steel manufacturing,
and automobile industries suffered the most and continued to face severe problems
till the end of next recession that hit the US in early 1990’s.
The Federal Reserve Bank wanted to control the pace of the rapid incline in inflation,
so they imposed the concretionary monetary policy to control inflationary levels;
the policy aims to reduce the size of Money Supply inside the economic cycle, theoretically
that should work to reduce inflation and lower prices, but the Fed ignored the high
rate in unemployment, thus effecting the output in the GDP.
Real GDP during that time, contracted in the second and third quarters of 1980 by
7.8% and 0.7% respectively; compared with the first quarter growth of 1.3%, and
during the following year the US Real GDP contracted twice in the second and fourth
quarter in 1981 by 3.1% and 4.9% respectively, and the contraction even extended
into the first quarter of 1982, as the economy’s real GDP contracted by 6.4%.
The impact was severe on financial institutions, since the recession struck the
economy amid several deregulation rules; which broadened banks’ lending powers and
raised the problem of moral hazard. Thus banks turned to real estate lending and
increased mortgage lending for consumers; by the second quarter of 1982, the number
of defaulting banks had surged and bankruptcies inclined to 42, and with interest
rates going higher makes it harder for consumers to pay back their loans, due to
high unemployment banks started to fail one by one. Forcing the Federal Deposit
Insurance Corporation to purchase up to $870 million bad loans from the bank’s;
while, the FDIC judged that 540 banks were considered “problem banks” that are near
collapsing.
At that time, The Continental Illinois National Bank and Trust Company was the seventh
largest bank in the United States, the bank started to fail so regulators stepped
in to save the bank, after getting assured by the bank’s executives over two years,
that steps has been taken to prevent the bank from failing.
The bank received a bailout loan from the government worth of $4.5 billion, in order
to save the bank after the bank’s collateral high-risk lending ventures had collapsed,
the bank was not that big to fail, but the collapse could have caused a huge failure
to the financial markets in the United States.
Meanwhile, the Savings and Loan Crisis in the early 1980s also contributed to the
recession, where in 1980 there were almost 4,590 states and federally-chartered
savings and loan institutions with approximate total assets worth about $616 billion.
However, losses started to mount in the 1980s, as net S&L income fell in 1981
to show a total loss of $4.6 billion; a loss of $4.1 billion in 1982, thus adding
further pressures on the financial industry and the economy in general.
In the meantime, President Ronald Reagan was trying to control the rising budget
deficit and accordingly he approved budget cuts in 1981; yet that back fired on
his approval rates as they sank heavily since Americans thought it was an insensitive
to the needs of average Americans. Nonetheless, Reagan won Americans’ hearts; after
refusing to increase income tax, though he approved a corporate tax increase in
1982, which was the largest tax increase since WWII.
Increased governmental spending and lower interest rates; helped the United States
pass the recession, unemployment fell from 10.8% in 1982 to reach 7.2% by 1984,
while inflation sank from 10.3% in 1981 to reach 3.2% by 1983. Moreover, corporations’
earnings inclined by 29% in the second quarter of 1983, in comparison with the previous
year.
Recession 1990’s
The recession in the early 1990’s; hit much of the world but was mainly caused by
the slump in savings and loans sector in the United States, putting millions of
American money at risk.
October 19, 1987, also called Black Monday, is what initially started the crisis
later on; stocks around the globe had crashed starting from Hong Kong to spread
throughout the world. Hong Kong’s stocks declined 45.8%, Australia’s 41.8%, Spain’s
31%, UK’s stocks declined 26.4%, the United State’s stocks sank 22.68% and Canada
22.5%, and meanwhile New Zealand’s stocks suffered the most as they sank 60%.
Black Monday caused indices a historical crash within one day, but the market managed to bottom by the next day. The figure to the right shows the severe slump in the DJIA on black Monday, as it shed more than 22.6% in less than 24 hours.
The Dow slumped from the peak of 2510.20 on 10-13-1987 to reach 1740.60.
The recession affected the economy, but not as severe as the previous ones, the
U.S government handled the crisis from the start to prevent it from deepening. They
boosted consumer confidence and on the other hand, increased consumer spending which
prevented the economy to collapse even further.
The U.S GDP (Real) during that time was affected, as it sank in the fourth quarter
of 1990 and the first quarter of 1991 by -3.02%, and -2.04%; compared to the previous
quarter which came slightly higher than flat, at 0.03% during the third quarter
of 1990.
Unemployment surged by the beginning of 1990, from 5.4% to reach above 7.5% levels;
throughout the years; 1991 and 1992, before going down below 7.0% in June 1993,
when speaking about the change in Non-farm payrolls, it sank in July 1990 by -47
thousand, and continued to deepen throughout the year reaching as low as -300 thousand
lost jobs; before showing signs of recovery on March 1992, as it inclined to 59
thousand; and continued to rise throughout the upcoming months after that.
Other factor that deepened the recession was the Saving and Loan Crisis (S&L
Crisis); which initially appeared on the surface, during the recession in early
1980s which had caused the failure of 745 saving and loan institutions, that use
to accept saving deposits and issue mortgage loans. The total cost of this crisis
alone topped $160 billion, the U.S government paid in return about $125 billion,
thus affecting in the widening of the Budget Deficit in the early 1990s.
The ripple affect of the crisis was merely as big as more than 1600 banks failed;
between 1980 and 1994, and the number of federally insured savings and loan institutions
in the United States declined to 1,645 from 3,234
The fast recovery, backfired on the U.S economy as the Gulf War started in the Middle
East and the rapid incline in Oil prices pressured inflationary levels to rise;
reaching as high as 6.2% in 1991, but mostly continued to hover around 5.5%, throughout
the upcoming two years.
Oil prices inclined, due to the Iraqi invasion of Kuwait as prices surged from $21
a barrel to reach $46 by mid October of the year 1990, contributing more misery
to the 1990’s recession.
The recovery came as stated above; by boosting consumer confidence and spending,
even as the recession lasted to 1992; the United States government managed to act
quickly with the crisis.
Furthermore, President Clinton at the time took office following George W. Bush
Senior, and contributed in raising the fractured economic conditions, by issuing
the 1993 Economic Plan; Cutting taxes on 15 million low income families and tax
cuts reaching 90%, while small businesses are raining taxes on 1.2% on the wealthiest
taxpayers.
The Clinton administration managed to provide about 6 million new jobs during the
first two years; an average of 250 thousand jobs created each month, which had finally
managing to narrow down the Budget deficit, which was the largest deficit reduction
in the United States history with $600 billion in Deficit reduction.
Clinton’s administration managed to expand markets for American goods, contributing
in raising exports to countries such as Mexico; since exports rose by 23%, during
the first 11 months in 1994.
President Clinton fought hard to surpass the GATT international law, lowering tariffs
globally by $744 billion which was the largest international tax cut in history.
Summiting all actions taken by the U.S President Bill Clinton:
- Signed the Economic Package, August 10, 1993.
- Provided 7.7 million new jobs during the first 34 months of this Administration.
- Passed the largest deficit-cutting plan in history -- saving more than $1 trillion
over seven years.
- Managed to slash Deficit on three consecutive years.
- Slashed federal spending by $255 billion over 5 years.
- Made new tax cuts available to over 90% of small businesses.
- Unemployment narrowed down to 5.6% compared with the previous 7%, which was during
the time he took office.
- The lowest combined rate of unemployment and inflation since 1968.
- 1994 real GDP growth was the highest in a decade.
The Dot-Com Bubble
The Dot-Com bubble (referred to also as the I.T Bubble) started in the year 1998
and persisted till 2001, while it managed to reach its peak by March, 10 2000 as
the NASDAQ Composite reaching 5132.52 levels. The bubble started by a massive formation
of new technological companies and internet sites.
At the mid nineteen’s technological companies started to grow and present different
internet start-ups, and due to the jump that was witnessed in internet users at
that time, those companies shares fired up and expanded, and was referred to in
the trading platform as the “Dot-Coms” where the name came from the “.Com” at the
end of web addresses.
Companies shares inclined severely and thus investors started investing in tech
shares causing the matter to grow beyond limits, therefore stocks market started
to incline dramatically, and those companies was focused on expanding their growth
rather than focusing on profits, as they believed that with wider consumer base
they could outtake the market, therefore tech companies started to expand and hundreds
of new companies was formed each day.
Investors started shifting their attention to tech companies and invested heavily in those companies thus pressuring the bubble to grow even larger and sending share prices to incline even higher, investors shifted their attention to profits with less caution as usual, meanwhile low interest rates in the 1998 – 1999 helped in boosting start-up capital amount for those companies.
Figure 1: NASDAQ Composite index clearly shows the Dot-Com Bubble peaking at March 10. 2000.
The burst of the bubble:
As the market grow and stocks inclined severely the only logical reason is to witness
a complete crash in the system as it was overloaded and overwhelmed during the peak
of the crisis, the crash came as all technological companies had the same business
plans which is to monopolize the market on their own.
During that time the Federal Reserve has raised the benchmark interest rates, taken
it from near 4.3% to reach above 6.5% in mid 2000, thus affecting the economy and
reduce its growth, because with defaulting companies and NASDAQ correctional movements
as analysts thought at the begging contributed in the slowdown.
Another main reason for tech companies to slump was in fact the United States versus
Microsoft case in courts, as the giant technological company faced monopoly charges
in federal courts and was found guilty and due to the judgment was anticipated and
expected in markets the NASDAQ composite slumped bringing down with it the massive
amount of tech companies that was founded during that phase and forced most of them
to declare their bankruptcy.
Massive Sell Orders came during the pre-market session thus forcing computer giants
such as Cisco, IBM and Dell to lose a respective amount of share prices, and the
index opened four percent lower which was considered the most intraday slump of
the entire year.
The Aftermath of the Bubble
As technological companies grew larger each day, America online was the first to
suffer the tragic results, as it was considered the largest internet provider in
the United States, acquired Time Warner and the founding company was named AOL Time
Warner, but the company was forced to drop “AOL” from the name which was considered
a symbol of dominance in markets during that period.
Different technological companies and internet providers was forced to sell their
assets cash of declare its bankruptcy, such as WorldCom company which was found
in Bankruptcy Court to have used Illegal Accounting Methods to overstate its billions
of dollars profits, therefore the company share crashed and the company was forced
to file for bankruptcy which was considered the second largest corporate bankruptcy
in the United States.
The effect on markets or say the economy as whole was massive as laid off technological
experts lost their jobs thus forcing unemployment to surge from 3.9% in September
2000 reaching 6% by 2002.
In the midst of all those economical factors that sent the U.S economy to drop came
as well the worst terrorist attack since Pearl Harbor when two planes hit the Twin
World Trade Towers in September 11th, 2001 whereas the effect of the terrorist attack
forced the economy to continue with a long term recession which had initially started
in the Mid 2000, to spread until 2003.
September 11th attacks and its affect on Economy:
As seen before the attacks the world’s leading economy has been sliding down for
quite some time, which led the economy vulnerable for any domestic or international
factors, and with the attacks surprised the U.S and the globe the impact was immediate
and recession was predicted at once to occur, the U.S Leading indicator had already
showed a deteriorating economy in August 2001; one month before the attack, as it
dropped by 0.1%, taken into consideration the Slump witnessed in the Real GDP for
the U.S throughout the second quarter of 2001 as it contracted by -1.41%, Or roughly
a nominal GDP growth by 0.24%.
Consumer Confidence index saw its worst slump in five years throughout the month
of September as it sank from August 114 figure to reach 97 in September, which is
the largest single month drop since the Persian Gulf war that took place in the
early 1990’s.
The U.S Leading indicator continued to slump further from August percentage reaching
in September -0.5% or 109.2, which triggered speculations that the economy will
continue to deteriorate further throughout 2002.
Rising jobless claims along with the fall witnessed in the stock market and decline
in housing permits contributed further in the slump, the U.S was clearly heading
for the first recession in the 21 century.
Along came Anthrax Threats which spread throughout the U.S and fear rose amidst
consumers taken the Consumer Confidence index to the lowest level in eight years,
reaching 85.5 in October from September 97 figure. And with this slump witnessed
in the consumer confidence it validated further that the economy will suffer a deep
recession throughout 2002.
Talking about the interest rates at the time, the Federal Reserve had slashed the
benchmark interest rates three times – on September 17, October 2 and November 6th,
with each rate cut being a complete 50 basis points taken it from January 2001 6.5
percent to 1.00 percent by 2003.
But the rate cut didn’t have any effect on the economy, whereas with high unemployment
rates, along with the slump witnessed in the manufacturing and services sector and
shrinking consumer confidence prevented the economy from responding positively with
lower interest rates thus having no impact or effects over the short term, while
the Fed policy was triggering inflationary risks over the long term.
Unemployment was a major downturn point for the already struggling economy, where
it continued to mount starting from September 11th, whereas unemployment reached
in September 4.9 percent, while in October the economy reported the worst jobless
jump in one month in more than 21 years, as more than 415 thousand people lost their
jobs.
Unemployment rate surged from 4.9% to reach 5.4% in October, whereas the manufacturing
sector shed more than 140 thousand jobs, the services sector reduced its workforce
by 110 thousand jobs, Travel - Related businesses lost 60 thousand jobs and losses
to the temporary employment agencies reached 107 thousand jobs. The job loss due
to the terrorist attacks mounted a staggering 625 thousand jobs all together and
unemployment rate reached above 6% within 2003 compared with 3.0% in 2000.
By the third quarter of 2001, the growth for the largest economy on earth contracted
by 0.4%, and with low interest rates, and falling prices inline with consumers halting
their spending as they expect more plunge in prices and more job losses, deflation
risks rose in the third quarter of 2001. Recovery was not expected to arrive any
time near as consumer confidence dropped along with rising U.S debt and high unemployment,
which was all wrapped in fears of more terrorist attacks.
The burst of the dot.com bubble however created a new bubble; the housing bubble,
which indeed led the world’s largest economy into one of its worst chapters ever,
as the actions taken to revive the economy back in early 2000s led to the credit
crisis which sent the U.S. economy into the depth of recession, those actions included
low interest rates, as the Federal Reserve Bank continued to slash their benchmark
interest rates down to 1.00 percent and accordingly mortgage rates dropped and demand
for mortgage loans increased ever since.
The housing bubble indeed helped in leading the economy back to its long term growth
potential, as Americans were encouraged to take mortgage loans even those with bad
credit history were able to get loans, since house prices were always on a rise,
however that managed at the time to take some of the pressure off the technology
sector.
Also the deregulation wave that dominated ever since led into a huge increase in
trading volume in U.S. financial markets and accordingly investments were flowing
in to further support economic growth in the world’s largest economy.
Former Fed’s Chairman Alan Greenspan and Former President George Bush both pushed
for deregulating financial markets in order to let markets to operate fully under
the free capital markets theory, which later proved to be a total mess, as corporate
greed managed to overcome everything else and average Americans were the ones to
suffer the misery.
However, those indeed helped the U.S. economy into rising back and lead global economies
into prosperity, as the U.S. economy continued to grow over a strong pace well into
2007, however 2007 marked another story for the U.S. economy, as the housing bubble
burst to announce the beginning of “a once every century crisis” and accordingly
the worst financial crisis since the Great Depression was born…
The Credit Crisis
Also known as the credit crunch or the credit squeeze, the general term means a
reduction in the availability of credit independent of a rise in the central bank’s
benchmark interest rates, which means credit becomes less available regardless of
how the central bank’s benchmark interest rates move.
The credit crisis was a result of expanded lending and the boom in the housing market
which is also known as the housing bubble, the roots of the crisis extend back to
the 2003 recession, as benchmark interest rates were as low as 1.00% a record low
back then, while the recovery was accompanied and supported by a strong boom in
the real estate sector in the United States, and accordingly everyone was able to
make good money as house prices continued to rise and people were making a lot of
money, this encouraged banks to expand lending and accordingly even people with
bad credit history were able to get loans to buy houses since house prices used
to always rise, so there’s no losing side here.
Banks on the other hand gather those loans in large pools and issued securities
that are backed by those loans which was called mortgage backed securities, while
insurers insured those securities, and those securities were gathered and divided
into tiers based on the risk they hold, safe securities that are tied to loans that
are paid on time, more risky loans that have a slight possibility of defaulting,
and finally the risky loans to those people with bad credit history that has high
default risk.
However, since everyone was making money out of this process no one really cared
how this whole process works so long as they were making money and home values continued
to rise, yet when house prices started to decline in the United States, that’s when
the real story began, as the effect spread onto a global level, as the whole financial
system proved to be rather fragile, and accordingly the credit crisis became global.
When people with bad credit history stopped paying their payments since home values
started to decline back in 2006 and those people couldn’t sell their houses and
accordingly banks didn’t get their money, and the value of those loans declined
which means that the value of mortgage backed securities also declined and that
led eventually to huge write downs by major banks and financial institutions.
Now, as banks started to lose huge amounts of money because of this problem, credit
became less available and that made banks even reluctant to lend each others, as
there were no guarantees that other banks will be able to pay back their loans,
and the effect of this was a total freeze in credit markets, however this time it
was on a global level, while financial institutions were already hammered by declining
home values in the United States, as the value of their investments in Mortgage-Backed
Securities were also declining.
Yet, the first spark of the crisis was witness in France, as BNP Paribas the French
bank announced in July 2007 that three hedge funds were closed on losses connected
to the U.S. Sub-prime mortgages, and ever since then, the U.S. economy has been
undergoing its worst recession since WWII.
As the crisis started to spread all around the economy and other sectors including
the manufacturing and the services sector started to feel the heat from the crisis,
where the result of reduced lending resulted in higher borrowing costs, which meant
there was no running away from the crisis, and companies from different sectors
were finding it very difficult to get funds to run their businesses, which led those
companies to start firing workers in a bid to survive the difficult conditions.
Meanwhile, the economy was still growing during the third quarter of 2007, as the
economy grew by 3.6% in the third quarter and grew by 2.1% in the fourth quarter
of 2007, however the U.S. economy started to contract during the first quarter of
2008, as the economy contracted by 0.7% before returning to growth in the second
quarter of 2008 as a result of the first fiscal stimulus which boosted economic
growth, where the U.S. economy grew by 1.5%.
The first fiscal stimulus which totaled $168 billion was handed to American in tax
rebates and tax cuts, as it helped in boosting consumer spending and accordingly
economic growth, though the effect was rather temporary, as the U.S. economy contracted
back over the next few quarters.
Moreover, the U.S. economy contracted by 2.7% in the third quarter of 2008 as the
effects of the fiscal stimulus started to fade, before contracting over a drastic
pace in the following two quarters, as the economy contracted by 5.4% and 6.4% in
the fourth quarter of 2008 and the first quarter of 2009 respectively.
Personal consumption started to decline in the first quarter of 2008 before rising
in the second quarter as a result of the fiscal stimulus, yet it continued to drop
over the next few quarters inline with economic growth and was rather the main reason
for economic contraction, since consumer spending accounts for 2/3 of economic activity
in the United States.
However, it’s worth mentioning that one of the most decisive points of the crisis,
was the failure of Lehman Brothers which used to be one of the biggest five investment
banks in the United States, and this failure was accompanied by a failure of what
used to be the world’s largest insurer, American International Group, and the Government-Sponsored
Enterprises, Fannie Mae, and Freddie Mac, which marked a black month in the course
of this crisis, or the so called “Black September.”
The effects of those failures were far more pronounced than anything before, as
credit markets froze entirely and in just two days $150 billion were withdrawn from
USA money funds that’s compared with an average of $5 billion for two days, everyone
went crazy back then, as this ignited a sell off wave that wiped out trillions of
dollars in value from equity markets all around the globe.
The lost value extended beyond imagination throughout this crisis, as home equity
values dropped in the United States from $13 trillion in 2006 to $8.8 trillion in
mid-2008, while total retirement assets dropped from $10.3 trillion in 2006 to $8
trillion in mid-2008, savings and investments assets lost $1.2 trillion and pension
assets lost $1.3 trillion.
As for the U.S. stock markets, the S&P 500 index for instance was down in early
November 2008 by almost 45% from its 2007 high, and the index continued to drop
during the first few months of 2009 to reach its lowest level in March as the index
had lost nearly 50% back then.
Meanwhile, the Dow Jones Industrial Average also suffered the same fate, as the
sell off wave dominated all over the world and accordingly the DJIA lost almost
53% from its 2007 high to reach the lowest level in March 2009, as the index rebounded
from that point and managed to rise above the 9000 levels in July of 2009.
Crude oil prices moved drastically throughout the recession, as at the first stages
the U.S. dollar lost ground heavily against major currencies, and since oil is denominated
by the U.S. dollar and have an inverse relationship with the dollar, crude oil prices
skyrocketed to reach its highest levels above the $147 a barrel level, which back
in 2008 was rather challenging especially amid the economic weakness that was dominant.
Yet crude oil prices soon started to free fall especially as global economies fell
into recession which of course meant lower levels of demand on energy and oil products
and that deeply affected prices, as it continued to drop to reach the $30s levels
in 2009, yet oil prices started to rise over the second and third quarters of 2009,
as the U.S. economy started to show some improvement.
As for the Federal Reserve Bank which at latter stages of the recession started
to get more involved, as in the early stages the Feds were rather optimistic and
signaled that the housing market was in a normal correction, yet as conditions intensified,
the Feds became more serious with their actions and eventually, the Feds were forced
to use unconventional tools such as quantitative easing and credit easing.
The Feds started though with their most conventional tool, their monetary policy,
as the Feds slashed their interest rates from as high as 5.25% to as low as 0%-0.25%
in December 2008, the rate cuts were rather gradual, as the Feds cut their benchmark
rates for the first time in September 2007 by 50 basis points and continued from
then to cut rates until December 2008 which was the lowest rate in the Federal Reserve
Bank’s history.
The Feds didn’t stop there, as the rate cuts along weren’t enough, the Feds also
decided to cut their discount rate from as high as 6.25% to as low as 0.50%, in
addition the Feds initiated several liquidity programs to help facilitate liquidity
and unlock credit markets, as they were determined to avoid another Great Depression.
The Fed started those programs with the Term Auction Facility (TAF), which was followed
by several programs aimed to provide liquidity to money and credit markets with
30 scheduled auctions through 2008, other programs from the Fed included the Term
Securities Lending Facility (TSLF), Primary Dealer Credit Facility (PDCF), Term
Asset-Backed Securities Loan Facility (TALF), ABCP MMMF liquidity facility, Commercial
Paper Funding Facility, and Money Market Investors Fund Facility. The Fed also decided
to pay interest on required reserve balances and excess balances in another mean
to provide banks with more capital.
The U.S. Treasury Secretary was also an important figure throughout the crisis,
however Mr. Paulson the former U.S. Treasury Secretary eventually was deemed to
be rather disappointing to investors in the financial markets; as after announcing
a new program called Troubled Assets Relief Program (TARP) which was brought to
world financial markets after a caesarian operation as the U.S. House of Representatives
rejected the first proposal which didn't include any sort of oversight by the government
yet eventually after some adjustments the U.S. Congress passed on the bailout bill
for the financial institutions which totaled $700 billion and was called back then
as "the Mother of all Bailouts" and its main goal was to enhance banks' capital.
But Mr. Paulson decided to spend $125 billion to provide the largest 9 U.S. banks
with capital, while another $125 billion was also available for other banks which
qualified for the TARP conditions and regulations.
Then all of a sudden Mr. Paulson decided that he will drop his initial plan and
will probably use the rest of the money to provide banks with more capital since
he deemed that the money left is not enough to purchase troubled assets from banks
and the Treasury left that for the Fed to use their TALF program which totaled $800
billion, in which $200 billion will be used to purchase guarantees for student loans,
credit card loans, and loans guaranteed by the Small Business Association, while
the remaining $600 billion will be used to purchase Asset-Backed Securities from
the GSEs.
The year 2008 also marked an election year for Americans who have had it with the
"War President" George W. Bush, who under his reign which lasted over eight years
took America into two wars which were highlighted by their ridiculous cost; two
candidates were running for the presidential race, Republicans' candidate John McCain
and Democrats' Barack Obama.
The economy became a major concern for Americans and accordingly Mr. Obama started
to take the lead since he seemed to know what was going on rather than Mr. McCain
who thought at one stage that the economic fundamentals were strong! From that point
on it seemed that what was unthinkable 40 years ago could be a possibility and Obama
which was seen as the underdog throughout the campaign became indeed the first black
President in the history of the United States!
President-elect Obama seemed to be determined to help revive economic growth in
the world's largest economy, as he started to assemble his economic team which was
applauded by all participants in the financial markets, especially after the announcement
that Mr. Timothy Geithner will be succeeding Mr. Paulson as the new Treasury Secretary.
President elect Obama also announced his new bailout plan which was projected to
be able to create 2.5 million jobs by 2011, the plan exceeded $789 billion and was
focused on infrastructure and was designed to revive the economy according to Obama.
One of the major events that took place during the credit crisis, as the auto industry
suffered deeply as well, as American automakers were already falling behind other
European and Asian competitors, as those made economic and cheap cars compared to
American cars that consumer a lot of fuel and were rather expensive.
The consequences though materialized with General Motors and Chrysler, as both auto
giants were forced to file for bankruptcy under Chapter 11, which includes restructuring
operations through selling the unsuccessful parts of the company while keeping the
goods assets and creating a new company.
This marked the end of another era for the United States, as the crisis already
resulted in the end of the investment banks era, and the auto industry which suffered
its worst conditions since the early 1980s was seeing a dramatic change, as automakers
were forced to accept governmental aid in order to survive. |