Plunder and Blunder: The Rise & Fall of the Bubble Economy

Dean Baker, “Plunder and Blunder: The Rise & Fall of the Bubble Economy”, PoliPointPress (2009) 145 pp. (Paperback)

This book was written in January 2009 describing two very serious financial crashes in the same decade: the 2008 housing bubble crash as well as the slightly more distant 2001 dot-com stock market bubble crash.   (The author only briefly mentions the 1980 savings and loan crash and the 1998 Long Term Capital Management episode.)  The point is: Is anyone getting annoyed with all the crashes?  Are there any competent economists understanding any of this; author Baker doesn’t find it all that complicated. 

The economy had no problem with financial bubbles during its period of strongest and most evenly shared growth during the years from 1945 to 1973. It only became susceptible to bubbles after the pattern of growth had broken down  -- when most workers no longer shared in the benefits of productivity growth, and businesses no longer routinely invested to meet increased demand based on growing consumption. There is not enough evidence to say that bubbles are a direct outgrowth of inequality, but, again, we do know that bubbles weren't a problem when income was more evenly distributed (and the author fails to mention, previously investment banks were partnerships, not corporations with limited liability).  However, it is a fact that bubbles were allowed to grow because people in position to do something about them (read Greenspan) repeatedly failed.  Under five presidents of both political parties, Greenspan gathered a cult-like following in the uncritical media.  None of them saw anything peculiar in the late 90s when stock PE’s were at 30 to 1, nor anything peculiar when housing prices diverged sharply from a 100-year trend.

My Notes:

Pg. vii:  The economic history of the first decade of the 21^st century is the history of asset bubbles.  Each time we convince ourselves that this is it, that tech stocks are going to make us all millionaires, or simultaneously that real estate prices never go down, only up.

Pg. 10:  Cheap computing power allowed for the proliferation of complex financial instruments, such as options on a wide range of commodities that were previously impractical.  Such options provided a mechanism for placing highly leveraged bets in which even small investors could track up large gains or losses.  As derivative markets expanded in the 1980s and 1990s, it became standard practice for companies to use these instruments to insure themselves against a wide range of possible risks, such as rises in commodity prices, fluctutations in currency values or interest rates and defaults by borrowers. 

Pg. 11:  The deregulation of savings and loan institutions in the 1980s led to the failure of over 2,400 U.S. thrift institutions and cost taxpayers about $560 billion.  The Glass-Stegall Act, which mandated separation between investment banks and commercial banks, was repealed in 1999.  The SEC budget was sharply reduced and competent regulators left the agency.

Pg. 16:  The pay of CEOs went from 24 times the pay of a typical worker in 1965 to 300 times the pay of a typical worker in 2000. This change was due to the breakdown in the corporate governance structures that had previously kept CEO pay in check.  CEO’s were answerable to boards of directors, whom they often appointed.  Fund managers did even better, even in bad years many made out just fine.  The upward redistribution of income after 1980 meant that the economy couldn’t sustain the same virtuous circle that characterized the postwar period.  Wages weren’t rising consistently, so workers couldn’t buy more with their income.  Even with more two-paycheck households, many families saved less and borrowed more to support their standard of living.  Increased globalization meant American firms could meet increases in demand with production from abroad instead of investment in American facilities.

Pg. 20:  The growth burst of the late 1990s had little to do with Clinton’s deficit reduction and had everything to do with two unsustainable bubbles—the stock market and an overvalued dollar.  (Both are again happening in 2014).

Pg. 34:  As a rule of thumb, overall unemployment rate for African Americans is twice the overall unemployment rate; for African American teens, it’s six times the overall rate. 

Pg. 46:  The cumulative loss in wealth from the peak of the market in 2000 to the trough in 2002 was close to $10 trillion, or $33,000 for every person in the country.

Pg. 58:  Recognizing a stock market bubble requires only a little bit of arithmetic.  The key is the price-to-earnings (PE) ratio.  Historically, this ratio has been close to 15 to 1.  At this ratio, if companies pay out 50 to 60 percent of their profits as dividends (roughly the historic average), shareholders will receive dividend yields of between 3.3 percent and 4 percent.  If the economy grows by 3 to 3.5 percent (in real terms) and the PE ratio remains constant, stock prices will rise by the same 3 to 3.5 percent annually.  This gives a total inflation-adjusted return of between 6.3 percent and 7.5 percent, the range seen between the end of the depression and the run-up in share prices in the late 1990s.  At its peak value in March of 2000, the PE ratio exceeded 30.

Pg. 118:  The Case-Schiller index indicated in 2008 that families had already lost close to $5 trillion ($70,000 per homeowner) as a result of the crash.  If the housing market corrects to its trend line level, the loss will be $8 trillion, or $110,000 per homeowner.

Pg. 119:  The most important reform that we need to our financial system is a clear and serious commitment by the Fed to combat asset bubbles such as the stock and housing ones we have just went through.  (This is probably politically impossible).

Pg. 127:  Like the lack of strict audits during the stock bubble, the lack of credible appraisals during the housing bubble can be attributed to a perverse incentive.  Because banks wanted to issue loans, they had no incentive to hire appraisers who made low appraisals. 

Pg. 133:  In the case of housing, bubble-deniers had to believe that some unknown force had caused house prices to suddenly diverge from a 100-year trend.  They also had to believe that a rapid and unprecedented rise in vacancy rates wouldn’t affect prices.  Finally, they had to believe that house sale prices were no longer connected to rental prices, that the former could soar while the latter remained nearly flat.