By: Ronald D. Struck                                                            October 1998

Compare 1989 to 1998

Market views - I am bearish about the economy – I feel that a recession is likely and that interest rates will decline and remain low for several years.  I am bearish because I feel a small blip in the economy could cause consumer confidence to turn sharply downward and take the economy with it, and with so much instability in the market, such a blip is extremely likely.  I am bearish because I am pessimistic about the absence of the political leadership necessary to implement, in a timely manner, programs to efficiently address the gravest economic problems in 50 years.  I am bearish because of the similarities that exist between 1989 and 1998, and 1998 could prove to be much worse than 1989.

1989 and related years - In 1989 market conditions were perceived to be strong, real estate values were high, market pundits were optimistic, and consumer confidence was high.  But much of the market optimism was attributable to the go-go years of the 1980s for the S&L industry.  Because of lax regulatory controls and gross mismanagement, from the early 1980s until 1989 the S&L industry imprudently poured virtually “free” (to them) money into the U.S. real estate market.  This caused real estate values to escalate and, as a result, consumer confidence to rise.  As the 80s ran their course, the government used Band-Aids in an attempt to correct the problems being caused by the S&L industry, instead of stepping up to take the bitter medicine that would really address the problems.  The Band-Aids had very little impact and for most of the 80s, S&Ls continued to operate with razor thin capitalization, make risky loans, and take enormous interest rate risks – in attempts to “hit the homeruns” to generate high earnings.  Over the course of the 80s, the government seized many of the most egregious S&Ls and by 1989; losses from these seizures had grown so large that they almost bankrupted the S&L insurance fund, putting the industry on the verge of collapse.  Finally, the government had no choice but to take the bitter medicine required to truly address the situation, and in August 1989, it passed “risk-based capital rules.”  The medicine was indeed bitter - The new rules caused MANY S&Ls to quickly go out of business, and the reduced capital available to real estate caused a major recession in the real estate industry.

Changes in consumer confidence during these years are significant and interesting.  From 1980 to 1983, real estate prices did not reflect the impact of the capital being pumped in by the S&L industry, and the consumer confidence index (CCI) ranged between 50 and 90.  This changed in 1984 when real estate prices began continually increasing from 1984 through 1988, and for a substantial portion of this time, the CCI was above 100.  By 1989, the real estate market was euphoric and the CCI hit its high of 120 for the decade, and held at over 115 most of the year.  Pundits and consumers were apparently oblivious to the S&L problems that had gotten completely out of hand over the years because, even after the “risk-based capital rules” were imposed in August, the CCI closed the year in December 1989 at 113.  But, in 1990 consumers finally focused upon the depth of the problems, real estate values began falling substantially, and so did the CCI.  By October 1990, the CCI was at 62; it hit its all-time low in February 1992 at 47, and was not above 100 again until November 1994.

1998 and related years – The problems of 1998 are far greater than those of 1989.  The world is the market, not just the U.S.  The capital markets of the 90s is equivalent to the S&L industry of the 80s.  Countries of the 90s are equivalent to the real estate developers of the 80s.  The economies of the world are equivalent to the real estate market of the 80s.  

Market conditions at the opening of 1998 were very strong, the DOW hit record highs, asset values were up, market pundits were very upbeat, and consumer confidence hit record highs.  But, like S&Ls and real estate in the 80s, much of the market optimism can be attributed to the go-go years of the 90s for the global economy.  In the 1990s, the global market was the darling of the capital markets – the best opportunity for growth and profits.  Capital poured into countries that were grossly mismanaged and lacked prudent regulatory controls.  Like real estate developers of the 80s, countries’ easy access to capital made them euphoric about their own strengths and future, and they expanded rapidly, pouring money easily obtainable from the capital markets into projects and investments that did not make economic sense, building their economies on houses of cards.  With all this worldwide economic growth, the capital markets became euphoric, even though problems in the international arena had been manifesting themselves since the early 1990s.  But, like the S&L debacle, pundits and consumers have appeared oblivious to glaring deficiencies and problems that have evolved in the global economy.  By 1997, countries were communicating their problems loudly with devaluations of their currencies and bailouts sought from international capital markets sources.  But, like the message communicated about S&Ls via “risk-based capital rules”, the capital market appears to be in a state of denial – “So, some countries are having trouble; this is the U.S. economy; what happens overseas can’t materially impact us, right”. 

Outlook –It seems inevitable to me that the global problems will eventually have a substantial negative impact on the U.S. economy, and, because this potential occurrence has now become the focus of the media (it wasn’t three months ago), it will eventually become the focus of consumers. 

In my mind, consumers are the key in determining which way the economy might turn.  Record highs for the consumer confidence index (CCI) in the decade of the 80s occurred in February and July 1989, in the midst of the fundamental changes that were occurring in the economy that would cause the CCI to plummet and a real estate recession to follow.  In the decade of the 90s, the all-time record high in the CCI occurred in June 1998 when it hit 138, at a time when the global economy may be undergoing fundamental changes that could negatively affect the U.S. economy.  If consumer confidence remains high for the next six months or so, my prediction for a recession may prove to be incorrect.  However, like the S&L debacle, the media is now constantly reporting that the global problems are much more severe that originally thought, that they are expanding into more and more countries, and they are in fact impacting the U.S. economy.  Like the S&L debacle, consumers could eventually recognize that the problems might end up being MUCH bigger than the market has been anticipating, at which point confidence could plunge.

But, can our political leadership address these problems before the market looses the confidence of the consumers?  Or, more importantly, are they prepared to take the bitter medicine required quickly enough?  I have been looking in vain for programs put forth by political leaders that can address the world’s increasingly serious problems.  To date I have seen nothing of merit proposed that has a chance of being implemented in a timely manner.  Like in the S&L debacle, perhaps programs that will really work involve medicine too bitter for the patients to willingly take.  In Russia, it may bring on total anarchy.  In Japan, they do not even want a bad taste in their mouth, much less bitter medicine.  And in the U.S., who can worry about taking bitter medicine when sex and perjury are so much more entertaining.

Conclusion - To be optimistic about the economy, one must be able to make a case that it is justifiable for consumer confidence to remain high; that the fundamentals underlying the economy are strong; that our political leadership has things under control.  I am unable to make such a case.  I see no political leadership.  I see nothing that leads me to believe that the global economic problems are abating - In fact, like in the S&L debacle, with increasing coverage by the media; it looks like the problems may have been grossly understated.  I think, “what can go wrong, will go wrong,” and perhaps soon.  Then, consumer confidence will fall sharply, along with the DOW, and interest rates will decline and remain low for at least three to four years.

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