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Bubbles Make Rich Richer and Others Unemployed

Bubbles Make Rich Richer and Others Unemployed
James Heintz: The battle to prevent economic bubbles is about to begin

Oct. 18 – TRNN When economic bubbles crash, they leave many households unemployed and deeper in debt, but the investment behaviours that cause them can be minimized with detailed regulation, said the Associate Director of the PERI Institute in Amherst, James Heintz. The Financial Reform Act, passed this summer, gives the framework for such regulation but will need to be supplemented with specific directions intended to curb investment behaviour, said Heintz.

“So it told, you know, the [Securities and Exchange Commission] that, yes, now you have to regulate derivatives in a way you didn't in the past, but it didn't say exactly how.”

Derivatives are contracts that allow investors to make money by betting that the price of a stock will move up or down, and are one of the ‘speculative investment tools’ used to turn a quick profit,  that contribute to market bubbles. Heintz said economic bubbles are created by a large pool of investors simultaneously betting that stock prices are going up. They all start buying stocks, which forces up the price.

“So it becomes a self-fulfilling prophecy,” he said. “Some of them might sell, some of them hold on to the stocks in anticipation of the prices going up further, and then you have a cycle: as more and more people enter and buy stock speculatively, not based on their long-run returns but based on trying to make a quick buck in terms of buying and selling stock, it causes the prices to go up and up and up, until at some point it all comes collapsing down.”

He said this affects unemployment when, as in the housing and financial market bubbles starting in 2002, the higher prices cause people to feel wealthier. People spend more, supporting consumption, and the inflated prices of stocks motivate investors to make real investment in industry, buying equipment etc., which in turn supports jobs, he said.

“So you had the bubble actually supporting demand,” he said. “But it was all tied to this very fragile situation.”

Heintz said when the prices finally fell, the basis for supporting that demand in the economy vanished, and jobs were slashed.

“So when the foundation of our low unemployment disappeared in 2008, it caused unemployment to skyrocket. And that's the direct cost of the bubble bursting for ordinary working people who lost their jobs.”

Similarly, these market bubbles deepen household debt as temporarily inflated real estate values provided extra collateral to borrow against, Heintz said. He said stagnant wages necessitated use of that extra credit, and climbing real estate prices enabled households to borrow increasingly more money until people could no longer afford their interest payments.

Another effect of stagnant wages was forcing households to work more to maintain the same standard of living, said Heintz.

“So you have all these factors, working longer hours, borrowing more, and then this illusion that you're wealthy, and that all helped support the bubble economy.”

Heintz said curbing the investment behaviour that causes market bubbles can be done by elaborating regulation in the Financial Reform Act, but it will be up to public organizations to fight for it against the banking industry.

“So over the next year or two, what we're going to see is a big battle for the precise details of all that regulatory framework that has been authorized. The banking industry, the financial interests are already lobbying very strongly to kind of water down the content of that. So I think there is a real need to put pressure on to make sure that those regulations are effective,” said Heintz. “I think it's organizations, trade unions, community organizations, that really have to start putting pressure on.”

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Story Transcript

PAUL JAY, SENIOR EDITOR, TRNN: Welcome to the The Real News Network. I’m Paul Jay in Washington. Unemployment is the issue in the upcoming November elections. There’s not a heck of a lot of talk about why there’s such high unemployment. Some vague references to financial meltdown, but not a heck of a lot of analysis about how we got here. And when one goes back into the 1990s and look at what was then called a boom economy and is now being called mostly an asset bubble, just what is the relationship of asset bubbles, whether it be dot-coms or the stock market boom, or in the end a housing boom that then crashes and takes a lot of the economy with it? Now joining us from Amherst, Massachusetts, to talk about unemployment and asset bubbles is James Heintz. He’s the associate director of the PERI institute in Amherst, and he also teaches at the university there. Thanks for joining us, James.

JAMES HEINTZ, ASSOC. DIR., POLITICAL ECONOMY RESEARCH INSTITUTE: Thanks a lot.

JAY: So start by talking about, first of all, what is an asset bubble and how deliberately is this created when the dot-coms go crazy or this housing market goes crazy. Is—there’s some deliberate hand in all this, isn’t there?

HEINTZ: Well, an asset bubble is a situation in which people make money off buying and selling assets, whether it’s a house, whether it’s a share of stock, or whether it’s one of these complex derivatives. And how they make money off of buying and selling them is they either bet on the price going up, and that’s usually the case, or they can also make bets on the price going down. And when you have price movements and you buy and sell appropriately, you can make some money off of it. And why it would be called a bubble is if everyone or a large pool of investors are all simultaneously betting that stock prices are going up, then they all start buying stocks, that forces the price up. So it becomes a self-fulfilling prophecy. And then they—some of them might sell, some of them hold on to the stocks in anticipation of the prices going up further, and then you have a cycle: as more and more people enter and buy stock speculatively, not based on their long-run returns but based on trying to make a quick buck in terms of buying and selling stock, it causes the prices to go up and up and up, until at some point it all comes collapsing down.

JAY: So everybody knows that’s involved in this that these bubbles have to burst. Like, if you’re betting on a dot-com company, for example, most of these dot-com companies in the final analysis were selling something to consumers, and it took no big brain to understand there wasn’t really going to be enough consumer demand to drive the prices, with maybe the exception of something like a Google. Most of these dot-come companies couldn’t have succeeded, and the business plans were just imaginary. It didn’t really matter to the investors, because as long as they’re going up, you just had to figure out when to get out. But everyone’s just betting on a fictional bubble. And the same thing with the housing market. Everyone knew there wasn’t enough money from the people taking these loans on houses. Anyone in on the game knew that the people didn’t qualify as borrowers. It didn’t make any difference. You create the bubble, make money on the bubble, and then just, I guess, hope you’ve either made enough before it crashes. What’s the connection to that to unemployment?

HEINTZ: Well, what we saw happening with the bubble, the stock market bubble in the 1990s, and then the housing bubble with all of the financial speculation that went on with it, beginning in 2002, 2003, and so forth, is that with these higher prices in terms of stocks, in terms of houses, people felt wealthier than what they did in the past. And so the bubble itself helped support demand in the economy. It helped support consumption. And what we also see in the data is that the asset price bubble also supported real investment, real productive investment in the economy, so not just the types of quick-win, buy-and-sell types of investment, but investment in plant and equipment, because people saw the higher prices in terms of stocks and in terms of financial assets as being a signal that profits were going to be higher in the future as well. So you had the bubble actually supporting demand. You had the bubble actually supporting some fixed investment. But it was all tied to this very fragile situation. So when the bubble burst—and it burst in a big way in the second half of 2008—all that basis for supporting demand in the economy, for supporting investment in the economy, real productive investment in the economy, disappeared. We had very low unemployment rates in the 1990s, and after—we had the short recession in 2001, but afterwards, again we achieved very, very low unemployment rates, but it was built on this bubble idea. So when the foundation of our low unemployment disappeared in 2008, it caused unemployment to skyrocket. And that’s [snip] the direct cost of the bubble bursting for ordinary working people who lost their jobs.

JAY: So how much is this connected to the fact that real wages have barely moved? And I understand they went up a little bit in the late ’90s, but from the early ’70s on there’s been very little movement. Is that part of the issue, that real demand actually hasn’t moved, and whatever demand there’s been has either been this spill-off of asset bubble or credit card driven and debt driven?

HEINTZ: Yeah, I think that’s a good point is that you have stagnation in terms of people’s wages, the wages that they were earning, and there were several responses to that. One was that people started borrowing more, so you had a buildup of debt. And this buildup of debt was connected to the bubble. So if you had a house, the rise in your house price became collateral for you to borrow more and more money until you couldn’t make your payments anymore and that would collapse. So the stagnant wages increased household debt. It increased perceptions of wealth, which were all paper wealth. It was paper wealth that evaporated quickly. And it also caused some other changes in the economy. And this dates back well before the bubble. But wages have been stagnating largely since the 1970s. So what you will see happening with stagnant wages is households started to change the amount of work that they were doing. So households started to work a lot more hours. And particularly this manifests itself with women entering the labor force. So you saw almost all households that had more than one adult being two-earner households, because that’s the way you made ends meet in terms of when wages were stagnating. So you have all these factors, working longer hours, borrowing more, and then this illusion that you’re wealthy, and that all helped support the bubble economy.

JAY: In the upcoming November elections, are you seeing anything from the Democratic Party or the Republican Party that would offer, in terms of policy, anything that would change this, that—you know, anything that would restrict an economy based on bubbles or anything that would actually lead to more employment?

HEINTZ: Let me take those two issues separately. In terms of the policies that might prevent another bubble from happening, we did have the Financial Reform Act that was passed a few months ago, and that has the potential to at least curb some of the forces that can create a bubble economy. The problem with that piece of legislation is that it mandated either existing regulators or created entirely new regulators to help deal with issues of financial regulation and financial instability, but it didn’t necessarily mandate the specific policies and regulatory framework. So it told, you know, the SEC that, yes, now you have to regulate derivatives in a way you didn’t in the past, but it didn’t say exactly how. So over the next year or two, what we’re going to see is a big battle for the precise details of all that regulatory framework that has been authorized. The banking industry, the financial interests are already lobbying very strongly to kind of water down the content of that. So I think there is a real need to put pressure on to make sure that those regulations are effective. I’m not—I don’t think it’s necessarily a big election issue, and I don’t think it’s necessarily going to come from the Democratic or Republican parties. I think it’s organizations, trade unions, community organizations, that really have to start putting pressure on.

JAY: Left unregulated, are these bubbles going to happen again?

HEINTZ: Yeah, if you don’t have regulatory safeguards put in place, then of course they can happen again and they will happen again. They’ve happened repeatedly since the deregulation happened in—beginning in the 1980s. I mean, think of the S&L crisis, think of the Mexican tequila crisis that happened right after NAFTA was signed, the huge East Asian crisis, and now we have our own version of our own financial crisis, all built on a foundation of deregulation.

JAY: In the next segment of our interview, let’s bring this back again to the question of employment and what can be done about it. Please join us for the next segment of our interview with James Heintz on The Real News Network.

End of Transcript

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