Monday, October 13 was a great day. Shrugging off the unlucky devil’s dozen date and the traditional curse of October, all three main indices on Wall Street moved up by 11 percent. The Dow narrowly missed posting its first quadruple-digit gain in history, but in any case its 936-point rally was the largest ever. The buying spree was something to celebrate, even though it came at the end of a grueling eight-day stretch during which blue chips lost 22 percent. Some analysts promptly called the bottom of the bear market, or at least a time to bargain hunt.
As the Dow on my screen climbed 300 points before the opening bell and kept on rising, past the 9,000 mark by 3 p.m. and straight up in the final hour, I felt sad for an end of an era. Traders and investors were so desperately hanging to the good old days, so eager to believe that all will turn out well, the governments will fix the global financial mess, the banks will resume lending and the stocks will return to their levels at the start of September. Those who failed to buy during this fluky dip would be forever tearing their hair out.
Small Part of EconomyOn the surface, why shouldn’t it happen exactly this way? The banking industry is not a dominant part of the economy. It contributes a mere 4 percent of GDP. Even if the entire financial services sector is taken together, it measures just 8 percent. In the U.K., for example, the financial sector is responsible for 14 percent of GDP.
The sector was a contributor to U.S. economic growth, at least before the subprime crisis began to bite in mid-2007, but it has been expanding at an average rate of around 6 percent, not so much faster than the overall economy. And, while paying salaries that are nearly twice as high as those in the average job in the economy, the number of jobs in the sector totals only 4.5 percent of U.S. payrolls.
But these figures do not even begin to describe the role of the financial sector in the economy. Of course, banks play a vital role in providing credit, the lifeblood of economic activity, but the financial sector has been even more crucial for the U.S. economy in recent years because we have been living above our means. We consistently consume much more than we produce — much more, when measured against the output of goods and services of the rest of the world. Our current account deficit, at around $850 billion a year, equals 1.2 percent of the entire world GDP.
It is logical that when you spend more than you earn you need to borrow or dip into your savings. Our savings rate has fallen to zero or even below, and over the past eight years, our consumer debt has ballooned by $6 trillion, which comes to $750 billion in net new borrowing per year.
During the current presidential election season, both parties have tried to portray the U.S. consumer as an innocent victim of Wall Street greed. In reality, the financial sector was merely a facilitator of a borrow-and-spend spree by the consumer. The Federal Reserve kept interest rates too low over the past 15 years, encouraging the borrowing excesses. Financial wizards kept inventing complex financial instruments so that households could squeeze every last dollar of credit from every asset. They helped millions of Americans transform their homes into ATM machines. Debt securitization and derivatives created new ways to serve the national appetite for credit. In the process, Wall Street securitized so much debt that its leading financial firms went under the moment the economy hiccupped.
Ballooning BubbleWith luck, a coordinated government effort around the world will succeed in recapitalizing the banking sector, guaranteeing deposits and credits, and steadying the nerves enough for banks to resume lending to each other and to creditworthy businesses and solvent consumers. Still, the good old days are never coming back — or at least not in their old form.
We will not be able to keep taking equity out of our homes and spending it on Chinese consumer goods, Korean and Japanese cars and Saudi, Russian and Venezuelan oil. House prices have fallen by over 16 percent in key markets around the country over the past year, which is a historically unprecedented development. One in six U.S. homeowners has negative equity in his house. In the year to mid-October, $12.4 trillion in equity value disappeared in the global selloff, some $7 trillion in the U.S. alone.