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Was the economy of the '90s really so bad?

Thumbnail image for Screen shot 2010-04-22 at 4.17.20 PM.png

One of the constant refrains in the debate over regulating derivatives is that if we do anything to tamp down on this massive market for customizable derivatives that are built-to-order by the five largest banks, we'll do some terrible damage to the economy. Or something.

But look at the graph atop this post: The real explosion in customized derivatives came in the aughts, and in particular, after 2005. Why after 2005? There are a couple of theories, but the most convincing is that the bankruptcy reform bill gave derivatives favorable treatment during bankruptcy proceedings. That made them a better investment than other types of financial products, and so demand exploded.

That's all in the game. But then, what reason is there for believing they're crucially important to a healthy and balanced economy. Was the economy of the 1990s really so bad? Was the period between 2005 and 2008 such a wondrous time for the American middle class? Have there been structural changes to the nature of American prosperity that customized derivatives -- and lots of them -- are necessary in 2010 while they weren't back in 1996? Maybe there's a good answer to that question, but I haven't really heard it.

By Ezra Klein  |  May 3, 2010; 3:45 PM ET
Categories:  Financial Regulation  
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"Why after 2005? There are a couple of theories, but the most convincing is that the bankruptcy reform bill gave derivatives favorable treatment during bankruptcy proceedings."

Perhaps that bankrupcy reform ought to be added to the list of things that require rereform sooner rather than later.


Posted by: bsimon1 | May 3, 2010 4:31 PM | Report abuse

Dude, we're talking about people who think that Reagan-era income tax rates would be socialism. I wonder what it is about Eisenhower's background that they think turned him into a socialist? Too much time in France?

Anyway, facts and history don't matter to these people.

Posted by: eelvisberg | May 3, 2010 4:35 PM | Report abuse

" Was the period between 2005 and 2008 such a wondrous time for the American middle class?"

It was fine, except for the part where it was all rigged with explosives and a timer to detonate randomly a few years later. If we could have enjoyed the economy of 2005 to 2008 without the housing bubble/crash and the real estate market tanking and unemployment exploding and Wall Street turning into a magical money pit where your retirement savings goes "Poof!" . . . I would have been cool with that.

To put in another way, I might like a tasty steak and a side of steamed vegetables, and maybe a cold frosty one. However, if it costs $10,000, plus I'm then evicted from my house, then it's really wasn't a good deal. Not that there was anything wrong with the steak and the vegetables--it was great!--but it should not have cost $10,000 and required I be evicted from my house.

I don't think there's a great defense for preserving derivatives in anything like their current form, but rich and powerful people seem to like them (in a bi-partisan manner), so I'm guessing we're stuck with them.

Posted by: Kevin_Willis | May 3, 2010 4:49 PM | Report abuse

In answer to your question -- yes, the 90s were an incredibly horrific hellscape. Thank God Bush saved us from that.

Posted by: AZProgressive | May 3, 2010 5:33 PM | Report abuse

Ummmm, Ezra, if you want to go back to the 1990s, you have to cross an ocean or two. Hidden behind the housing bubble was our decision in 1998-2008 to hand over our manufacturing economy to China, and our IT economy to India. The 90s wouldn't have been so much fun without those 15M jobs, and they are now gone forever.

Look forward, don't look backward.

Posted by: Dollared | May 3, 2010 6:37 PM | Report abuse

I think most analyses of Wall Street ignore the extent to which participants are *not* profit motivated. I think Wall Street has a tendency to attract borderline and outright gambling addicted personalities. These are not people who accurately evaluate risk. It is also the reason they fight regulation even when that regulation would help them on the long run. Sure we could ban derivatives and increase average profits, but from the perspective of traders, Wall Street would be a lot less fun.

Posted by: zosima | May 3, 2010 11:48 PM | Report abuse

For starters, our manufacturing economy was alive and well mid-decade (and is currently experiencing a strong recovery).

Manufacturing contributed $1.6 trillion to 2006 GDP, and total output was valued at $4.5 trillion, according to the EPI.

Despite the nasty recession, manufacturing was slightly higher in March than the 2002 average (flat for 8 years isn't great, but it was a very severe recession).

In any case, we shouldn't worry about manufacturing. Manufacturing is the next agriculture - in a few decades we'll probably only need 2-3 million manufacturing workers to produce 2-3x what today's 11 million do.

In any case who would want China's manufacturing jobs? Sure, China has over 100 million manufacturing workers, but the average pay in 2006 was $0.81/hr.

It's not as if China was able to increase manufacturing jobs either - it also has a long term downtrend, because as in America productivity increases are freeing the need to have so many workers in manufacturing. From 1996 to 2006, manufacturing workers fell from 126 million to 112.6 million. If all goes well, I'll bet that's down to 40-60 million by the mid 2030s and then probably cut in half again by the 2050s. That will be good for China though. All of those $0.81/hr jobs will be automated, and China will be able to have $70/hr manufacturing jobs like the U.S (and before you say $70/hr is total compensation and not the hourly wage, I know - that $0.81/hr figure is also total compensation).

Posted by: justin84 | May 3, 2010 11:50 PM | Report abuse

Due to the chaos in the housing market, there was a lot of trade in derivatives as the market participants tried to get rid of risk. Some of the hedging worked. Counterparty risk was still mispriced, and system didn't have enough redundancy, while it carried too much debt.

That said, what I have learned from the debacle is that we desperately need to preserve ways for the guys like Chanos and Paulson to make big shorts sales. We need to do it with less debt (less leverage), but that information has become important to the more efficient pricing of securities.

Posted by: staticvars | May 4, 2010 12:03 AM | Report abuse

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