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The Crash of '99:
A Cautionary Tale About Prognostication and Politics
By Jock O'Connell

This is a working draft (July 1, 1999). It is being circulated for comment only.

In retrospect, the most puzzling aspect of what came to be euphemistically known as the Great North American Insolvency of 1999 is why everyone didn't see it coming. Admittedly, economic forecasting back then was an absurdly primitive art -- a fact, regrettably, that neither the purveyors nor the consumers of these prophesies were willing to concede.

Nor was economic policy much more sophisticated. The era's shapers of opinion evidently believed that national prosperity required nothing more than the continued health and good humor of a man named Alan Greenspan.

To be sure, a few arms had been waved by observers worried that U.S. economic expansion was principally leavened with debt, much of it short-term. In general, though, the nation's sages discounted the possibility America might go the way of, say, Japan -- the industrial giant whose own economic bubble had burst a decade before. The U.S. economic model was superior to Japan's in nearly every way, they argued. (Historians today think it was an abbreviated memory span rather than good manners that kept Pre- Millennium Americans from pointing out how many of these same pundits had once been fervent proponents of Japanese economic policies.)

No where was the hubris of economic forecasters more evident than in California. As the summer of 1999 began, the mega-state's economic gurus unanimously proclaimed that the Golden State's economy would speed safely into the next century. Cheered by such optimism, few recalled how closely 1999 paralleled 1990, the last time the state's economy had taken a severe tumble after having looked so good.

In early 1990, the state's foremost experts had been nothing if not upbeat about California's economic prospects. John O. Wilson, Bank of America's senior economist, issued a report in January stating: "BofA believes there is virtually no chance of a regional recession in California." Around the same time, a survey published by the Small Business Alliance likewise betrayed great optimism about the state's future. More than three-quarters of those responding to the survey expected their businesses to grow during the coming year. Nearly one-third, in fact, looked to see "robust" growth. Not to be out-enthused, Joseph Wahed, then the senior economist at Wells Fargo Bank told the Sacramento Economics Roundtable in a speech on March 21: "All I can see ahead is growth."

Unfortunately for everyone, the entree served up at the economists' Christmas party later that year was crow. But that was not all. Almost incredibly, the state's leading economic experts, having failed to anticipate the recession that befell California during 1990, also failed to foresee the depths of the depression California's economy ultimately entered. By the winter of 1990-91, just about everybody conceded the existence of a recession. But virtually all expected a recovery that would keep the downturn brief and mild. Typical of the economic analyzes being offered at the time was the annual forecast issued by First Interstate Bancorp in November 1990. Among other indications of good new, it looked for a solid 1.5 percent job growth rate for California in 1991.

Likewise, on January 2, 1991, PG&E's chief economist, Tapan Munroe, told the Bee: "A strong economic performance in the Central Valley will help the state avoid a recession in 1990-91 but just barely." But that September, Munroe would tell a Sacramento Area Commerce and Trade Organization conference that California's recession is "certainly coming to an end" although "it would set a record for slowness in the recovery." In fact, it would be another year before the Golden State's economy finally bottomed out and another seventeen months until definite symptoms of recovery were readily identified.

The state's unemployment rate, which had stood at 5.2 percent in January 1990, had increased to 6.9 percent by year's end. The bottom would not be reached until the autumn of 1992. From September 1992 through January 1993, unemployment remained steady at 9.7 percent, with a million and a half Californian workers were officially idle. Only then did conditions begin to improve for most Californians. Even so, it would not be until May 1999 that the unemployment rate would fall to the levels of early 1990.

Over the next few years, fundamental changes in the global and national economies had outpaced adjustments in the theoretical models economists had been devising. Whether in Mexico in 1994, Thailand in 1997, Russia in 1998, or Brazil in early 1999, the preponderance of expert economic opinion had been outsmarted by real world developments which, in turn, had often been made worse by the application of inappropriate economic remedies. Yet despite an increasingly dubious record, bullish economists were still going largely unchallenged as the fateful summer of 1999 began.

To be sure, there had ben some fairly vigorous hand-wringing over dangerously inflated stock prices -- especially where Information Technology and Internet issues were involved. Yet talk of the Wall Street "casino," which allegedly bore little relationship to the real economy, did not prevent millions of Americans from investing heavily in the stock market. Unfortunately, the casino analogy proved false on two counts. First, in that both were aggressively over-leveraged with debt, the stock market very much mirrored the real economy. Second, in a casino, someone always wins -- even if it's normally the house. In the crash of 1999, everybody lost. By then, of course, the U.S. securities markets looked less like a casino than a Thomas Kinkaid gallery, where banality was deftly packaged and sold at astonishing prices to buyers desperate to acquire God knows what simply because they had been left out.

What brought down the vaunted economic juggernaut were forces that Greenspan himself had fretted over only months earlier. The fundamental issue was whether a system that sought to promote the unhampered trade of goods and services could tolerate the free flow of its most essential commodity, capital.

In a November 1998 speech, Greenspan had posed the critical practical question facing central bankers, international trade policymakers, and investors alike : "Why had a relatively conventional slowdown in capital investments and capital outflows to East Asia over the preceding year and a half induced such a wrenching adjustment in individual economies and why had the degree of contagion been so large?"

The answer, Greenspan submitted, lay in the very same advances in computer technology, telecommunications, and in the development of sophisticated (and increasingly arcane) investment vehicles that had increased the efficiency of the international financial system. Transactions that had once taken weeks or months to accomplish could now be concluded instantaneously. Even before the onset of the financial meltdown in Asia during the second half of 1997, there had been ample warnings that international flows of private capital -- unprecedented in both volume and volatility -- had become capable of destabilizing fundamentally healthy economies, setting back years of economic and social progress, undermining governments, and ultimately leading some world leaders to raise new doubts about the gospel of free trade.

The actual numbers were unfathomable to most. Daily foreign exchange transactions had more than doubled to over $1.5 trillion by 1999. That represented roughly 60 times the value of all the goods and services then being traded internationally on an average day. Cross-border bank lending had also doubled in the preceding decade.

Indulging in a rare bit of psycho-economics, Greenspan had concluded that "the crises that have recently occurred seem to reflect an inability of people to come to grips with the vastly accelerated pace of financial activity--its complexity and its volume." Perhaps that's why the rooms at major banks and investment houses where currencies and securities were traded looked like military command centers during combat operations -- right down to the levels of tension, the youthful visages, and the sophisticated electronic gear -- where the participants, knowing that opportunity as well as disaster lurk only seconds away, eternally operate on a computer-aided hair-trigger.

Greenspan, of course, had not been the first to observe that the global financial system had grown more reactive and less proactive during the 1990s. Program trading had emerged as an established feature on equity and bond exchanges during the previous decade and had figured prominently in the Wall Street crash of October 1987. These pre-determined, computer-executed strategies were triggered not by human deliberation but by the appearance of a constellation of specific electronic impulses. So great had the premium on speed become and so overwhelming the flow of data that human intervention was considered a liability.

As far as the FBI would later determine, the specific event that triggered the lancing of the North American bubble economy, was the handiwork of either a technologically sophisticated, anti-capitalist terrorist ring operating in Berlin amply financed by international terrorist Osman bin Laden or an alternative high school student from Ridgewood, New Jersey. Whoever the hacker was, an electronic raid had been mounted on the "Green Monster," a Boston mutual fund company computer ingeniously hidden behind the hand-operated scoreboard in Fenway's Park's ancient left field wall. The perpetrator then activated the fund's "Ebb Tide Protocol," an ultra-secret program designed to quietly liquidate its equity positions whenever financial Armageddon appeared to be nigh.

Within a few seconds, the fund had completely cashed out of some $80 billion in stocks. But this avalanche of sell orders set off alarms at brokerages and pension funds around the globe, triggering their own massive sell programs. Within fifteen seconds of the opening bell on Wall Street, the Dow went into free fall. It was as though someone had shouted "George Soros" on a crowded trading floor.

As Greenspan had feared, investor confidence was breeched. A mere general alarm panic was soon replaced by hysteria. Institutional investors around the world began to pull their money out of the US as well as out of dollar-denominated securities. Individual investors struggled to follow suit. Officials rushed to prevent a market meltdown by suspending trading on the New York Stock Exchange and on smaller regional exchanges. But to no avail. Within hours, equity and bond trading shifted from the traditional bourses to hundreds and, ultimately, thousands of Internet websites.

What had not been completely understood was that the last couple of years of US spending had been financed almost entirely by short-term capital that had sought out US economy as a safe haven from economic chaos that had beset other parts of the world. Ironically, those billions now rapidly fled to money markets in Europe and to the recovering markets of the Far East. The pace stunned everyone, even though it should have been anticipated. Within days, the Dow-Jones Industrial Average, having only recently soared above the 11,000 mark, had shrunk to just under 6,000 -- a massive decline comparable, if still smaller, than the drop Japan's key Nikkei Index had sustained when Japan's bubble had burst a decade earlier.

By the end of the week, the savings tens of millions of Americans had entrusted to mutual funds and pension plans had been nearly halved. Housing prices plummeted, especially in the hyper-inflated housing markets of places like Silicon Valley where tract homes had been fetching close to a million dollars. There, an entire generation of young techno-entrepreneurs who had never witnessed an economic downturn suddenly found themselves on the streets or, worse, moving back in with their parents. In local lore, it would become known as "The Big Wipe-Out" as hundreds of high-flying firms whose names invariably ended in .COM moved to a new domain, .RIP.

The political fall-out was equally instantaneous. Presidential aspirants from both major parties abruptly canceled pilgrimages to California as Silicon Valley's political ATM went decidedly off-line.

In Sacramento, meanwhile, the rundown of both the national and state economies been so precipitous that fund-raising events went unattended and the newly-minted state budget was already in desperate need of revision. Things also got nasty quickly. The era of good feelings and bipartisanship engendered by massive budget surpluses was over. Political agendas changed virtually over-night. Public-private partnerships the once a fashionable mode for dealing with fundamental and costly issues ranging from education to infrastructure died a quick death.

Business lobbyists, having seen their clients gored by the free-market, predictably blamed everything on government. Among the most surprised by the sudden change of events were the self-described "New" Democrats, most of whom owing to term limits had never seen anything like this before. Confident that they had forged a working relationship with business groups turned off by the ideological stridency of those controlling the Republican Party in California, these moderate Democrats were stunned to see their erstwhile allies desert them.

But history was merely repeating itself. The late 1980s had seen a broad consensus crystallize among business organizations, labor unions, educational groups, state and local elected officials and others concerned with the long-run economic development needs of California. As demonstrated most vividly by the business community's active support of a major gasoline tax increase in 1988 to fund vital transportation projects, business leaders then seemed to recognize the indispensable nature of strategic investments in the state's economic future. Representatives of some of the state's largest corporations set out to rescue California from the clutches of short- term thinking. What they produced, under the auspices of the California Economic Development Corporation, was a thoughtful and far-reaching set of policy recommendation in a report entitled "Vision: California 2010."

By 1991, though, this tune had changed. Business associations suddenly professed to be more concerned with competition from neighboring states than with competition from Germany and Japan. It was widely believed that something had gone singularly wrong with the Golden State's business climate and that, unless the problems are soon fixed, California would continue to lose jobs to states with a more accommodating attitude toward private enterprise. Tax cuts and regulatory relief took center stage on the business lobby's agenda. It would be years before concern over the quality of the state's schools and infrastructure would again receive serious consideration.

Copyright 1999 by J.A. O'Connell