We're not the only people looking back at the crash this week. I just got my regular list of new research papers issued by the National Bureau of Economic Research and was intrigued by one of the newest titles, one so exciting that even practitioners of the aptly named dismal science felt it deserved an exclamation point: The Stock Market Crash of 1929: Irving Fisher Was Right! Irving Fisher was an economist who said in September of 1929, "Stock prices have reached what looks like a permanently high plateau," landing him forever in the lists of people with famously bad judgment, like the guy at Decca who rejected the Beatles because guitar music was on the way out and Thomas Watson for his comment that there was a world market for only five computers. Fisher did say there would be no crash, and then there was, but then so did John Maynard Keynes, and his reputation is still pretty good.
The authors of the NBER study, Ellen R. McGrattan and Edward C. Prescott, looked at the stock prices in 1929 and concluded that the stock market did not crash because the market was overvalued. In fact, they say the evidence they found strongly suggests that stocks were undervalued, even at their 1929 peak—one more exhibit for the prosecution from the extraordinary popular delusions and the madness of crowds crowd. If Fisher's heirs held on to whatever was in his portfolio, they've done pretty well, but that requires a longer investment horizon than most people are willing to undertake.
What does that tell us about today's stock prices? On Monday, the Wall Street Journal quoted James Gipson, manager of a $2 billion fund who described current stock prices as a "Wile E. Coyote market." I'm sure you remember the Road Runner cartoons where Wile E. Coyote, in perpetual hot pursuit, runs off the side of a cliff and hangs suspended in air for a moment until he looks down and, realizing that there's nothing underneath him, drops like a coyote-shaped Acme anvil. Gipson says investors will soon look around this market "and see that there's no support there," with the same vertiginous result. But later, the same article quotes an analyst who tracks stock funds. He's a little puzzled that some stocks are doing well despite the widespread bearish outlook of most professional investors. "It's a good lesson in market psychology," he concludes. "About the time you reach a massive consensus that things are bad, it's about time for it to turn around." So, maybe Mr. Coyote's landing will be a softer one than we fear.
I know you don't like the "oh, it all boils down to psychology" shrug, but the most disturbing parallels between the world Klein describes and the years we've just lived through are the echoes of that mysterious thing that falls somewhere between Zeitgeist and tipping point. I liked Klein's review of the rapid acceleration of technological and cultural change in the 1920s. It took more than 100 years, until 1911, for the U.S. Patent Office to issue 1 million patents. It took only 14 years to issue the second million. In 1922, General Electric sold one product. In 1929, it was selling a wide variety of household products, half unknown a decade before. Compare that to the technological and cultural changes of the 1990s. My kids are just as uncomprehending when I tell them I grew up without VCRs, ATMs, microwaves, cable TV, or home computers as I was when my parents tried to tell me about life before television. When Bill Clinton took office, there were 13 pages on the World Wide Web. Now, well, here we are.
Most eerily like our own recent history is Klein's description of the speculative and rapacious dreams of individual investors. Then, as in the days of the high-tech bubble, people seemed less driven by dreams of wealth than by fears that everyone else was getting in on it while they were being left behind. Klein says, "The market replaced chatter about sex among the smart set, about books among the literati, and about baseball in cheap restaurants." He cites David Kennedy's description of "the mood of speculative expectation that hung feverishly in the air and induced fantasies of effortless wealth that surpassed the dreams of avarice." That sure sounds like some dinner parties I attended in the late 90s. But we haven't heard much about day-traders or college kids buying mansions for their parents for a while.
A lot has changed in our system since 1929. The crash led to all kinds of reforms, many of which are still in place and even expanding. Perhaps just as important, the fortunes of the government and the market are much more closely connected. The Federal Reserve is more independent and powerful than it was in the 1920s. And the government is much more of a participant in the economy now than it was then. Klein tells us "in 1929 federal expenditures comprised a mere 2.5 percent of the gross national product, compared with 22 percent in 1990." Most important, the idea of the economy as a problem the president should solve is much more widespread now than it was then. Remember James Carville's edict to the Clinton campaign: "It's the economy, stupid." We expected the government to bail out the airlines following the terrorist attacks, something that would have been considered unthinkable in Hoover's time. The expectation of government involvement makes it easier for the government to respond as a circuit breaker before a major economic meltdown.
Still, if we do not see "perfect storm"-style disasters like the 1929 crash, we do see some major carnage from smaller squalls like last week's collapse of Enron. There is still plenty of room for improvement in improving disclosure requirements. There's a reason that accounting principles are referred to as "generally accepted" and not "certifiably accurate." Current accounting principles are based on 19th-century concepts, with most of the value coming from land and equipment, not intellectual property or human capital. I was very encouraged to see the new chairman of the SEC call for a thorough re-examination. Yesterday, the SEC went even further and issued an "investor alert" advising "appropriate and healthy skepticism" in reviewing "pro forma" accounting results (ones that don't meet traditional accounting standards) and "cautionary advice" to companies that issue pro forma numbers, letting them know that Big Brother is watching very carefully.
Corporate governance can use some improvement as well. The corporate laws of Delaware are so management-friendly that almost all public corporations are "domiciled" there. So they have become in effect a sort of federal corporate law without the accountability of the federal system. Large institutional investors are still not able to provide the kind of oversight that can prevent outrageous pay packages or disastrous business strategies. There are still too many Enrons. I still think the market can work efficiently if we can level the playing field so that the people who invest capital—the biggest pot of which is the retirement funds invested on behalf of America's working people—can respond effectively when management goes astray. I'll bet your retirement money is handled by TIAA-CREF, Ted. They're one of the best on these issues. If corporate retirement funds and public retirement funds followed their lead, we'd be in much better shape to weather the storms, perfect and otherwise.
As for what happened back in 1929, now that we know from NBER that it wasn't overvalued stocks, perhaps the most apt explanation of booms and busts comes from our dear George Harrison (the Beatle, not the New York banker), who said, "All things must pass." So maybe holding onto today's stocks for the long, long term is the right answer after all.
Thanks, Ted. This was fun.