Out of Control Policy Blog

Financial crisis: the fear of fear itself

Speculation–the purely human, completely emotional drive–has been the backbone of the American and world economy for decades. The delicacy of our underpinning has not gone unnoticed, but has been accepted for the wealth it has created. Speculation brings with it the potential for corruption, for deception, and for large losses without much control. However, it has been a necessary evil because while there has been potential for loss, there has been equal opportunity for gain–huge gain.

Our economy has been built by leveraging assets in order to raise capital for continued investment, but the result has been the creation of invisible wealth. The stock market's loss of over one-fifth of its value in just one week didn't destroy a single house, car, road, or brick of gold. All our property has remained, but the subjective value of that property has disappeared. We no longer have as much invisible wealth, that subjective value, to create more wealth. Unfortunately none of this money had to go away; fearful speculation has been the main cancer of Wall Street's collapse.

However, while we can blame investor fear–a lack of market confidence–for Wall Street's losses, that does not answer what spurred on the fear. The large drop post-9/11 was fear of more attacks, fear that we didn't have our nation secured like everyone thought. The 2008 crisis started its drop with Fannie Mae and Freddie Mac complicating the housing market. Their demise expedited the devaluing of mortgage backed securities, which in turn demolished asset values at America's major finance institutions. Unable to back their losses with adequate capital, firms began going bankrupt. So housing instability certainly shares a heavy blame for the fear in the market place.

But there is much more: the U.S. government.

Every time the government has released a doom and gloom statement, the market has responded negatively–creating a self fulfilled prophecy. Every time the government has tried to stabilize the market with regulations, the market has responded negatively–dropping interest rates may have increased demand for borrowing, and encouraged lending, but it decreased investor incentive. Furthermore, the higher taxes are on investing, the more barriers to investment there are.

At a time when stability is the key, the government shouldn't be throwing money at the problem, buying up commercial paper or giving AIG more loan money; that is just giving the money they taxed away from firms back to them, with taxed money from other firms too. Instead of redistributing Wall Street's money, the can temporarily stop taking it, and encourage greater investment, while letting firms retain their capital.

Furthermore, regulations like banning short selling until yesterday didn't help, but instead contributed to investor fears that the market lacked stability. When the Securities and Exchange Commission banned short selling it was trying to reign in predatory investors. Instead, it rattled general investor confidence. Hedge fund manager William Ackman, who runs New York-based Pershing Square Capital Management, said the short-selling ban "did more to destroy investor confidence than anything."
All of the government's reactions have caused Wall Street to lose over 20% in the past week. Here are just today's events:

  • Wall Street lost over 8% of its value in early morning trades before gaining back all of it and more only to lose again and be down 1.5% on the day. In the midst of the rollercoaster trading day the Dow Jones had a 1000-point swing, as all Indices and Averages continually crank out never before seen events.
  • Europe's and Asia's markets lost another 7% each on average, continuing their collapse
  • The price of oil fell below $79 a barrel, down 17% in the past week and nearly 50% from this summer
  • Anthony Randazzo is Director of Economic Research


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