How Does Wall Street Affect You?
ECONOMICS has been called the dismal science. Still, it’s a science that touches the lives of all of us. The prices you pay in the store, the availability of jobs, the services your country’s government provides—they all depend on the strength of the economy in your land.
‘But what does that have to do with Wall Street?’ some might ask. ‘It’s too far away to matter to me.’ Well, the stock market is like a mirror of the economy. And today the nations of the world are so interdependent that no economy is an island.
A Globalized Economy
The president of the American Stock Exchange said that the shock of Black Monday “made it abundantly clear that no country is totally in control of its own destiny.” In Italy a writer for La Repubblica put it this way: “West Germany’s taxes yesterday, the Latin American debt today, and . . . legislation by the U.S. Congress tomorrow are events that once were isolated from one another or interconnected only over a long period of time. Today they are welded together instantaneously. To realize this, just step into the trading room of a big international bank, where a kind of electronic spaceship is linked day and night with all the world markets.”
What country, what economy, can claim isolation from this globally interconnected and interdependent system? African countries? The editors of a business monthly that monitors the African economy say that “African economies are very vulnerable to exterior shocks.” What about Latin-American countries? An editor of Jornal do Brasil said that the stock market crisis was part of an international financial crisis. What about the Middle East? The deputy editor of Ma’ariv of Tel Aviv cited a saying of a former prime minister of Israel: “If America catches cold, Israel sneezes.”
Who, then, is safe from today’s economic storms? If a passenger basking on the deck of an ocean liner was told that the ship had sprung a leak in the hull below, could he reasonably feel safe from danger just because the trouble spot was so far away? No; all parts of the ship are connected—not one of them floats alone. The same might be said of the world’s economies. Trouble in one may spell trouble for you.
Dangerous Waters for Little Fish
After the crash, small investors left the market in droves. The mass exodus meant severe losses to the brokerage industry, which suffered some 25,000 layoffs after the crash. But it has meant even more trouble for the stock market itself.
What scared many investors away from Wall Street? Obviously, the crash had a lot to do with it. But in other ways too, Wall Street began to seem a hostile environment for the small investor, like waters too dangerous for little fish to swim in. Let’s briefly explore three of the trends that have contributed to this: computerization, the buyout binge, and the debt explosion.
Are Machines Running the Show?
Black Monday was a bad day for computers. The tidal wave of trading that day was more than they could handle. All across the country, brokers watched in impotent rage as their terminals flashed a screenful of question marks or just went blank. In the heart of the storm, the New York Stock Exchange, the crash caused shutdowns in almost every part of the system. But many felt that computers were not just victims of the crash but actually accomplices in generating the selling stampede. One man put it this way to The New York Times: “It’s just computers selling to computers.”
Of course, that’s not strictly true. But with some complex trading schemes favored by big institutional investors, computers are automatically triggered by conditions in the market—such as a drop in the price of a stock—to suggest to the broker what he should do. The problem is, he rarely has time to question his computer’s suggestions. Thus, computers can choreograph hordes of traders like a troupe of dancers. They obey their computers in unison, creating huge selling waves that in turn generate other selling waves. So computers may have amplified the crash, much as noise feedback on a public-address system can escalate into an ear-splitting screech. Some blame computers for 300 points of the 508-point drop.
Computers may be indispensable to the stock market, but they made the little fish feel smaller than ever on Black Monday. Individual investors couldn’t even get their brokers on the telephone in order to sell their plummeting stocks. Meanwhile, big investors with their computer-driven program trades were unloading their shares in huge blocks.
A Feeding Frenzy
Many find it worrisome, too, that the large- and medium-sized fish have been embroiled in a feeding frenzy over the last several years, devouring one another in hostile takeovers and leveraged buyouts. “People are buying companies today the way they used to buy stocks,” said one retired investment banker interviewed by Awake!
The leveraged buyout, or LBO, is very popular on Wall Street. One company uses “leverage” (massive amounts of borrowed money it has raised by, for instance, selling junk bonds) to “buy out” another company by buying up the outstanding shares of its stock. Once the predator has bought up its prey, it cuts it up and sells the pieces to pay off all that debt. So the predator may end up owning what is left for free! By selling junk bonds, small companies can afford to devour big ones, like minnows gulping down sharks.
Takeover deals yield almost unthinkable amounts of money to the banks, lawyers, and businessmen that put the deals together. In one gigantic LBO in late 1988, the fees to banks and advisers alone approached $1 billion. Some men who grew famous as predators made hundreds of millions of dollars in just a few years. Not a few ran into trouble with the law.
The Debt Explosion
LBOs are but one illustration of America’s continuing love affair with debt. Individually, Americans save only about 5 percent of their earnings. West Germans save about 13 percent, and the Japanese about 17 percent. Americans’ love of the credit card and the ‘buy now, pay later’ credo have become legendary. U.S. corporations owe over $1.8 trillion, and the federal debt is over $2.6 trillion. The U.S. government has also managed, in just eight years, to go from being the world’s largest creditor to its biggest debtor in its international trade. A writer for Canada’s Globe and Mail summarized the U.S. policy as “spend, spend, and just borrow.”
A recession could spell big trouble for America’s debt-laden corporations. Companies saddled with debt would suddenly become fragile in such a climate. A wave of defaults and bankruptcies could ensue. Banks too are out on the debt limb: They have made billions of dollars of risky loans. Several hundred are in trouble, and many have been forced to close.
Debt on a global scale is even more ominous: Third World countries owe a staggering $1.2 trillion. No wonder, then, that investment banker Felix Rohatyn assessed the economy this way: “We have created a gigantic financial house of cards. We have had fair warning about its weakness.”
So to the small investor, Wall Street may seem dominated by computerized trading making huge waves, the big fish in a feeding frenzy, and a bottomless chasm of debt threatening to swallow the whole pond. Is it any surprise that the little fish have made an exodus from the market?
But even more than fear, there is one trend that has driven many small investors away from Wall Street. It is governed by the same emotion that seems to be running the whole world these days. What is that emotion?
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Several hundred U.S. banks are in trouble, and many have been forced to close
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A Guide to Wall Street Words
What happens on Wall Street may seem foreign to you because the financial world has a language all its own. The following is a brief sampling of Wall Street’s most common words.
◆ STOCK: When you buy a share of stock in a company, you are actually buying a piece of that company. This is one way companies raise money. Periodically, stockholders may receive a small percentage of the company’s profits, called a dividend.
◆ BOND: Another way corporations raise money is to borrow it by selling bonds. When you buy a company’s bond, you are lending it money. The company pays for the use of your money by means of interest payments. Stocks and bonds both fit under the blanket term “securities.” While bonds do not generally grow in value the way stocks sometimes do, they are often considered a safer investment. An exception is the junk bond, one that has been officially rated as very risky. The company that issues it is more likely to default, not paying you as agreed. People buy them because junk bonds pay a high interest rate.
◆ STOCK EXCHANGE: An organized auction, or marketplace, where securities such as stocks and bonds are bought and sold. On the floor of the exchange, brokers carry out the buy-and-sell orders of their clients, investors, and get paid by means of a commission.
◆ THE DOW: Short for the Dow Jones Industrial Average, this is the most popular indicator of the health and value of the New York Stock Exchange. It is an average based on the current value of 30 industrial stocks. When people ask, “How is the market doing?” the common answer is to quote where the Dow stands.
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“We have created a gigantic financial house of cards. We have had fair warning about its weakness.”—Investment banker Felix Rohatyn