Posted by: N.S. Palmer | September 16, 2008

Mr. Miyagi’s Wisdom for Financial Markets

Today’s 504-point drop in the American stock market, as Lehman Brothers went bankrupt and Merrill Lynch was sold to Bank of America, takes us back to those golden days of the 1980s.

Ah, yes … the 1980s. The indispensable nation, as the United States now styles itself, was in better shape then, though not as good as we remember through the rosy filters of memory. I was there. I know.

Disco music had finally departed, and with it, bell bottoms. Phil Collins was still whining out tunes on the radio, just as annoyingly maudlin as you please; the Sandinistas in Nicaragua were giving Washington fits; and Dubya’s wicked father was vice president of covert mayhem. But a lot was good, too. We believed with certainty that our country was improving instead of sliding down the razor blade of history. You could board an airplane or walk into a Congressional office without being stopped, searched, or even getting a dirty look from a security guard. And President Reagan had his flaws, but like FDR in the 1930s, he breathed optimism into our souls when we needed it.

We’re inclined to forget that October 19, 1987 saw a market crash even bigger, proportionally, than the one on September 15, 2008. The nominal size of the drop in the Dow-Jones Industrial Average was similar: 508 points in 1987 versus 504 points today. However, in 1987, that 508 points was a 22.6 percent drop. Today’s drop was a mere 4.4 percent of the Dow.

The reason we forget the market crash of 1987 is that market crashes have only a tenuous connection with troubles in the wider economy. As the economist John Maynard Keynes once remarked, stock market crashes have predicted nine out of the last five recessions. In 1987, the economy barely noticed the problems in the stock market. Things went on just fine.

But back to the 1980s, and to the title of this essay. Mr. Miyagi was a character in the 1984 film “The Karate Kid.” He taught self-defense to a hapless youngster who was bullied by tough kids at school. He advised his student not to study karate unless he meant to do it seriously:

“Man walk on road. Walk left side, safe. Walk right side, safe. Walk down middle, sooner or later, get squished just like grape. Same here. You karate do yes, or karate do no. You karate do “guess so”, just like grape.”

If the U.S. government had taken Mr. Miyagi’s advice more seriously, today’s market crash — and the subprime lending crisis that triggered it — could probably have been avoided. Instead, they tried to deregulate a little bit and regulate a little bit. They — or, more precisely, world financial markets — ended up in the middle of the road. Get squished like grape.

The lesson is that you can either have Wild-West unregulated financial markets with no bailouts (and be ready to take the consequences), or you can have markets with prudent and adequate regulation. You can’t serve up a dog’s breakfast of regulation and deregulation.

If you try to partially deregulate markets but still have some regulation and bail out big players when they get into trouble, you’re setting up conditions for a disaster.

Conservative economists’ complaint that regulated markets grow more slowly than Wild-West markets now seems hollow. Slower, regulated growth sounds pretty good right about now. Unregulated fast growth isn’t such a bargain if it’s built on foundations that collapse.

Copyright 2008 by N.S. Palmer. May be reproduced as long as credit is given.

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