Early 1980s recession

Template:Globalize/USA The early 1980s recession was a severe recession in the United States which began in July 1981 and ended in November 1982. The primary cause of the recession was a contractionary monetary policy established by the Federal Reserve System to control high inflation.

The recession was not only unexpected but was the most serious recession since the Great Depression.

Causes of the recession

In the wake of the 1973 oil crisis and the 1979 energy crisis, stagflation began to afflict the economy of the United States. Unemployment had risen from 5.1% in January 1974 to a high of 9.0% in May 1975. Although it had gradually declined to 5.6% by May 1979, unemployment began rising again thereafter. It jumped sharply to 6.9% in April 1980 and to 7.5% in May 1980. A mild recession from January to July 1980 kept unemployment high, but despite economic recovery unemployment remained at historically high levels (about 7.5%) through the end of 1981. Inflation, which had averaged 3.2% annually in the post-war period, had more than doubled after the 1973 oil shock to a 7.7% annual rate. Inflation had reached 9.1% in 1975, the highest rate since 1947. Inflation declined to 5.8% the following year, but had edged higher. By 1979, inflation had reached a startling 11.3% and in 1980 soared to 13.5%.

A brief recession occurred in 1980. Several key industries—including housing, steel manufacturing and automobile production—experienced a downturn from which they had not recovered by the start of the recession in 1982. Many of the economic sectors that supplied these basic industries were also hard-hit.

Determined to wring inflation out of the economy, Federal Reserve chairman Paul Volcker slowed the rate of growth of the money supply and raised interest rates. The federal funds rate, which was about 11% in 1979, rose to 20% by June 1981. The prime interest rate, at the time a highly important economic measure, eventually reached 21.5% in June 1982.

Economic effects of the recession

The Federal Reserve's extremely tight monetary policy intentionally plunged the American economy into a deep recession.

Employment conditions deteriorated throughout the year. The unemployment rate reached 10.8% in December 1982—higher than at any time in post-war America. Job cutbacks were particularly severe in housing, steel and automobiles. By September 1982, the jobless rate had reached 10.8%. Twelve million people were unemployed, an increase of 4.2 million people since July 1981. Unemployment rates for every major group reached post-war highs, with men age 20 and over particularly hard hit. Blacks and Hispanics also suffered proportionally greater job losses than whites.

Financial institutions crises

The recession hit financial institutions such as banks and savings and loans particularly hard.

Banks

The recession came at a particularly bad time for banks due to a recent wave of deregulation. The Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) had phased out a number of restrictions on banks' financial practices, broadened their lending powers, and raised the deposit insurance limit from $40,000 to $100,000 (raising the problem of moral hazard). Banks rushed into real estate lending, speculative lending and other ventures just as the economy soured.

By mid-1982, the number of bank failures was rising steadily. Bank failures reached a post-depression high of 42 as the recession and high interest rates took their toll. By the end of the year, the Federal Deposit Insurance Corporation (FDIC) had spent $870 million to buy up bad loans in an effort to keep various banks afloat.

Congress reacted with a distinctly inappropriate piece of legislation. In July 1982, Congress enacted the Garn-St. Germain Depository Institutions Act of 1982 (Garn-St. Germain), which further deregulated banks as well as savings and loans. The Garn-St. Germain act authorized banks to begin offering money market deposit accounts in an attempt to encourage deposit in-flows, removed additional statutory restrictions in real estate lending, and relaxed loans-to-one-borrower limits. The legislation encouraged a rapid expansion in real estate lending at a time when the real estate market was collapsing, worsened competition between banks and savings and loans, and encouraged overbuilding of branches.

The recession affected the banking industry long after the economic downturn technically ended in November 1982. In 1983, another 49 banks failed—easily beating the Great Depression record of 43 failures set in 1940. The Federal Deposit Insurance Corporation (FDIC) listed another 540 banks as "problem banks" on the verge of failure. Not helping matters was a series of banking failures in East Tennessee when fraudulent activity led to the failure of Jake Butcher's United American Bank.

In 1984, the Continental Illinois National Bank and Trust Company, the nation's seventh-largest bank (with $45 billion in assets), failed. The FDIC had long known of Continental Illinois' problems. The bank had first approached failure in July 1982 when the Penn Square Bank, which had partnered with Continental Illinois in a number of high-risk lending ventures, collapsed. But federal regulators were reassured by Continental Illinois executives that steps were being taken to ensure the bank's financial security. After Continental Illinois' collapse, federal regulators were willing to let the bank fail in order to encourage banks to rein in some of the more risky lending practices. But members of Congress and the press felt Continental Illinois was "too big to fail." In May 1984, federal banking regulators were forced to offer a $4.5 billion rescue package to Continental Illinois.

Continental Illinois may not have been "too big to fail," but its collapse could have caused the failure of some of the biggest banks in the United States. The American banking system had been significantly weakened by the severe recession and the effects of deregulation. Had other banks been forced to write off loans to Continental Illinois, institutions such as Manufacturer's Hanover Trust Company, Bank of America and perhaps Citicorp would have been insolvent.

The S&L crisis

Main article: Savings and Loan crisis

The recession also significantly worsened a crisis in the savings and loan industry.

In 1980, there were approximately 4,590 state- and federally-chartered savings and loan institutions (S&Ls) with total assets of $616 billion. Beginning in 1979, S&Ls began losing money due to spiraling interest rates. Net S&L income, which totaled $781 million in 1980, fell to a loss of $4.6 billion in 1981 and a loss of $4.1 billion in 1982. Tangible net worth for the entire S&L industry was virtually zero.

The Federal Home Loan Bank Board (FHLBB) regulated and inspected S&Ls, and administered the Federal Savings and Loan Insurance Corporation (FSLIC), which insured deposits at S&Ls. But the FHLBB's enforcement practices were significantly weaker than those of other federal banking agencies. Until the 1980s, savings and loans had limited lending powers. The FHLBB was, therefore, a relatively small agency overseeing a quiet, stable industry. Accordingly, the FHLBB's procedures and staff were inadequate to supervise S&Ls after deregulation gave the financial institutions a broad array of new lending powers. Additionally, the FHLBB was unable to add to its staff because of stringent limits on the number of personnel it could hire and the level of compensation it could offer. These limitations were placed on the agency by the Office of Management and Budget, and were routinely subject to the political whims of that agency and political appointees in the Executive Office of the President. In financial circles, the FHLBB and FSLIC were called "the doormats of financial regulation."

Because of its weak enforcement powers, the FHLBB and FSLIC rarely forced S&Ls to correct poor financial practices. The FHLBB relied heavily on its persuasive powers and the states to enforce banking regulations. With only five enforcement lawyers, the FHLBB was in a poor position to enforce the law even had it wanted to.

One consequence of the FHLBB's lack of enforcement abilities was the promotion of deregulation and aggressive, expanded lending to forestall insolvency. In November 1980, the FHLBB lowered net worth requirements for federally-insured S&Ls from 5% of deposits to 4%. The FHLBB further lowered net worth requirements to 3% in January 1982. Additionally, the agency only required S&Ls to meet these requirements over a 20-year period. This phase-in rule meant that S&Ls less than 20 years old had practically no capital reserve requirements. This encouraged extensive chartering of new S&Ls, because a $2 million investment could be leveraged into $1.3 billion in lending.

As the risk exposure of S&Ls expanded, the economy slid into the recession. Soon, hundreds of S&Ls were insolvent. Between 1980 and 1983, 118 S&Ls with $43 billion in assets failed. The Federal Savings and Loan Insurance Corporation (FSLIC), the federal agency which insured the deposits of S&Ls, spent $3.5 billion to make depositors whole again. The FSLIC pushed mergers as a way to avoid insolvency. From 1980 to 1982, there were 493 voluntary mergers and 259 forced mergers of savings and loan overseen by the agency. Despite these failures and mergers, there were still 415 S&Ls at the end of 1982 that were insolvent.

Federal inaction worsened the industry's problems. Responsibility for handling the S&L crisis lay with the Cabinet Council on Economic Affairs (CCEA), an intergovernmental council located within the Executive Office of the President. At the time, the CCEA was chaired by Treasury Secretary Donald Regan. The CCEA pushed the FHLBB to refrain from re-regulating the S&L industry, and adamantly opposed any governmental expenditures to resolve the S&L problem. Furthermore, the Reagan administration did not want to alarm the public by closing a large number of S&Ls. These actions significantly worsened the S&L crisis.

The S&L crisis triggered by the recession lasted well beyond the end of the recession. The crisis was finally quelled by passage of the Financial Institutions Reform, Recovery and Enforcement Act of 1989. The estimated the total cost of resolving the S&L crisis was more than $160 billion.

Political fallout

Main article: United States House elections, 1982

Main article: United States Senate elections, 1982

The recession was nearly a year old before President Ronald Reagan finally admitted on October 18, 1981, that the economy was in a "slight recession".

The "Reagan recession," coupled with budget cuts (which were enacted in 1981 but began to take effect in 1982), led many voters to believe that Reagan was insensitive to the needs of average citizens. Reagan's approval ratings sank. In January 1983, Reagan's popularity rating fell to 35%—lower than the 39% reached by President Richard Nixon at the height of the Watergate scandal. Reagan's reelection seemed unlikely.

Pressured to counteract the increased deficit caused by the recession, Reagan finally agreed to a corporate tax increase in 1982. However, he refused to raise income taxes or cut defense spending. The Tax Equity and Fiscal Responsibility Act of 1982 instituted a three-year, $100 billion tax hike—the largest tax increase since World War II.

The 1982 mid-term Congressional elections were largely viewed as a referendum on Reagan and his economic policies. The election results proved to be a major setback for Reagan and the Republicans. The Democrats gained 26 House seats, which at the time was the most for the party in any election since the "Watergate year" of 1974. However, the net balance of power in the US Senate was unchanged.

Recovery

The mid-term Congressional elections proved to be the nadir of the Reagan presidency.

A combination of deficit spending and the lowering of interest rates slowly led to economic recovery. From a high of 10.8% in December 1982, unemployment gradually improved until it fell to 7.2% on Election Day in 1984. Nearly two million people left the unemployment rolls. Inflation fell from 10.3% in 1981 to 3.2% in 1983. Corporate earnings had risen by 29% in the July-September quarter of 1983 compared with the same period in 1982. Some of the most dramatic improvements came in industries hardest hit by the recession, such as paper and forest products, rubber, airlines and the auto industry.

By November 1984, voter anger at the recession had evaporated and Reagan's re-election was not in doubt.

See also

• Supply side economics
• Reaganomics

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