And more cheerful reading:
cepr.net
an excerpt:
The Consequences of a Plunging Stock Market
The United States does not have enough experience with crashing stock markets or a declining currency
to be able to determine with much certainty what the effects will be. However, it is possible to say a few
things about what is likely to happen as a result of the deflation of these bubbles.
The demand side implications of a stock market crash are likely to be dramatic. If the market were to
decline by 50 percent, it would destroy approximately $9 trillion of paper wealth (more than $30,000
per person). A generally accepted rule of thumb is that every dollar of stock market wealth increases
annual consumption expenditures by three to four cents. This means that a 50 percent decline in the
stock market would reduce annual consumption expenditures by between $270-360 billion, or
approximately 3.0 percent of GDP. If this happened in a short period of time, it would virtually guarantee
a steep recession.
Compounding the impact on the household sector is the fact that consumers have built up an
extraordinary amount of debt over the last decade. The ratio of non-mortgage debt to disposable income
stood at 20.8 percent at the end of the first quarter of 2000. This is more than 2 percentage points above
the previous peak in 18.6 percent in 1990. The increase in household debt over this cycle is actually
understated by this data since it excludes car leases. Car leasing grew from very low levels in 1990 to the
point where nearly one in three new cars is leased rather than sold. Since the lease obligation is very
similar to a car loan, the effective debt burden is probably at least 2.0 percentage points higher than
indicated by this data. This level of indebtedness should raise concerns about a large number of personal
bankruptcies in the event of a stock crash. In any event, it will certainly slow the pace of new spending in
the aftermath of a crash.
On the business side, a sharp decline in stock prices will lead to a substantial reduction in investment.
Although firms are net buyers of stock, many firms, particularly in the high tech sector, are issuing stock
to finance investment. If share prices plummet, then this source of financing will quickly disappear. A
second, perhaps equally important effect, will be the impact of the decline in share prices on corporate
pension funds. Over the course of the market's run-up, large firms with traditional defined benefit pension
plans had to make little or no contribution to these plans. A stock market crash would reverse this
pattern; firms will have to again make substantial pension contributions, which will be a drain on profits
and cash flow. This could lead to further reductions in investment.
A market crash will also lead to a large reduction in government revenue. In 1999, the federal
government collected approximately $91 billion in capital gains taxes. The Congressional Budget Office
projects that it will collect approximately the same amount each year over the next decade. If the market
crashes, tax collections on capital gains would fall almost to zero. This would leave a shortfall of close to
$900 billion in projected revenue over the next decade, in addition to the lost revenue due to the
recession. If a future Congress and President remain committed to balancing the non-Social Security
budget, even in the wake of this sort of downturn, it will require huge tax increases and spending cuts,
further constricting demand.
In addition to having a large impact on the demand side of the economy, a stock market crash could also
have a substantial effect on the supply-side as well. The main reason is that a significant segment of the
workforce now expects to receive a substantial portion of their compensation in the form of stock
options. In extreme cases, such as Internet start-ups, the wage or salary that workers receive might be
the smaller portion of their expected compensation; they anticipate that most of their compensation will
come from cashing in on stock options. If these options suddenly become worthless, it is likely to reduce
the willingness of many of these people to work. This is especially true for those who have already
managed to cash out significant gains in the stock market. This could radically reduce the number of
people willing to work in some crucial areas, such as computer programming and software design.
There is no easy way to try to quantify the potential magnitude of this effect, primarily because there is no
reliable data on how many workers are being paid partly with stock options, nor how large a share of
their compensation is accounted for by such options. However, a recent survey by the Federal Reserve
Board (Lebow et. al., 1999) provides some insight into the prevalence of stock options. The survey
found that just over a third of the firms questioned include stock options in compensation packages for at
least some of their employees. Disproportionately, the firms using options were large and fast growing
ones. The study found that options were still relatively rare among lower paying occupations, but 32.8
percent of the professionals and managers in the firms surveyed received a portion of their compensation
in stock options. The value of these options has increased enormously in recent years. The crude
extrapolations in the study put the exercise value of the stock options at more than 1.6 percent of total
labor compensation in 1998, while the realized value of the capital gains on these options in 1998 was
more than 9.2 percent of compensation. Both figures are more than three times as high as their 1994
share.
This data suggest that a general loss of value of stock options will significantly reduce the compensation
package for a large group of well-paid workers. It is likely that firms will be forced to at least partially
offset this loss through straight salary or some other form of compensation. Insofar as this is the case, it
could lead to a very substantial reduction in corporate profits. For example, if corporations paid out an
additional amount in salary equal to the exercise value of options issued in 1998 reported in the Federal
Reserve Board survey, it would reduce after-tax corporate profits by more than 10 percent. |
