Stocks Plunge: What Does It Mean?

February 2018 began with massive losses on Wall Street. The stock market recorded historically high one-day losses and overall losses of about 5%. Investors lost about 2 trillion dollars.

Analysts have attributed the disaster to a number of causes:

  • fears of inflation
  • fears of the Federal Reserve (the U.S.’s central bank) tightening credit as a result of fears of inflation (tightening credit means raising interest rates, which makes it harder for people to borrow money)
  • fears of a “bubble” caused by stock prices going higher than is warranted
  • fear of declining corporate profits because of higher wages
  • fear of huge government deficits (because of the huge tax cuts passed by Congress), causing money to flow out of stocks into lending money to the government

Before we go further, let’s consider what stocks are. Owning stock in a company means owning a piece of that company – also called owning shares in the company. When people buy shares of stock, they are helping to finance the company. Shares of stock can be bought and sold through the stock market. The stock market is not a physical place, but rather a loose network of economic transactions, taken together.  

So what is the impact of the stock market plunge? Do you care? Should you?

These are complicated questions. And your answers might depend on other questions:

  • Do your family members invest in the stock market?
  • Does your family have retirement funds in the stock market? If so, will they be needing that retirement money soon?
  • Do you sympathize with people who lost money even though you and your family didn’t?
  • Are you worried that the stock market “correction” will lead to more damage to the economy?

Before we try to gauge how much the stock market matters, let’s take a quiz.

 



Quiz
 

1. True or false: The recent stock market “correction” (or small crash) began with a jobs report from the Department of Labor which showed better-than-expected growth of jobs and wages.

2. True or false:  More people own stocks today than ever before.

3. What is a stock market bubble?

  1. A plastic enclosure for stock traders to keep conversations private.
  2. The inverse relationship between a breakaway gap or exhaustion gap (whichever is larger) and the most recent island reversal
  3. B—but only as it relates to dark pool liquidity
  4. A phenomenon when stock prices quickly rise to more than they are really worth according to companies’ actual finances
  5. A tradition on Wall Street that when the Dow Industrial Average reaches a landmark number (e.g. 1900 or 2000 or 2200), traders all break out a stick of gum at the closing bell

4. True or false: The finance industry spent more money on lobbying in 2017 than any other industry.

 

Answers:

  1. True
  2. False: Since the 2007 recession, the percent of Americans owning stock has dropped 13%.
  3. D
  4. False: The health industry spent $555 million and the finance industry only $517 million.
     

 

Reading
 

Only about half of Americans own stock, so many American families are not directly affected by the Wall Street losses. According to Jared Bernstein writing in the Washington Post, less than a third of all households have more than $10,000 invested in stocks. So, while half of America owns stock, the wealthiest 10% of the population own about 80% of stock value. And the top one percent own almost 40% of stock wealth.

The larger question is how much those trillions of dollars that evaporated due to the stock market correction will affect the broader economy. Will businesses have to shut down or hire fewer workers? Will towns and cities have to eliminate services? Will there be a full blown recession affecting all sectors of the economy?

The likely answer is “no” to all these questions, at least for now. It’s not uncommon for the stock market to lose 5% of its value. 

Nevertheless, many adults can remember the 2007 real estate bubble, which led to a huge drop in stock market and an economic recession that persisted for years. The depth of the crash was due in part to the size of the “bubble” that popped. Before the crash, speculators were not only buying and selling actual properties, they were buying and selling and reselling peoples’ mortgages – and buying and selling bundled groups of those mortgages. All of this pumped up the value of the housing market far beyond what the actual value of the homes and mortgages warranted. So when the bubble popped, losses were magnified.

Wealthy investors have accumulated so much money that they are always looking for new places to invest it. With little or no regulation,  stock traders have  invented and offered to investors new and creative financial “instruments” to invest in: credit default swaps, basket default swaps, collateralized debt obligations (CDOs), CDOs of CDOs, put bond stripping, asset-backed securities, repacks, default swaptions, and lots more. Involved in this latest market downturn is trading on VIX notes—also known as the “fear index.” This exchange was set up to allow traders to invest in bets on the coming volatility of the stock market. (And then, the VIX’s evil twin, the XIV, was invented to bet on the calmness of the market.)

Many analysts suggest that these indexes themselves, which are based simply on hunches, helped accelerate the rapid decline of the stock market that began in 2007.

Businesses need access to money in order to grow and employ more workers. But in 2007 – and now – much financial speculation has little to do with investing in actual companies or properties. The trading more resembles side-bets among gamblers than actual investments.

Enormous amounts of money are tied up in these markets. The financial industry itself has almost tripled in size since 1980 (from 2.4% of GDP—gross domestic product—to 8.4%). Because of the potential of financial fiascos spreading to the wider economy, many analysts have called for stricter regulation of the industry.

 


 

For Discussion
 

  1. Given that most Americans have little or no money invested in the stock market, why do you think the news media provides daily reports on whether stocks have gone up or down?  Is this important news to report? Why or why not?
     
  2. Do you think there should be stronger regulations against financial speculation? Why or why not? The stock market always seems to bounce back after corrections and even after recessions. As far as regulations, is this a case of “if it ain’t broke, don’t fix it?”
     
  3. Do you think campaign contributions by the financial industry to candidates running for elected office affect whether or not such regulations are passed? Why or why not?

 



For Further Research
 

  1. Challenge students to research any of the investment “products” mentioned above (from CDOs to repacks) and explain to the class what that product is.
     
  2. Break students into small groups and ask each group to research one of the following questions. Have students share their findings and lead a discussion about them in class.
  • Before the stock market fell, President Trump repeatedly about how well the market had done under his presidency. How much should he take credit (or blame) for how the market is doing? Explain your arguments. 
     
  • The “trickle down theory” claims that a tax system that delivers more money to the wealthy will trickle down to everybody else through job creation. Explain how the stock market system supports or doesn’t support trickle-down economics. Explain your argments.
     
  • Wall Street firms have developed billion-dollar stock trading programs that react to market events in fractions of a second. Does this make the market unfair for small investors? Is there such a thing as “unfair” in the market? Explain your argments.

 


 

Sources
 

http://www2.ucsc.edu/whorulesamerica/power/wealth.html

http://www.investinginbonds.com/assets/files/lehmanexoticcredderivs.pdf

https://www.theguardian.com/business/2018/feb/09/betting-calm-investors-worsen-stock-market-fall-xiv

https://www.washingtonpost.com/posteverything/wp/2017/03/02/perspective-on-the-stock-market-rally-80-of-stock-value-held-by-top-10/?utm_term=.699d9fa8f17c

https://www.thebalance.com/what-if-the-stock-market-didn-t-exist-2637105

https://www.opensecrets.org/lobby/top.php?showYear=2017&indexType=c

https://www.npr.org/2017/03/01/517975766/while-trump-touts-stock-market-many-americans-left-out-of-the-conversation