Populism and Financial Crises
Within the last few years, populism, which I will take to mean appealing to the feelings of the people through rhetoric and exaggeration, has been on the rise throughout the world, with leaders like Donald Trump in America, Jair Bolsonaro in Brazil, and Viktor Orban in Hungary gaining power and influence. Today’s wave of populism is predominantly rooted in right-wing ideologies: xenophobia, intense nationalism, protectionism, isolationism, etc. However, populism has occurred at various points throughout history, and has been associated with all kinds of political beliefs. To label one ideological brand of populism as “good” and the other as “bad” sets a dangerous precedent. Populism is nothing new; however, its rise can be closely correlated with sharp economic downturns, which, in turn, are related to deleterious economic deregulation, as shown in the various panics of the 1800s, the Great Depression, and the 2008 crisis.
The financial collapse that swept the nation in 1837 was the result of one principle factor: the failure of the Bank of the United States (BUS). President Jackson, himself a populist, harbored a deep mistrust of banks, stemming from various land deals that went poorly for him. On top of that, the only form of currency in which he had faith was specie: gold and silver. Having won reelection in 1832 and paid off the national debt in 1835, Jackson set himself to destroying the BUS. To do this, he vetoed the bill to renew its charter and to move federal deposits to state banks. Since Jackson eliminated the nation’s debt, the government actually made money from 1835-1836, but the president’s policy of redistributing debt to the states would have drastic consequences First, it severely limited the federal government’s ability to intercede in potential crises; second, it sparked rampant over-speculation in the states as they pursued infrastructure improvements and frontier exploration; and third, it decentralized the nation’s currency, which had previously been regulated by the BUS. The strain Jackson placed on the economy was heightened when he declared the policy of Specie Circular, which stated that federal loans could only be repaid with gold or silver. As a result of these policies, thousands of banks defaulted on their loans, credit froze across the nation, and the economy fell into a six year recession that devastated the country.
In response to the Panic of 1837, the presidents that followed Jackson tried to control the crisis but failed miserably. Eventually, President Polk capitalized on the desire for stability that followed from the Panic. In the election of 1844, Polk narrowly defeated Henry Clay. Polk switched attention from the controversial banking topic to the overwhelmingly popular idea of Manifest Destiny and advocated not only for the annexation of Texas, an idea popular among Southerners, but also for the occupation of Oregon, a policy favored by Northerners. The problem with those proposals was that they strained relations with both Mexico and Britain. With regards to Oregon, the phrase “Fifty-four Forty or Fight,” referring to the longitudinal line to which Americans wanted to expand, gained popularity. Rather than fight, Britain agreed to a treaty granting control of Oregon to the U.S., but Mexico and Texas were another problem altogether. Riding high on his victory in Oregon, President Polk channeled the fervor of Manifest Destiny into annexing Texas, ultimately culminating in the Mexican-American War. The economic boom that stemmed from mobilizing for war served to resuscitate the economy and quell populist feelings.
Following the Civil War, the railroad industry experienced an almost unprecedented period of growth. The bubble was bound to burst, and it did in 1893. In the spring of that year, the gold reserves in the U.S. Treasury fell below $100 million, raising concerns that the country would have to abandon the gold standard. The fear of scrapping the gold standard triggered a massive sell off in the stock market, which was already reeling from the failure of one of the nation’s largest railroad companies. In response, banks all across the nation began demanding payment on outstanding loans; the strain was too much, and the economy came crashing down. By the end of 1893, 4,000 banks had closed. On top of that, 50 railroads failed, causing almost 14,000 businesses to fail because the railroads were responsible for connecting nearly every industry. While all this transpired, the government was hemorrhaging gold reserves. To stabilize its coffers, the government cut off the purchase of silver and received a $65 million bailout from Wall Street magnate J. P. Morgan, who charged $7 million in interest on the loan. Meanwhile, the government did nothing to directly alleviate the effects of the depression.
With no social welfare programs in place, the depression was felt harshly across the country as wages stagnated and fell. In 1894, there were an estimated 1,300 labor strikes as people fought for better pay to support themselves. The newly formed Populist Party began to garner massive support among farmers and miners. It advocated for abandoning the gold standard in favor of the silver standard, which it believed would improve conditions for the working class. In the election of 1896, William McKinley (R) defeated William Jennings Bryan (Populist with Democratic support). The issues at stake in the election centered around the gold standard and expanding America’s global influence. McKinley supported both, while Bryan did not. At the same time, public support for Cuban independence started to grow, but government leaders remained opposed to it as they did not want to anger Spain. However, after the sinking of the USS Maine in Havana, public outcry swayed politicians to mobilize, starting the Spanish-American War. Once again, mobilizing for war spurred economic growth and started a period of prosperity that would last until the 1920s.
The industrial boom caused by entering World War I started a decade of decadence and flourishing that became known as the Roaring Twenties. Wanting to sustain this economic growth, the government rolled back numerous regulations placed on businesses in the 1900s. Interestingly enough, the Secretary of the Treasury responsible for economic policy at the time was Herbert Hoover. Economic growth increased production in the manufacturing industry, banking confidence, and consumer interest in the market. Bank credit increased, and the standards to secure a loan were lowered; consumers began buying stocks “on margin,” which meant placing a down payment as low as 10% of the stock price and borrowing the rest on credit. In August 1929, the Federal Reserve Bank of New York raised interest rates from 5% to 6%, bringing down investor enthusiasm. In October of 1929, manufacturing companies had a massive excess of product and were forced to sell at a loss, causing share prices to plummet. Investors panicked as stock prices tumbled and started rapidly selling off all their stocks and securities. Within days, the market fell a record 25% with tens of millions of shares sold. As people lost money in the market, they began to rush banks to withdraw their savings. But the banks had loaned their money to investors, who had invested and lost the money in the market. So when customers came to withdraw money, the banks quickly went under. Throughout the Depression, over 9,000 banks failed; those that did not fail restricted credit loans and raised the standards necessary to secure a loan, thereby paralyzing the credit system.
The effects of the crash and subsequent depression were felt around the world, especially in Germany. Fresh off its defeat in World War I, Germany was in shambles, suffering from rampant inflation and the mandatory reparations it owed the Allies. People were starving on the streets, desperate for relief from the abject poverty in which they were living. The stage was set for Hitler to seize power. Leading the National Socialist Party, Hitler began talking of a new Reich and advocating for the destruction of the Treaty of Versailles, which he believed to be hamstringing the economy. Furthermore, he began to channel the animus of the German people toward a group of people dubbed “The Undesirables:” namely Jews. He began speaking of the “true Aryan race” being slighted and cheated by Jews. This is a clear example of xenophobic right-wing demagoguery. Halfway across the world, the United States was experiencing its own form of populism in the form of Franklin Delano Roosevelt. FDR was swept into office in a near unanimous victory against Herbert Hoover, who was directly involved in ruining the economy. FDR drew on popular anger at the Republicans for allowing the crisis to happen to handily defeat Hoover and promote his New Deal. Ultimately, the populist sentiments that arose across Germany led to the formation of fascism and the start of World War II. As in prior historical cases, the war efforts spurred the U.S. economy and led to almost three decades of uninterrupted prosperity. The minor recessions that occurred in the last half of the 20th century were simply part of the natural business cycle of expansion and recession.
The government finally began to learn its lesson about regulating the financial system. Two responses to unchecked economic policy and investing were the Federal Reserve System and the Securities Exchange Commission (SEC), founded 1913 and 1934 respectively. These two independent watchdog organizations are the principle entities responsible for maintaining the stability of the financial system. The Federal Reserve System is the central bank in charge of setting interest rates and maintaining the stability of the dollar. The SEC is responsible for protecting investors and ensuring the credibility and smooth functioning of the markets. Additionally, the Federal Deposit Insurance Corporation (FDIC) was established in 1933 to insure deposits in commercial banks within the U.S. to prevent another massive loss of savings after banks closed during the Great Depression.
In the late 1980s and early 1990s, the government began to relax some of the restrictions placed on businesses and banks. One of the most important steps of deregulation was the passage of the Garn-St. Germain Depository Institutions Act. This lowered loan-to-value ratio (the size of a loan you take out compared to the value of the property securing the loan) standards that banks had to enforce, meaning that people could take out a greater loan against a property of significantly lesser value, thus increasing the risk.
Coming into 2008, the real estate market had been experiencing explosive growth, with home ownership skyrocketing as the result of low interest rates throughout the early part of the decade. For most Americans, a house was an investment; it represented the bulk of their wealth. To capitalize on the housing boom, banks began to lower the standards for loans, a massive number of which were consequently purchased on credit, which was secured in properties far below that of the loan value. These loans carried a very high risk with them and were not insured by the FDIC, so companies, AIG in particular, began to buy the debt from the banks. This led to a select few companies assuming all the debt, and thus, all the risk. Then, housing prices began to fall, causing many home values to decrease below the value of the mortgage. Rather than sell at a loss, many homeowners faced foreclosure. With mortgages defaulting, many companies and banks panicked because they bought mortgage-backed securities, which were quickly becoming worthless. To save themselves, many banks froze their credit and refused to lend to each other. The first notable company to fail was Bear Stearns, but it was saved by government intervention and merged with another bank. Then, Lehman Brothers failed. This time, the government did not directly aid the company, but rather sought to split it among other companies. When this failed, Lehman Brothers filed for bankruptcy, causing a domino effect of bank failures.
After Lehman Brothers, the government took direct action to prevent the total collapse of the entire American and global financial system (for an in-depth look, I recommend the documentary Too Big To Fail). The immediate solution was a $700 billion bailout of the remaining large national banks. The long term remedy was President Obama’s $195 billion stimulus plan, which the administration implemented in 2009. This served to halt the falling GDP and stabilize the financial system even though unemployment continued to rise.
The effects of the 2008 recession could be seen in the 2016 election. Both Bernie Sanders and Donald Trump took advantage of the latent animosity from 2008. Sanders appealed to liberals who viewed the establishment as being in the pocket of Wall Street. For example, one of Sanders’s mottos was “no bank is too big to fail.” Trump capitalized on the ill-feelings of many working-class Americans following the recession; he championed extremist views from the right in an effort to bring them into the mainstream. Aside from that, Trump railed against several of President Obama’s policies aimed at business regulation following the recession. Many laborers viewed the government bailout as choosing businesses over people, and Trump played to those feelings by painting himself as a hero of the common man, as being pro-America. Both of these candidates highlight how potent a populist campaign can be. Sanders’s supporters were enraged at how he was treated during the Democratic Convention, and Trump managed to pull off one of the most shocking political victories in history.
In order to prevent another catastrophic crisis, the government needs to adequately regulate business. A free market is a wonderful thing when there are safeguards in place to protect the consumer and the company from harm. However, preventing financial crises does not eliminate populism. The onus still falls on people to see populism for what it is: a dangerous force that can stem from any political ideology and threaten democracy. Today, we find ourselves caught in the midst of a populist storm. If we, as a country, are to weather this storm, we have to recognize populist demagogues for who they are and vote accordingly.
(Overhead picture courtesy of the Nassau Institute.)