When governments try to protect economic agents from the consequences of risky behavior, the risky behavior increases.
The pandemic-relief stimulus checks may have created a fiscal-policy equivalent to the Greenspan put, and it could encourage risky behavior in much the same way.
W hen the stock market crashed in 1987, Federal Reserve chairman Alan Greenspan acted decisively to prevent an economic collapse. Subsequently, whenever the market tumbled, the Fed swooped in to the rescue. This regular pattern created a belief in what traders called “the Greenspan put.” The “put” is an option that lets you sell a share at a given price, regardless of where the market is. If you had a put that gave you the right to sell a stock for, say, $10, you wouldn’t care if the price dropped to $5. Similarly, traders didn’t shy away from risky assets when prices dropped, because they assumed Greenspan would soon adopt policies that would reverse the decline.
There is widespread belief that the regular tinkering with markets during this time induced excessive risk-taking that eventually led to the financial crisis of 2008. Since risk-takers expected to be bailed out, they took more and more risk, and eventually, there was so much risk on the table that a crash was inevitable.
Looking at the latest data, something like the Greenspan put appears to be emerging in our post-pandemic world. In the past, when the economy experienced two consecutive quarters of negative GDP growth numbers, consumers would engage in something economists call “buffer stock” savings. They would reduce their consumption in anticipation of possibly losing their jobs. This would build a buffer stock that might help see them through difficult times, but in the short run, the consumption decline would make the downturn steeper. In the first half of this year, however, when the economy experienced two consecutive quarters of negative GDP change, we saw no buffer-stock behavior at all.
For example, real disposable personal income is down about 3 percent relative to last year. Normally, that would lead to buffer-stock saving, and a paring down of consumption. But real consumption is up about 2 percent year-over-year, and is even accelerating. According to the Atlanta Fed’s GDPNOW forecast, fourth-quarter GDP growth is expected to be 2.8 percent, buoyed by euphoric consumption behavior, which is set to add 3.2 percentage points to GDP in the quarter. In other words, consumers are on a spending binge, and absent that binge, the GDP numbers would be negative.
Without income to support consumption, consumers are running up massive debts. Total household debt, which includes mortgages, is up by 8.3 percent relative to last year, and credit-card debt is up 15 percent. Add higher interest rates to that equation and the fundamentals are aligned for consumers to hit a brick wall sometime next year.
In other words, we are seeing the reverse of the normal recession pattern from consumers. Normally, things get a little rough, and then prudent consumers prepare for the storm by reducing their debts and increasing their savings. This time, things got a little bit rough in the beginning of the year, and consumers threw a massive party.
The best explanation for this behavior is that the extremely generous fiscal policy during the pandemic and even after it has taught consumers that there is a fiscal-policy analogue to the Greenspan put. Call it the “Covid put.” Just as Greenspan was always there to bail out equities when times got tough, Congress will be there to mail checks as soon as the seas are stormy. And it’s not just the federal government: California has already mailed “stimulus” checks of up to $1050 this year.
The problem, of course, is that risk is real. When governments try to protect economic agents from the consequences of risky behavior, the risky behavior increases. People who lose their jobs as the Fed tightens over the next year will have no room left on their credit cards to protect their families.
It took more than a decade for the Greenspan put to turn into a genuine crisis. This time, when the inevitable negative shock happens, the collapse will be much larger unless the government doubles down on its bailouts. But if it does that, then it will confirm the presence of the Covid put, which will make the next cycle even worse. As consumption begins to head south next year, policy-makers will have to decide whether they will continue to feed this devastating economic spiral. Right now, consumers seem to believe that they will.