The early 1980s recession describes the severe global economic recession affecting much of the developed world in the late 1970s and early 1980s. The United States and Japan exited recession relatively early, but high unemployment would continue to affect other OECD nations through at least 1985.[1] Long term effects of the recession contributed to the Latin American debt crisis, the savings and loan crisis in the United States, and a general adoption of neoliberal economic policies throughout the 1980s and 1990s.
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The early 1980s recession was a severe recession in the United States which began in July 1981 and ended in November 1982.[2][3] The primary cause of the recession was a contractionary monetary policy established by the Federal Reserve System to control high inflation.[4] 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.[5] In mid-1982, Rockford, Illinois had the highest unemployment of all Metro areas with 25%.[6] In September 1982, Michigan lead the nation with 14.5%. Alabama was second with 14.3% and West Virginia was third with 14.0%. The Youngstown–Warren Metropolitan Area had an 18.7% rate, the highest of all Metro areas. Stamford, Connecticut had the lowest with 3.5% unemployment.[7]
The peak of the recession was in November and December 1982, when the nationwide unemployment rate was 10.8%, highest since The Great Depression. As of 2011, it is still the highest since the 1930s.[8] In November, West Virginia and Michigan had the highest unemployment with 16.4%. Alabama was in third with 15.3%. South Dakota had the lowest unemployment rate in the nation, with 5.6%. Flint, Michigan had the highest unemployment rate of all Metro areas with 23.4%.[9] In March 1983, West Virginia's unemployment rate hit 20.1%. In the Spring of 1983, thirty states had double digit unemployment rates. When Reagan won re-election in 1984, the latest unemployment numbers (August 1984) showed West Virginia still had the highest in the nation, 13.6%, with Mississippi in second with 11.1%, and Alabama in third with 10.9%.[10]
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 reached 9.1% in 1975, the highest rate since 1947. Inflation declined to 5.8% the following year, but then edged higher. By 1979, inflation reached a startling 11.3% and in 1980 soared to 13.5%.[2][11] A brief recession occurred in 1980. Several key industries—including housing, steel manufacturing and automobile production—experienced a downturn from which they did not recover through the end of the next recession. Many of the economic sectors that supplied these basic industries were also hard-hit.[12] Each period of high unemployment was caused by the Federal Reserve, as it substantially increased interest rates to reduce high inflation; each time, once inflation fell and interest rates were lowered, unemployment slowly fell.[13]
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, a highly important economic measure, eventually reached 21.5% in June 1982.[3][14]
The recession had a severe effect on financial institutions such as savings and loans and 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).[15] 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.[16] By the end of the year, the Federal Deposit Insurance Corporation (FDIC) had spent $870 million to purchase bad loans in an effort to keep various banks afloat.[17]
In July 1982, Congress enacted the Garn–St. Germain Depository Institutions Act of 1982 (Garn–St. Germain), which further deregulated banks as well as deregulating savings and loans. The Garn–St. Germain act authorized banks to begin offering money market 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, increased the unhealthy competition between banks and savings and loans, and encouraged overbuilding of branches.[15]
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.[17]
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 reduce moral hazard and encourage other banks to rein in some of their 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.[15]
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.[18]
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.[15]
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.[15][19] In financial circles, the FHLBB and FSLIC were called "the doormats of financial regulation."[20]
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.[15]
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.[15][19]
Congressional deregulation worsened the S&L crisis. The Economic Recovery Tax Act of 1981 encouraged a boom in commercial real estate building projects. The passage of DIDMCA and the Garn–St. Germain act expanded the authority of federally-chartered S&Ls to make acquisition, development, and construction real estate loans and eliminated the statutory limit on loan-to-value ratios. These changes allowed S&Ls to make high-risk loans to developers. Beginning in 1982, many S&Ls rapidly shifted away from traditional home mortgage financing and into new, high-risk investment activities such as casinos, fast-food franchises, ski resorts, junk bonds, arbitrage schemes, and derivative instruments.[15]
Federal deregulation also encouraged state legislatures to deregulate state-chartered S&Ls. Unfortunately, many of the states which deregulated S&Ls were also soft on supervision and enforcement. In some cases, state-chartered S&Ls had close political ties to elected officials and state regulators, which further weakened oversight.[15][21][22][23]
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.[24] 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 loans overseen by the agency. Despite these failures and mergers, there were still 415 S&Ls at the end of 1982 that were insolvent.[15][19][22][23][25]
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.[15]
The S&L crisis lasted well beyond the end of the economic downturn. The crisis was finally quelled by passage of the Financial Institutions Reform, Recovery and Enforcement Act of 1989. The estimated total cost of resolving the S&L crisis was more than $160 billion.[26]
The recession was nearly a year old before President Ronald Reagan stated on October 18, 1981, that the economy was in a "slight recession".[27]
The "Reagan recession,"[28][29][30] 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.[31][32][33] In January 1983, Reagan's popularity rating fell to 35%—approaching levels experienced by Richard Nixon and Jimmy Carter at their most unpopular.[34][35][36] Although his approval rating did not fall as low as Nixon's during the Watergate scandal, Reagan's reelection seemed unlikely.[37][38][39][40][41]
Pressured to counteract the increased deficit caused by the recession, Reagan 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.[42]
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 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.[43][44][45][46][47][48] However, the net balance of power in the Senate was unchanged.
As with most of the developed world, recession also hit the United Kingdom at the turn of 1980s, although the economy had been plagued by a string of crises for most of the 1970s and unemployment had gradually increased since the mid 1960s.
When the Conservative Party led by Margaret Thatcher won the general election of May 1979 and swept James Callaghan's Labour Party from power, the country had just witnessed the Winter of Discontent in which numerous public sector workers had staged strikes. Inflation was about 10% and some 1,500,000 people were unemployed; compared to some 1,000,000 in 1974, 580,000 in 1970 and just over 300,000 in 1964.[49] Margaret Thatcher set about to control inflation with monetarist policies and change trade union laws in an attempt to reduce the strikes which had blighted Britain for so many years.
Mrs Thatcher's battle against inflation resulted in the closure of many inefficient factories, shipyards and coalpits – mostly during her first four-year term in power. This helped bring inflation below 10% by the turn of 1982 (having peaked at 22% in 1980) and by spring 1983 it had fallen to a 15-year low of 4%. Strikes were also at their lowest level since the early 1950s.
However, it also resulted in unemployment reaching 3,000,000 by January 1982 – a level not seen for some 50 years. Even the 2,000,000 figure first seen towards the end of 1980 had not been reached in over 40 years.
By April 1983, Britain – once known globally as the "workshop of the world" due to its strong manufacturing base – became a net importer of goods for the first time ever, largely due to the loss of heavy industry under Thatcher. Areas of Tyneside, Yorkshire, Merseyside, South Wales, the West of Scotland and the West Midlands were particularly hard hit by the loss of industry and subsequent sharp rise in unemployment. The national average by January 1982 was around 12.5%, but in some of these regions it was approaching 20% and would remain similarly high for a number of years afterwards.
In the first three years of Mrs Thatcher's premiership, opinion polls gave the Tory government approval ratings as low as 25%, with the polls initially being led by the Labour opposition and then by the SDP-Liberal Alliance which was formed by the Liberal Party and the Labour breakaway Social Democratic Party during 1981.
The mid-term Congressional elections proved to be the low point of the Reagan presidency.
According to Keynesian economists, a combination of deficit spending and the lowering of interest rates slowly led to economic recovery.[50] However, conservatives insist that the significantly lower tax rates caused the recovery. From a high of 10.8% in December 1982, unemployment gradually improved until it fell to 7.2% on Election Day in 1984.[5] Nearly two million people left the unemployment rolls.[51] Inflation fell from 10.3% in 1981 to 3.2% in 1983.[2][52] Corporate earnings rose 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.[51]
By November 1984, voter anger at the recession evaporated and Reagan's re-election was not in doubt.[40][41][48] Reagan was subsequently re-elected by a landslide electoral and popular vote margin in the 1984 presidential election. Immediately after the election, Dave Stockman, Reagan's OMB manager admitted that the coming deficits were much higher than the projections released during the campaign.
As for the United Kingdom, economic growth was re-established by the end of 1982, although the era of mass unemployment was far from over. By the summer of 1984, unemployment had hit a new record of 3,300,000 (although the depression of the early 1930s had seen a higher percentage of the workforce unemployed) and it remained above the 3,000,000 mark until the spring of 1987, when the Lawson Boom – so named as it was the consequence of tax cuts by chancellor Nigel Lawson – sparked an economic boom that saw unemployment fall dramatically. By early 1988, it was below 2,500,000. By early 1989, it fell below 2,000,000, and by the end of 1989 just over 1,600,000 were unemployed – almost half the figure of three years earlier.[53] Other incentives which aided the British economic recovery after the early 1980s recession included the introduction of Enterprise Zones, on deindustrialised land where traditional industries were replaced by new industries as well as commercial developments – with businesses being given tax breaks and exemption from rates for a certain period of time, as an incentive to set up base in these areas.[54]
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