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RESE... The H LIRRARY Federal :-~.J··ve B.s nk of St . Louis AP er 2 199f Economic Education Newsletter Federal Reserve Bank of Boston Vol. 17, No. 1-Spring 1991 11 The Top Ten'' Economic Events of 1990 H ere are the Public Services Department's choices for the "Top Ten Economic Events of 1990~ As is the case with most "Top Ten" lists, our choices are subjective. We make no claim that ours is the definitive list, nor do we offer an in-depth analysis of each event. Rather, we hope that our list will prompt you to review last year's events, make your own choices, and extensively discuss the events you choose. Some specific cases or incidents are noted to refresh your memory on what a busy year 1990 was in the world of economics. The S&L/Bank Crisis Continues T he bailout of the savings and loan industry continued to make headlines. When the crisis began in the late 1980s, original estimates had put the cost of protecting depositors of failed institutions at $60 billion, but by the end of 1990 the projected cost had soared to $500 billion. Analysts continued to offer a variety of explanations for the S&L crisis. Some pointed to portfolios of real estate loans that had gone bad, while others attributed the crisis to such things as deregulation, junk bonds, lax supervision, and fraud. There seem to be enough examples to partially support any of the theories. In April, officials of Columbia Savings and Loan (Beverly Hills, CA) announced that their institution was insolvent. Columbia, once the most profitable S&L in the United States, had fallen victim to its big stake in junk bonds. When the market collapsed, Columbia's junk bond portfolio lost more than half its face value. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Charles Keating and Lincoln Savings and Loan were back in the news in September when Keating surrendered to authorities on a 42-count criminal fraud indictment. Although his attorneys won dismissal of more than half the charges in November, Keating's problems were far from over. There were also indications last year that banks, particularly northeastern banks, were experiencing some of the same difficulties that had beset S&Ls. The year began with Citicorp's announcement on January 17 that it was adding $1 billion to reserves for problem Latin American loans . Less than two weeks later, the board of directors at the troubled Bank of New England ousted that bank's president. Bank of New England's loan portfolio was filled with real estate deals that had gone sour. In July, regulators ordered U.S. banks to write-off 20 percent of their $11 .1 billion in loans to Brazil and 20 percent of their $2.9 billion in loans to Argentina. Two months later, Chase Manhattan announced that it would slash its dividend and cut its staff by 5,000. Most observers seemed reluctant to predict how much the protection of insured bank deposits might ultimately cost the U.S. taxpayers, but whatever the cost, it would be in addition to the $500 billion projected for the S&L bailout. The Three Rs: Recession/Real Estate Slump/Rising Unemployment B ack in October of 1987, investors were badly shaken when the U.S. stock market lost more than 500 points during a single day of trading, but the one-day "crash" didn't trigger a recession . The American economy continued an expansion that had begun five years earlier. By the end of 1990, however, most analysts agreed that the economy was sliding into recession with New England and the Mid-Atlantic states leading the way. The northeast's real estate and construction boom had gone bust and caused problems for developers and bankers alike. Even Donald Trump couldn't escape the ill effects. Midway through 1990 it looked as if the person who had brought the world Trump Towers, the Trump Shuttle, and the Taj Mahal Casino was in danger of defaulting on a bond payment until his bankers put together a $65 million Trump bailout. Beyond the headlines, newspapers offered yet another indication that the economy had cooled. With each new edition, " help wanted" ads seemed to lose more column inches to real estate auctions and foreclosure notices. Company after company announced major lay-offs. Sears, Data General, McDonnell Douglas, Chase Manhattan, Pan Am , and a host of other companies eliminated thou sands of jobs. U.S. Debt/Government Shuts Down During Columbus Day Weekend C olumbus Day Weekend (1990) was not a good time to visit a national park, a national historic site, or the nation's capital. The doors to the Smithsonian were locked . The pandas at the National Zoo munched their bamboo shoots without the usual crowd of onlookers. Park range rs turned campers away from Yosemite. Boats that normally ferried passengers to the Statue of Liberty remained tied to their moorings. All these things happened, or didn't happen, because the U.S . government had run out of money. Despite a series of high-profile budget summits, Congress and the Administration had been unable to agree on a deficit reduction program . At the beginning of the 1980s, The U.S. debt had stood at just over $1 trillion. By mid-1990, it had surpassed $3.2 trillion. The budget deficit for FY 1990 was approximately $221 billion-the second highest in U.S. history. Government sources predicted that the deficit for FY 1991 would be a record $318 billion, but it could go higher depending on whether or not our allies make good on their commitment to defray the cost of the Persian Gulf war. German Reunification E very map of Europe printed from 1945 to 1990 showed a divided Germany and a divided Berlin . As recently as two years ago hardly anyone would have dared predict that East and West Germany would be reunited anytime soon, but that is exactly what happened on October 3, 1990. "The Wall~ which had divided East and West Berlin since 1%1, had begun to come down at the end of 1989. And even before reunification became a reality, throngs of East Berliners made day-trips to gaze at the astonishing variety of consumer goods in West Berlin's shops. By and large, Germans, Europeans, and Americans looked upon German reunification as a positive development. But reunification also raised a number of complex, and sometimes troubling, economic issues. How would West Germans react to the unrestrained flow of East Germans seeking economic opportunity in the West? How would the German government cope with the unemployment resulting from the shutdown of uncompetitive East German factories and businesses? Who would pay to clean up the frightful environmental damage wrought by 45 years of East German government neglect and indifference? Would the German and page2 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis European capital that had been helping to finance the U.S. budget deficits now go to finance the economic revitalization of East Germany? How much more formidable an economic competitor would a united Germany prove to be? As of December 1990, these questions remained largely unanswered. The Gulf Crisis I n August of 1990, Saddam Hussein sent Iraqi troops to invade and annex Kuwait. His action had immediate economic repercussions. By the middle of October, oil prices had topped $40 a barrel, and analysts were predicting even higher prices if a shooting war erupted between Iraq and the coalition of forces arrayed against it. (Events proved them wrong. By December, the price of a barrel of crude had dropped back into the twenties.) No one was sure how much the war would cost and who would pay for it. In an effort to defray the expense, U.S. diplomats successfully pressed Japan , Germany, and Arab allies to pledge billions toward the war effort, but the $300-$500 million daily pricetag could rise to more than $1 billion if hostilities escalate into a full-scale ground war. [A full-scale land war commenced and ended in February 1991. The monetary cost hasn't yet been calculated.] On top of all that, the U.S. government has forgiven a $7 billion debt owed by Egypt, and Israel has requested billions in U.S. aid . All this comes at a time when the U.S. budget deficit for FY 1991 is projected to be a record $318 billion . There had been talk of a war tax, but Administration officials seemed reluctant to call for one. Meantime, domestic critics of U.S . policy in the Persian Gulf have lamented the fact that military action has diverted scarce resources from urgent problems at home. Earlier in 1990, warming relations with the Soviet Union and the democratization of Eastern Europe had fostered hopes that the U.S. government might be able to spend less on defense and more on education, health care , the environment, and the country's decaying infrastructure. By the end of the year, however, it had become apparent that that there would be no "peace dividend~ An end to the Cold War didn't necessarily mean that the United States could shift billions from defense spending to domestic programs. The 1990 Census T he 1990 census confirmed what many people have long suspected: The Sunbelt's population continues to increase while many northern cities and states seem to be declining in population . Politicians on either side of the MasonDixon line are reacting very differently to the census results. In the North, many big city mayors, governors, and members of Congress are charging that the latest figures aren't accurate. They claim the census didn't fully count the homeless and the inhabitants of poor urban neighborhoods. By contrast, southern politicians seemed fairly satisfied with the results. Some half-jokingly talked about the Confederacy's long-awaited revenge. At stake in the census controversy are Congressional seats and federal dollars. If the figures are indeed accurate, the ensuing Congressional reapportionment could lead to a shift in the Congressional balance of power, resulting in an increased flow of federal funds to the Sunbelt-perhaps at the expense of northern cities and states. Of course something quite different could also happen. Politicians in the Sunbelt's expanding metropolitan areas might conclude that they share many common interests with their northern counterparts . Ultimately, members of Congress might form alliances that depend less on geography and more on the need to address problems that affect metropolitan areas in all parts of the country. Foreign Ownership of U.S. Companies and Real Estate D oes it really matter if a foreignowned company controls the food, lodging, and souvenir concessions in Yosemite National Park? Apparently, quite a few Americans think that it does. Last year there was an unanticipated side effect when Japan's Matsushita Electric Industrial Company paid $6.6 billion to acquire MCA Inc., the Los Angeles-based entertainment production and theme park company. Before the deal was even final, a number of sources, including the U.S. Depart- ment of the Interior and the National Park Service, expressed concern over the fact that Yosemite's MCA-owned concessionaire was part of the package. The thought that a foreignowned company would control the concessions in one of America's preeminent national parks seemed to be more than many Americans could bear. As a result of the uproar, Matsushita and MCA agreed to put the Yosemite concessionaire in escrow and find an American buyer for it. The flap over who would run Yosemite's hotels, shops, and bus tours was yet another indication that Americans seem increasingly concerned over the trend toward foreign ownership of U.S. companies and real estate. MCA wasn't the first major American entertainment company to be acquired by Japanese owners. Sony bought CBS Records in 1987 and Columbia Pictures in 1989. Foreign buyers have also displayed great interest in American real estate. During the 1980s, buyers from Europe and the Middle East spent- heavily on U.S. properties, and Japanese investors bought New York's Rockefeller Center. Will the trend continue in the 1990s? If so, what will the effects be? Does it matter who owns Rockefeller Center? Should Matsushita's ownership of MCA cause Americans any more concern than General Electric's own ership of NBC? The ability of the Japanese to make huge investments in the United States is a result of Japan's large surplus in its merchandise trade with the United States. The foreign trade deficit of the U.S. could easily be considered one of the major economic events of the year. The Environment and the 11 Green Revolution" T he twentieth anniversary of Earth Day may have received the most media hype, but several other stories about the environment figured prominently in last year's economic news. Passage of a second Clean Air Act, disagreement over the seriousness of global warming, concern over the loss of "old growth" trees and tropical rain forests, increased demand for products that don't harm the environment, and defeat of California's "Big Green" referendum question are issues that reflect the ongoing conflict between increasing concern for the environment and established economic interests. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The Clean Air Act of 1990 provides a perfect example. Nearly everyone hailed the Act as a "historic" measure that would eliminate or substantially reduce urban smog, acid rain, and toxic chemical emissions, but the ease with which it sailed through Congress (89-10 in the Senate; 40125 in the House) belied the fact that a number of powerful interest groups had successfully lobbied Congress and the White House for years to block passage of new clean air legislation. One provision of the Act called for a drastic reduction of the sulfur dioxide emissions that cause acid rain . To comply with the stricter regulations, utilities knew they would have to install costly scrubbers, retrofit their plants with "clean coal" technology, or switch from high-sulfur to low-sulfur coal; all would lead to higher utility rates, lower utility company profits, and severe economic dislocation in areas that depend on the mining of high-sulfur coal. Faced with those impacts, the utility companies, the high-sulfur coal producers, and their respective constituents felt compelled to lobby against clean air legislation. Joining them in their efforts were the automakers, chemical companies, and other groups that feared higher costs. It took years of legislative wrangling and compromise to overcome their objections. Similar conflicts surrounded other environmental issues in 1990. California voters defeated "Big Green; a farreaching referendum question that would have banned many pesticides, strengthened the state's air pollution regulations, banned offshore oil drilling, and set aside money to buy stands of ancient redwood trees ("old growth" forests). In Brazil, there was conflict between those seeking to develop the Amazon rain forest and those who feared its destruction. World attention focused on the trial of wealthy landowners accused of murdering Chico Mendes, a Brazilian rubber-tapper and environmental activist who opposed further development of the rain forest. Yet there were also stories of successfu I attempts to strike a balance between environmental concerns and economic interests. After years of pressure from environmental groups, the major tuna processors adopted policies to protect the dolphins that often accompany schools of tuna. As a result of the new policies, most cans of tuna now sold in the United States are labeled "Dolphin Safe~ In another encouraging development, McDonald's and the Environmental Defense Fund agreed to cooperate in finding ways for the nation's biggest fast food chain to reduce its volume of solid waste and increase its use of recyclable packaging materials. One of the first steps McDonald's took was to announce the phase-out of its plastic foam meal containers. The Demise of Drexel and the Collapse of the Junk Bond Market B anking Terminology, published by the American Bankers Association, defines junks bonds as "speculative bonds .. . sold at a low price or at very high interest rates because of their high risk of default': (When a company issues junk bonds, its debt burden increases, often without any corresponding increase in earning assets.) In the eyes of buyers, the higher yield compensates for the higher risk. During the 1980s, junk bonds proved to be an effective instrument for financing leveraged buyouts and entrepreneurial ventures. Many new enterprises that were unable to raise capital through traditional means, such as investment-grade bonds and stock offerings, got their start thanks to junk bond financing. Along the way, however, many investors seemed to lose sight of the fact that junk bonds pay a higher yield because they carry a higher risk, and last year the junk bond market collapsed. It was a particularly bad year for Drexel Burnham Lambert, the investment house most closely associated with junk bonds, and for Michael Milken, the Drexel financier credited with originating the junk bond concept. Drexel Burnham Lambert (pronounced lam-bare) filed for bankruptcy protection and Michael Milken faced $600 million in fines and a tenyear prison sentence. The ill-effects of the junk bond market collapse weren't limited to Wall Street. The downfall of Columbia S&L (Beverly Hills, CA) was widely attributed to Columbia's large investment in junk bonds. At one time, Columbia's junk bond holdings had a face value of $4 billion. By the end of 1990, the bonds were worth half that much. (Many of Columbia's junk bonds were bought from Drexel.) page3 New England Update Trouble for the Airlines T he U.S. air travel industry experienced quite a bit of turbulence last year. Much of it was in bankruptcy court. Ledger Award Goes to B.C. High Teacher Soaring fuel prices resulting from the Gulf Crisis combined with a softening economy to cause big problems for some of the most renowned names in American aviation. Eastern, founded in the 1920s by World War I flying ace Eddie Rickenbacker, filed for bankruptcy in 1989, and its fortunes worsened in 1990. [Eastern ultimately failed in early 1991.) Pan Am, which pioneered international air travel and jet passenger service, experienced severe financial difficulty last year. Continental, a carrier that initially benefited from airline deregulation, filed for Chapter 11 bankruptcy protection in December 1990. lWA, saddled with a $2.6 billion debt and an aging fleet of fuel-guzzling aircraft, also experienced financial pressure last year. Some industry analysts also pointed to deregulation as the source of the airlines' woes. Deregulation was supposed to foster increased competition and lower fares . Those things came to pass but not in the way that most people expected . More often than not, the lower fares were the result of desperate fare slashing by airlines in the most dire financial straits. Passengers who didn't fly routes affected by the price wars found themselves paying higher fares than ever before . And rather than stimulating the growth of new carriers, deregulation seemed to be hastening the consolidation of the airline industry. Get 'Em While They're Hot C opies of the Bank's newly revised and redesigned Public Information Catalog are now available. The attractive new catalog lists all the publications and multimedia materials available through the Federal Reserve Bank of Boston . For a free copy, write to : Publications, Public Services Department, Federal Reserve Bank of Boston, P.O. Box 2076, Boston, MA 02106-2076. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ~ ii "0 • •= IIC .c IL ii IIC > .Q 0 0 .c IL Nicholas Argento (center) receives congratulations from B.C. High social studies chairperson Margaret Florentine (left) and Ledger editor Robert Jabaily. T he Ledger Award is presented annually to a teacher or administrator who has demonstrated a commitment to furthering economic education in the First Federal Reserve District. It is named for The Ledger, an economic education newsletter published quarterly since 1974 by the Federal Reserve Bank of Boston's Public Services Department. The Ledger Award for 1990 went to Nicholas Argento, a social studies teacher at Boston College High School in Dorchester, MA. Ledger editor Robert Jabaily presented Mr. Argento with a framed certificate during a special awards assembly at the school, and he noted that it was "a pleasure to present The Ledger Award to someone who is not only an outstanding teacher but a genuinely nice person as well': Students and teachers at the assembly gave Mr. Argento a standing ovation when he rose to accept the award. The school's executive vice principal, Paul J. Hunter, described Mr. Argento as "a teacher who is active and involved in all aspects of the school~ He said that Mr. Argento "has an excellent rapport with students and faculty" and added that "B.C. High wouldn't be the same without him~ Social Studies Department chairperson Margaret Florentine called Mr. Argento "a valuable member of the staff who is always there in a pinch': Mr. Argento has been a member of the faculty at Boston College High School for nearly nine years. The Federal Reserve Bank of Boston has been involved in economic education for more than 20 years. During that time the Bank's Public Services Department has worked with teachers and administrators to foster high quality economic education in the First Federal Reserve District. If you would like to nominate a teacher or administrator in the First Federal Reserve District for The Ledger Award, please let us know by writing to : The Ledger, Public Services Department, Federal Reserve Bank of Boston, P.O. Box 2076, Boston, MA 02106-2076. page4