Was That Really Prosperity?

During the recent presidential election and in our current “fiscal cliff” debates over tax and spending policies, I’ve heard frequent reference to the economic boom years of the 1990s. Many have pointed out that the United States had higher tax rates and also high economic growth under the administration of President Clinton. If only we could go back to Clinton-era policies, the argument goes, we could return to prosperity. However, it seems to me fairly obvious that the economic benefits of that earlier decade were not produced by tax policy and that many of our current problems have their roots in the artificial prosperity of that time.

To some extent, the demise of the Soviet Union and the end of the Cold War boosted the American economy just as President Clinton came into office. More importantly, though, two bursts of speculation pumped up temporary national well-being. First, the “dot.com” bubble took off, as the United States became a center of new communication technology and investors rushed to put their money into this new industry, inflating stock values. This bubble didn’t really burst, since investment in communication technology did not disappear, but it did contract suddenly. However, another bubble was expanding at that same time. Housing prices jumped in the early 2000s, but the rapid growth in the price of houses began in the middle of the 1990s.

If we look for Clinton-era policies that affected the economy, we should probably focus on housing and mortgages, rather than taxes. The Clinton administration took aggressive steps to end and perceived discrimination in housing, making lenders more reluctant to refuse to make loans. More importantly, the administration encouraged mortgage lending to lower-income borrowers in order to promote more widespread home ownership. In 1995, the Department of Housing and Urban Development (HUD enabled Fannie Mae and Freddie Mac to get affordable housing credit for buying subprime loans that often went to low-income borrowers. This encouraged the mortgage industry to extend loans to those most likely to default. The growing industry absorbed investments from all over the world, and the values of homes and the increasingly sophisticated financial instruments that carried debt shot up.

The two bubbles helped transform the American economy into one that was based heavily on finance, concentrating wealth, even while the mortgage bubble pushed poorer Americans into unsustainable debt. This type of speculation was clearly not a sound basis for an economy. Also, governmental efforts to increase home ownership became a classic case of unintended consequences: egalitarian policies that ultimately increased income inequality, created a greater burden of debt for poorer people, and helped transform the economic structure into one that offered opportunities for investors rather than for workers.

I don’t know whether we will go over the cliff and see taxes immediately go up and government spending immediately go down or not. But regardless of what happens at the end of this year, the ultimate goal should be to build an economy based on sound economic activity and not on speculation. Nostalgia for the Clinton prosperity is like waking up with a bad hangover after a drunken spree and saying, “gosh, I’d feel great if I were only soused again.”