So it turns out that the stock market can go down, too. Who knew? Well, everyone knew, probably even President Donald Trump, who has been boasting about the Dow Jones industrial average’s spectacular rise since his election - and now must absorb whatever political consequences flow from its dramatic gyrations over the past few days.
A decade of easy money from the Federal Reserve encouraged investors to buy relatively risky assets, such as stocks. Now that the Fed has gradually begun to unwind those policies, and to plan small but steady interest-rate increases, a sell-off of some kind, or at least more normal levels of volatility, was bound to occur.
Yet there are few signs of panic. In part, that’s because the overall U.S. economy appears far better positioned to withstand turbulence on Wall Street than it was in 2007-2008, when a sudden cooling of overheated financial markets triggered the Great Recession -which is why the Fed enacted the aforementioned aggressive policies. If anything, the market mavens are getting nervous now because employment and wage growth are so strong that they might trigger a spike of inflation, which, in turn, would cause the Fed to raise interest rates faster.
Today’s relative confidence is also based, in part, on the restored strength of the financial sector. Recapitalized and reorganized over the past decade, America’s banking system has the wherewithal to survive even in the unlikely event of a catastrophic downturn. Consequently, no one fears that a financial market correction would spawn the kind of contagious insolvency that previously seized Wall Street. Just eight months ago, in fact, the Federal Reserve announced the results of its annual “stress test” for the nation’s 34 largest banks. Every one of them had enough capital to make it through a hypothetical recession in which unemployment hit 10 percent (it’s 4.1 percent now), housing prices fell 25 percent - and the stock market lost half its value, not just the 10 percent correction ithas approached of late.
This stabilization did not happen by accident or spontaneously. Tougher federal regulations, in particular the Dodd-Frank Act, which mandates the periodic stress tests, forced banks to hold more capital and to get out of certain risky activities. Echoing overblown Republican claims that Dodd-Frank hurts economic growth, Trump targeted the law in an executive order last year, which led Treasury Secretary Steven Mnuchin to make a series of proposals to weaken it. The Republican-controlled House of Representatives has passed a bill that would reduce the stress tests from an annual exercise to a biennial one, among other questionable ideas.
Weaning the economy off extraordinary monetary policy without major disruption is Job One for the new chairman of the Federal Reserve, Jerome Powell, who was chosen by Trump in part for his reputation for favoring lighter bank regulation. We have no advice for Powell on the technical aspects of his task, such as the precise size and timing of interest-rate changes. But when it comes to financial regulation, experience - including very recent experience - teaches that less is not necessarily more.