- The Washington Times - Monday, April 30, 2001

The sad stories can be found on the Internet chat boards of the trendy online brokerages that enticed millions of Americans to invest their money in the great bull stock market of the 1990s.
"I have not paid attention to what my husband has been doing in our account. We have lost close to everything," laments one Charles Schwab account holder. She confides that shes "having trouble communicating" with her husband and is taking courses on making conservative investments to try to recoup their losses.
Another investor on the same bulletin board, dubbed "Everyone Makes Mistakes," says he bought $2,000 of Xybernaut stock on a whim after seeing wearable computers like those made by the company portrayed on "The X-Files." The $20 shares "headed south from there and are now around $3," he said. "I lost hard-earned money being cute."
"I know people who have lost their homes trading, and worse," said a frequent trader on E-Trades Internet High Flyers discussion board. "I wish I was more conservative… . This is the most difficult market Ive seen in 25 years."
These online investors are voicing the woes of millions more Americans who prefer to suffer in silence. Hopes of earning big money in a market that seemed to go nowhere but up in the late 1990s have been brutally dashed in the past year as the ebullient bull turned into a snarling bear that has consumed more than $4.5 trillion in household wealth.
With nearly every major stock index down by 20 percent to 30 percent, an army of investors must decide whether to keep hoping for a turnaround or to turn "paper" losses into real ones and live with the consequences: postponed spending plans for new cars, vacations, and even for a college education and retirement.
Economists say the overhang of stock losses is unprecedented because nearly half of Americans own stock far more than during the last bear market in 1990. And because the losses could have a potentially enormous depressing effect on consumers, they also could help drive the already sluggish economy into a recession.
While the bull was raging on Wall Street, the double-digit gains enjoyed by most American investors spurred a spending spree like none ever seen before. Simply by cashing in and spending a mere 4 percent of their yearly stock gains, consumers drove up the average growth rate from 3 percent to 4 percent a year, economists estimate.
But now many fear that trend will reverse: The drop in stocks will force consumers, already deeply in debt and dipping into their savings, to grow more cautious and retrench on spending.
"The outlook for U.S. consumption growth is bleak," said economist John H. Makin with the American Enterprise Institute, in view of the "severe damage to household balance sheets" caused by the past years stock losses.
Mr. Makin expects consumers to cut back spending and increase their savings to more normal levels from the record low rate of minus 1.3 percent set earlier this year. Historically, savings has ranged between 3 percent and 5 percent of income, while today, consumers are dipping into their savings to pay for purchases.
Even a modest increase of $350 billion in savings this year could cut economic growth by 3.5 percentage points, Mr. Makin said. When combined with plunging business investment spending and falling exports, that retrenchment in spending could cause "a nasty recession," he said.
Goldman Sachs economists agree that if consumers increase their savings back to more normal levels, the effect on growth could be "severe." They expect the negative effect from stock losses to unfold slowly and build over time.
L. Douglas Lee, president of Economics from Washington Inc., said the threat of disappearing wealth pulling the rug out from under consumers was very much on Federal Reserve Chairman Alan Greenspans mind last week when he ordered interest rate cuts for a fourth time this year.
The Feds rate-setting committee mentioned "the possible effects of earlier reductions in equity wealth on consumption" as a principal concern in a statement it issued along with the rate cuts.
"We are in uncharted territory," said Mr. Lee. The Fed believes the changes in wealth affect consumer spending with a lag, he said. That explains why consumer spending has held up in the past year despite the plunge in the stock market.
The lingering effects of the long bull market helped to buoy spending throughout 2000 and early this year, Mr. Lee said. But next year, the reverse could be true.
"Mr. Greenspan is not interested in taking any chances," he said.
"The message to equity investors is clear," said Edward Yardeni, chief investment strategist with Deutsche Banc Alex.Brown. "The folks at the Fed dont want a recession, and they do want consumers to keep shopping."
Mr. Yardeni said the Fed made a "dramatic reversal" when it admitted that the lagged effect of stock market losses could drag the economy down. Only last year, Mr. Greenspan argued that the stock market was stimulating too much spending in the economy.
Even with aggressive action by the Fed to prevent a recession, "some argue that the cumulative loss of equity wealth over the last few quarters has made an extended downturn in spending unavoidable," said Neal Soss, economist with Credit Suisse First Boston.
According to Mr. Soss, "History suggests that recessions occur about 50 percent of the time that bear markets occur."
A recession is more likely the longer the bear market lasts, he said. Todays bear market already has lasted as long as some that occurred in previous recessions.
But on the positive side, Mr. Soss said, the Fed reacted much earlier in this bear market than in previous ones.
David A. Wyss, chief economist with Standard & Poors DRI, said fears of a recession induced by stock losses are overblown.
"The level of wealth remains high," he said, noting that the ratio of household net worth to income hit a record 6.4 in the first quarter of 2000 before declining to 5.9 in the first quarter of 2001.
"That still would have been a record before 1999," he said. "Were still rich, just not as rich as we thought we were a year ago."
Joel Naroff of Naroff Economic Advisors also scoffed at the idea that consumers have been daunted by big stock losses.
"I guess when your wealth collapses, the only thing to do is buy a new home," he said, joking about how "worried" consumers drove up new home sales to record levels over 1 million a year just last month.
People simply dont make the biggest purchase of their lives when the economy is tanking, he said.

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