Booms, Busts, and Bailouts: The Federal Role in Building Investor Confidence

Analyzing the relationship between government and the economy from 1980 to the present

Throughout United States history, economic policy has been at the core of the country’s development. Since Adam Smith’s Wealth of Nations introduced Laissez-Faire economics in 1776, the proper role of government in the economy has been a subject of contentious debate. Until the 1900s, the United States experienced fluctuating periods of government involvement and nonintervention. Nevertheless, toward the middle of the twentieth century, following the Great Depression and World War II, the United States entered a period of economic stability, during which it embraced government spending and regulation through its adoption of Keynesian economics. This success was short-lived, as the 1970s were characterized by crippling stagflation, a time of widespread inflation and unemployment. Instability led to the need for a change, which was brought about by the Reagan Administration in the 1980s. From 1980 to the present, governmental responses have significantly increased investor confidence and participation, leading to growing markets; however, this confidence has occasionally led to risky behavior and caused market downturns rather than sustained growth.

In the 1980s, the Reagan Administration’s emphasis on supply-side economics increased investor participation, resulting in a shift from a bear to a bull market. Ronald Reagan began his presidency in 1981 during a bear market, reinforcing the need for economic reform. He introduced a series of policies known as Reaganomics, which aimed to uplift the country’s economic state. This financial plan reduced regulations, enabling small businesses to enter the market with lower start-up costs. These decreased barriers to entry resulted in a more competitive environment, so businesses were forced to constantly innovate and improve their efficiency, as well as lower their prices to have greater public appeal. These conditions produced better products, increasing consumerism and stimulating investments as people saw businesses flourish. Another important aspect of Reaganomics was reduced government spending on social welfare programs. This process encouraged more people to find jobs due to the fewer benefits available, and the expanding workforce boosted economic success. The country’s need to borrow money to support such programs also reduced, causing lower interest rates, which made participation in the market more attractive for investors. Additionally, Reagan’s plan cut taxes with his proposal of the Economic Recovery Tax Act of 1981. This legislation reduced federal income tax for individuals and gave tax breaks to businesses. For example, Reagan dropped the tax rate of the highest earners by 20% and reduced individual tax rates more broadly by about 25% over the three years following the ERTA. As a result, people had more money, and businesses’ net profits kept increasing, making people more inclined to invest. However, due to currency instability from declines in global markets, the United States economy experienced a crash in 1987 known as Black Monday, with the bull market reaching a halt. This event resulted in significant losses; nevertheless, it was short-lived and recovered entirely by mid-1988 due to government intervention: Reaganomics advocated for monetarism, which refers to controlling the supply of money in the economy. The Federal Reserve made financial systems more liquid, causing a greater circulation of cash. With a surge of money, there was a growth in investor activity, leading to another bull market by the end of the decade.

In the years following, consistent government intervention during bear markets led to a continued increase in investor confidence, consequently resulting in bull markets. At the beginning of the 1990s, the United States entered a period of economic recession due to the Persian Gulf War. Iraq, led by Saddam Hussein, invaded Kuwait in hopes of gaining control over oil reserves. The United States and its allies attempted to prevent this occupation by launching a military campaign to expel Iraq from Kuwait. This uncertainty about the oil supply led to a major increase in oil prices. With oil being a key driver of economic growth, the stock market fell, and inflation rose. By 1991, the United States succeeded in preventing Iraq from taking over Kuwait, restabilizing the market as oil prices sharply declined. Inflation decreased while the market increased, causing a growth in investment activity. This revitalized bull market continued into the second half of the decade. It was supported by the Dot Com Bubble, a period in the second half of the 1990s during which the government funded and supported the research and development of many startups. Emerging technologies like the internet, digital financial services, and online communication tools rapidly grew, yielding massive investment.

Although this surge in investor activity initially led to market success, investor behavior ultimately developed into overconfidence and excessive risk-taking by the turn of the century. President Bill Clinton, aware of this dynamic, recognized the need to change financial policies. In 1999, the Clinton Administration introduced the Gramm-Leach-Bliley Act, which repealed parts of the Glass-Steagall Act and allowed banks, insurance companies, and investment firms to merge. Bill Clinton claimed that the Glass-Steagall Act prevented the financial service industry from adapting to the changing global landscape since it kept investment banks, commercial banks, and insurance companies separated in an increasingly integrated economy. With the Gramm-Leach-Bliley Act now allowing for a more interconnected economy, financial institutions significantly grew in size and also began to offer a greater diversity of services. This system of universal banking saved banks time and money. As a result, there was higher efficiency and faster output of financial products, yielding larger profits. Consumers and businesses also benefited from these conditions, strengthening investor activity and initiating another bull market by 2003. The market continued to increase through the primary part of the decade due to the government’s pro-growth stance. Many investors became reliant on the Fed Put, which was the belief that the Federal Reserve would support market downturns. This excessive assurance promoted risky trading, as investors believed that housing markets would rise indefinitely. Low interest rates and easy access to mortgages also increased real estate investments. However, developing into overconfidence, this risky investment attitude led to the 2008 Financial Crisis, caused by the collapse of the mortgage market. People were unable to repay their home loans, experienced weak regulation of lending, and endured unstable investments from banks pooling bad loans and spreading the losses across the global banking system. 3.1 million Americans lost their houses due to foreclosures, and 9 million lost their jobs, making it the worst economic crisis since the Great Depression.

The government’s lack of transparency during its immediate response to the 2008 Financial Crisis further reduced investor confidence; nonetheless, its transparent, direct intervention toward the end of the crisis generated a shift to a stable bull market. The crisis resulted in a substantial decrease in risk tolerance and an increase in risk perception, which led to significant market volatility. Investors sold most of their stocks in panic and shifted to safer investments like government bonds. Credit markets also froze, as banks became unwilling to lend to people, businesses, and each other. The market became more stagnant, which made it hard to sell even relatively safe assets at a decent price. September 15, 2008, marked the most detrimental day of the 2008 Financial Crisis, as one of the biggest investment banks at the time, the Lehman Brothers, went bankrupt. In response, on October 3, 2008, the government enacted the Troubled Asset Relief Program, with its main goal being to prevent a total collapse of the economy. As a result, it planned to pour 700 billion dollars into large, failing financial institutions by buying toxic assets. While the immediate liquidity prevented further recession, this measure was met with limited success. It disproportionately targeted large banks instead of individuals to stabilize major institutions. Through this initiative, the United States was only able to prevent around 700,000 to 800,000 home foreclosures, much fewer than its projected three to four million. The government’s lack of transparency and consistency caused investor uncertainty in the government’s ability to help. There was also a fear surrounding the skyrocketing national debt, leading to decreased investor confidence despite the prevention of a full-blown market collapse. Consequently, on November 25, 2008, the Federal Reserve introduced its first round of Quantitative Easing, where it supported housing markets by agreeing to buy up to 100 billion dollars in debt obligations and an additional 500 billion dollars in mortgage-backed securities. This measure increased the supply of money and lowered long-term interest rates due to greater liquidity. Borrowing became cheaper, and people continued to reallocate their money into safer assets. Investors started to see their investments growing, significantly boosting confidence. In 2009, the economy began to see another bull market after the introduction of the American Recovery and Reinvestment Act, followed by continued growth with the 2010 Dodd-Frank Act. The American Recovery and Reinvestment Act promoted job creation through infrastructure projects, provided tax cuts for businesses and individuals, expanded unemployment benefits, and invested in education. The Dodd-Frank Act limited risky trading, increased regulation of big banks, and created the Consumer Financial Protection Bureau to protect people from unfair financial practices. The S&P 500 rose about 2,000 points over this stretch. Through these conditions, the United States experienced its longest bull market in the country’s history, which lasted from 2009 to 2020, until the United States faced another economic crash due to the Coronavirus pandemic.

Following the bear market that occurred with the 2020 COVID-19 crash, governments continued to adopt a more interventionist policy by enacting stimulus programs, leading to a bull market through greater investor confidence. In late February 2020, the market experienced a significant fall after the global pandemic shut down businesses, banned travel, and brought about a lockdown. Investors panicked and quickly sold large amounts of shares, resulting in one of the fastest declining stock markets in history. The Dow Jones Industrial Average experienced a 1,300-point drop in this period, and the unemployment rate peaked at about 14%. In order to prevent a complete collapse of the economy, the government rapidly took action. In March 2020, it enacted the Coronavirus Aid, Relief, and Economic Security Act, more commonly referred to as the CARES Act, which provided over 2 trillion dollars in emergency funding to stabilize the United States economy. The government made direct payments to individuals, expanded unemployment benefits, and offered forgivable loans to small businesses. Direct payments were up to 1200 dollars per adult and 500 per child under seventeen, remarkably helping families who suffered a loss in income with the restrictions imposed by the lockdown. The increase in unemployment benefits helped people who lost their jobs, ensuring they had sufficient resources while looking for a new one. Businesses were also able to stay afloat through this act, as the small loans they were given helped them keep a level of liquidity and have the money to pay their employees. The CARES Act went further by funding hospitals, schools, and local governments with billions of dollars, in addition to pausing payments of student loans and protecting people from home evictions. On the whole, this act heavily increased liquidity and indicated strong support from the government. It helped reverse the stock market decline, as conditions became more stable and people increased their investing activity. The government funding also resulted in the growth of the technology, entertainment, and healthcare sectors, which provided many opportunities for innovation during a medical crisis. Investors became optimistic about seeing massive growth in these areas, so stocks began to surge and generated lofty profits, soon making the bear market bullish. At one point, the volume of trading was going up by 13.9% every week, signaling the extent to which the market was growing. With more acts gradually imposed, the stock prices continued increasing, and the new government policies fueled a desire from investors to continue engagement in the market.

The United States government’s role in the market has continually evolved in the past few decades. From the 1980s deregulation through Reaganomics to the 2008 and 2020 government-backed stimulus programs, the government’s place in the economy has gone through major changes. Nevertheless, there has been a constant pattern where government intervention has led to market stabilization and an increase in investor confidence. These periods of federal involvement have shaped bull markets; however, at times, they have led to overconfidence and excessive risk, resulting in bearish conditions. Even through these conditions, the government has always responded in order to encourage investment activity and lead to market resurgences. With the current Trump Administration, the market has gone through major fluctuations as a result of the aggressive tariffs and protectionist policies. Although they have attempted to boost many domestic industries, numerous companies face major problems surrounding the increased prices of foreign goods. Due to the difficulties of adapting the currently outsourced supply of goods to local products, many businesses have raised their prices, leading to higher consumer costs. Investor confidence has weakened due to market volatility, and this ever-changing dynamic of bearish and bullish periods reflects the significant impact that changes in government intervention have on the market and its investors.

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