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The Behavioral Economist
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I hold multiple undergraduate degrees with concentrated focus in the fields of Psychology, Sociology, History, and Economics. Prior to working as an independent strategist for a handful of clients, I was employed as a behavioral economist for a private London based group. Before that, I worked... More
  • The Potential Market Pitfalls Of America's Political Polarization

    When President Barack Obama defeated Republican challenger Mitt Romney in 2012 to retain his presidency and enter into his second term, the social reaction was equal parts jubilation and horror. From a behavioral standpoint, watching America's mixed reactions was both fascinating and terrifying. It was, as a response to a domestic political election, as equally divided a social response as I had ever seen. It appeared as though every American, both those who exercised their right to vote and those who didn't, felt some sort of personal satisfaction or devastation following the election night announcement.

    Historically speaking, the 2012 election didn't carry the contentiousness of Hayes' victory over Tilton in 1876, nor was it as feverishly controversial as Bush's election victory in 2000. So what was it that had made the 2012 election such a catalyst for social and political outcry? On the surface, one could argue that it was ideological. After all, Hayes and Bush were both republicans who had claimed victory over their democratic challengers. Obama of course had won from the blue side of the ticket. However considering the ideology of the Republican Party during Hayes' time, it hardly allows for comparison to the modern era. No, something in 2012 was different. It was something the American public hadn't seen before.

    At first I thought to myself, it must be technology's fault. If twitter, CNBC, and Fox News had existed during the time preceding the Civil War, today wouldn't seem so bad by comparison; right? Let's just blame media bias and move on with our lives. Unfortunately, it wasn't that easy. Sure, the political lines in mass media are clearly etched into stone, but it would be shortsighted to blame all of our ideological differences on a few news anchors and a couple of radio show hosts. Once again, something in 2012 was different. I was determined to figure out what had gone wrong, and when we had turned the corner. When and why had America become so polarized?

    1987: Ted Kennedy and Robert Bork

    On June 26, 1987 Supreme Court Justice Lewis Powell made the announcement that he would retire. Liberals immediately took to the streets. For them, this man's retirement represented the worst possible scenario. At the time, the presidency belonged to staunch conservative Ronald Reagan, and his track record regarding congressional appointments was well known. In the six years prior to Powell's announcement, Regan had already appointed Sandra Day O'Connor, Antonin Scalia, and William Rehnquist. Needless to say, Regan never hesitated to act as the driving force of conservative values. Thus, when Powell announced his retirement, liberals saw the writing on the wall. Regan was going to appoint another one of "his guys" to the Supreme Court, and in doing such he would swing the power back to republican circles.

    Before Powell could even finish his formal announcement, Massachusetts Senator Edward Kennedy, a man with steadfast liberal values and royal democratic bloodlines, sought out the nearest media outlet. In fact, his comments started to garner as much attention as those of Powell or President Regan. Immediately going on the offensive, Kennedy said;

    "Congress will ensure that President Regan does the right thing here, as opposed to the 'far right' thing".

    And so it began. Liberals felt that Regan was abusing his power blindly without even an ounce of bipartisanship, and Regan, quite frankly, didn't care. To this day, opinions of Regan can stir up as much animosity among political opposites as abortion, health care reform, or immigration law.

    Eventually, Regan announced his nominee for Powell's soon to be vacant seat. His selection was ultra-conservative, District of Colombia Court of Appeals judge, Robert Bork. Many Republican henchmen had wanted Bork appointed at the time Regan named O'Connor, so to hear Bork's name now sent the nations conservatives into a state of euphoria. Needless to say, the nation's liberals reacted in a manner adamantly opposed to the nomination.

    Bork was a competent man. He was educated at the University of Chicago, was on the faculty at Yale, and was considered to be one of the country's experts in antitrust law. Almost none of that mattered at this point. Who he was became irrelevant in comparison to what he was. He was a Regan nominee. He was the guy who could swing power in the Supreme Court to a president devoted to conservative causes as much as anyone in history. He was no longer just a man; he was a catalyst for significant change. Depending on one's political ideologies, that change could have been either good or bad.

    Enter into the fold the fear mongering, the impossible promises, and the linchpins of modern era politics, and the battle for Powell's vacant seat ensued. On the Republican side there was Regan and Bork. On the opposite side, the loudest voice was that of Senator Kennedy. As the media warfare continued, Americans became engulfed in the chaos. People, who had never before even considered or cared to understand what an ideological majority in the Supreme Court meant, suddenly had opinions, passions, and voices devoted to one side or the other. The nomination took on the momentum of a presidential election.

    Then it happened. Kennedy, doing his job as both a democrat and member of the Senate Judiciary Committee, arguing his perspectives on the Bork nomination, made the following comment;

    "Robert Bork's America is a land in which women would be forced into back-alley abortions, blacks would sit at segregated lunch counters, rogue police could break down citizens' doors in midnight raids, and children could not be taught about evolution."

    That was it. The gloves were off. Whether Kennedy was right or wrong is of no consequence. Whether Bork was a capable genius, or a detached and indifferent bigot, is of no consequence. Whatever ones opinion was, America had changed. Voters had changed. The electoral process had changed. The side of the ticket someone was on had become more important than who the candidate or appointee was. Bork would never see his nomination come to fruition. The senate, inevitably, rejected his nomination. Regardless, the damage had been done to the collectively psyche of the American public. The foundation had been laid for each citizen to firmly declare being either a republican or a democrat, and soon there would be no more middle ground.

    Where We Stand Today

    Since 1987 the divide between the parties has be growing considerably, as can be seen by the chart below (taken from a Duke University Study in May 2013).

    (click to enlarge)

    In the upper right corner of the above chart you can see a small modular measurement going back a century. Yes, there were spikes around the turn of the century, as well as at the onset of World War Two, but they fail to impress in comparison to modern times. This, of course, brings us back to the original question; what is so different about 2012? Why does the gap now seem so insurmountable? Why are politicians regularly compared to petulant children? What makes this era, these people, and this social construct so different? It is my contention that the state of our market economy over the last 8 years is the difference. For perhaps the first time, people are associating financial markets directly to ongoing political animosity, and nothing weighs on the conscience of an individual more than financial stress. The polarization of the political system is carrying over to the economic system in such a way where the two systems are functioning as catalysts for one and other to a degree that has never before existed.

    Consider also that the Bork nomination was rejected on October 6, 1987. This represented one of the first events in the recent political era that truly separated the parties with such ferocity. 13 days later, the stock market experienced "Black Monday". The losses were substantial. In fairness, there were many factors that contributed to the drop; the economy had been slowing since 1986, issues between Iran and Kuwait were escalating, and Treasury Secretary James Baker had gone public with his market concerns. However, it was in the wake of the growing divide between the parties, sparked from the Bork nomination, that led the global belief that if American's political stability was uncertain, then the continued growth of the American economy was in doubt. The economy had taken a fall off a cliff, largely in part to strictly political factors (see below).

    (click to enlarge)

    Behavioral Finance Theory

    In the simplest of terms, behavioral finance theory is the conceptual interdependence between the market and social behavior. It is a means for defining and understanding the relationship between everyday people and the everyday economy. It has always existed. This is not a new social paradigm. However in a historical context it has largely resided in obscurity . Classical economic theories focus more on supply and demand, currency and commodity, distribution and product. In recent years though, it has become clear that behavioral finance theory is growing not only in relevance, but in effect. As social behavior evolves, so does the economy. For this reason, political polarization in America is having an effect on financial markets, both directly and indirectly.

    During the government shutdown most of the coverage was saturated with details about the debt ceiling and potential default. Certainly, this was a matter of real concern and was worthy of the efforts committed to its coverage and exploration. However, there were additional concerns that went largely overlooked. Those concerns circulated around the everyday American and their everyday activities in the financial markets.

    When the government shut down, the basic systems which are often overlooked but largely depended on by the American people, were shut down with it. Recipients of social security benefits, disability benefits, the welfare system, and government pensions were in threat of not receiving their checks. Federal employees of lower and middle level public designations were without work. The Bureau of Alcohol, Tobacco, and Firearms was shut down. The U.S. Post Office was under threat as well. Small business loans, federal mortgage funding, business licenses, liquor licenses, firearm permits, and personal debt extensions with any government agency, were temporarily halted. These actions have real effects on real people in the everyday world. Sadly, all of it stemmed from a polarized two party political system incapable of bridging the gap between them.

    When everyday people can't function, they can't contribute. Small business owners awaiting license extensions can't continue to operate and generate revenue. Entrepreneurial Americans waiting on SBA loan funding can't start their contributions to commerce. The neediest members of the consumer construct; the elderly, the disabled, and the poor, can't receive their benefits. None of these people can make contributions to the economy if the system is not supportive.

    On the surface, maybe these seem like small factors. However, these are just a few of the many examples which exist. The bottom line is that when people can't go out and spend money, procure products, and live their lives, they are hurting the markets. Whatever your equity positions are, ask yourself where they would be if revenues fell, customers dried up, and growth ceased? The equities market is driven by growth and earnings, therefore without growth, and with reduced earnings, the markets go backwards. Eventually, potential gains grow more likely to become significant losses. When people don't spend, businesses don't grow.

    When everyday businesses, like grocery stores and gas stations, are suddenly without customers the entire market slows. The tanker companies that bring the oil, the shipping companies that deliver the grain, the manufacturing companies that make cereal boxes, the rubber and plastics companies that engineer gas pumps; they're all suddenly entities of less value. The everyday consumer is what makes the neighborhood store a client for the distributor. The neighborhood store is what makes the distributor capable of being a customer for the manufacturer. The consumer chain and the supply chain function in reliance of one and other. The self-sustaining economy that feeds capitalism is dead without reciprocity. Therefore, if one link in the chain is broken, then by definition, the whole chain is broken. Consumers drive markets.

    When political dysfunction leads to consumer destruction the economic system fails to thrive. In the event that dysfunction continues, then the economic system could theoretically cease to exist. All the world's great civilizations have followed the same reciprocal cycle; from servitude to autonomy, from autonomy to wealth, from wealth to complacency, from complacency to apathy, and from apathy back to servitude. The political cycles in these civilizations have changed alongside the economic climate. Whether it be totalitarianism, tyranny, anarchy, fascism, communism, capitalism, or a wildly dysfunctional two party democracy stuck somewhere between democratic republic and free market libertarianism. Where will it go next?

    One of the strengths of behavioral finance theory is that it is constantly adapting. It is reasonable. It moves forward with a willingness to assess new information as it becomes available. It's a shame that America's politicians can't function the same way. If this polarization between the parties continues, then the effects on the market could be dire.

    Conclusion

    America stands at an impasse in economic history. The fractures in the political system are adversely affecting the strength of the financial system. While recovery from the "Great Recession" is finally starting to gain traction, it would be tragic if this natural course of events was pulled off the rails by political upheaval. However one cannot blame the politicians alone.

    Politicians are products of the jurisdictions they represent. The people, who make up these jurisdictions, whether they are communities, corporate entities, or political action committees, are equally responsible. It is in fact the polarization of the people that is reflected in the polarization of the government.

    In today's world, one can't go to the grocery store without being overwhelmed with opinion. Every other car in the parking lot is covered with firmly opinionated bumper stickers. Tables are set up outside the entry to the store with people looking for donations for their causes. At the exit, tables are set up for people seeking donations for the exact opposite cause. It is chaos.

    It has long been proven that when two people can't agree on what to do, they often do nothing. This rarely brings about progress. I'm not a political scientist. I don't have the answer. I am however capable enough to foresee that the future of the economy, and the equity markets, will move hand in hand with political progression. Currently, this doesn't bode well. Whether one is a bull or a bear, they can at least usually agree that their perspective is one of measured opinion as opposed to divine certainty. In fact, that is what Seeking Alpha is, a platform for an exchange of ideas in order to allow investors to weigh both sides of a potential stake. All of us manage to co-exist here.

    Maybe donkeys and elephants should function more like bulls and bears. Perhaps congress should look to Seeking Alpha for a more functional communication model. Who knows? What is known is this; politics are broken in America, and for as long as this problem goes on unresolved to such a profound degree, then the future of the equities market will remain at risk. As long as politics in America remain massively uncompromising, the markets will respond in a reciprocal fashion. We've just endured the "Great Recession". Could we really handle another "Black Monday"?

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Oct 28 5:49 PM | Link | 8 Comments
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