November 30, 2022

Bad Business of Recession

Investing in markets, stock, real estate, and otherwise, is a gamble and with all such bets there are inevitably going to be winners and losers. 

At the NY Times, David Leonhardt writes that the Federal Reserve’s "great moderation" may have been a mere illusion fueled by stock and land rushes over the last 16 years.

The recent financial turmoil has many causes, but they are tied to a basic fear that some of the economic successes of the last generation may yet turn out to be a mirage. That helps explain why problems in the American subprime mortgage market could have spread so quickly through the world’s financial system. On Tuesday, Mr. Bernanke, who is now the Fed chairman, presided over the steepest one-day interest rate cut in the central bank’s history.

The great moderation now seems to have depended — in part — on a huge speculative bubble, first in stocks and then real estate, that hid the economy’s rough edges. Everyone from first-time home buyers to Wall Street chief executives made bets they did not fully understand, and then spent money as if those bets couldn’t go bad. For the past 16 years, American consumers have increased their overall spending every single quarter, which is almost twice as long as any previous streak.

It’s natural for spending to rise as one’s income or worth, or the perception of same, is on the rise.  But was that perception based in reality?  Not in all cases.  While stocks are still overvalued – by 10%, according to a Merrill Lynch analyst – and real estate prices in many locations are as well, American consumers, many of whom should have known better, took on increasing levels of debt during the Clinton and Bush years.

Consumer spending kept on rising for the last 16 years largely because families tapped into their newfound wealth, often taking out loans to supplement their income. This increase in debt — as a recent study co-written by the vice chairman of the Fed dryly put it — “is not likely to be repeated.” So just as rising asset values cushioned the last two downturns, falling values could aggravate the next one.

“What people have done is make an assumption that these prices could continue rising at the rate they had been,” said Ed McKelvey, an economist at Goldman Sachs. “And that does seem to have been an unreasonable assumption.”

Exactly.  Unfortunately, today’s losers are often families and individuals who bet on the housing market by taking out loans they didn’t understand and/or could not afford.

Some have suggested that lenders preyed upon uninformed consumers and pushed them into riskier loans that was prudent.  Undoubtedly this has happened, but as a question of nation-wide scope, I cannot believe such practices are the root cause of the lending market’s implosion.  While both lenders and borrowers are culpable in this mess it is primarily because of lack of proper conservative thinking on their parts that is to blame far more than criminal wrongdoing.

Contrary to what Barbie says, math is not hard.  Percentages are taught from elementary school through high school in every district in this country.  If any American does not understand the implications of interest rate risk it is through an almost deliberate ignorance of reality.  Lending companies, like the savings and loan companies before them, made too many loans to the wrong customers, people who had to have known what they were capable of paying off, what they were risking, and that interest rates had to – had to – go back up.  But both parties acted in bad faith anyway.

Now President Bush is working hard with the Democrats, at last, on a economic stimulus package.  That is not great news, in my opinion.  We’ve overspent ourselves into this situation.  Exactly how is further taxation, debt, and interest supposed to rectify the current financial situation?  This approach is not just counter-intuitive, it’s wrong.

Worse, all of the Democratic presidential candidates are getting in on the act and turning it into a political necessity.  Hillary had this to say in the recent South Carolina debate:

I would have a moratorium on home foreclosures for 90 days to try to help families work it out so that they don’t lose their homes. We’re in danger of seeing millions of Americans become basically, you know, homeless and losing the American dream.

I want to have an interest rate freeze for five years, because these adjustable-rate mortgages, if they keep going up, the problem will just get compounded. And we need more transparency in the market.

Her last sentence is true, obviously, just as it was true in the wake of the Enron ponzi scheme and in the aftermath of the S&L collapse under President Reagan.  More transparency in government and markets is always needed but rarely achieved. 

Freezing interest rates and stripping banks of the option of foreclosure will shift some of the losses from the consumers to the financial institutions.  But this action would not make these losses go away.  The money has to come from somewhere, either from the pockets of consumers, lenders, or shareholders.

Similarly, the funds to be spent by the federal government as a part of a stimulus package cannot be created from thin air.

The deficit seems to be an afterthought as lawmakers race toward agreement with President Bush on a plan to pump perhaps $150 billion worth of deficit spending into the economy. The bulk of the plan would come as tax cuts, though Democrats are pressing for additional help for the unemployed and people on food stamps. Constituency groups in both political parties are pressing for even more, such as Democratic-sought aid to cash-strapped states and people with high heating bills.

The argument that tax cuts do not equate to spending is false because the government will spend $X in the FY 2009 budget regardless of whether the stimulus package is passed or not, regardless of the budget deficit, regardless, in fact, of anything short of bankruptcy.

Borrowing more money to stimulate the economy now is a fool’s errand that simply passes the buck for this generation of leadership’s bad behavior to our children and their children and their children, just as bailing out the consumers of ill-advised sub-prime loans at the expense of tax payers, stockholders, and those borrowers who resisted the siren call of the ARM loan penalizes these parties.

Caveat emptor, anyone?

marc

Marc is a software developer, writer, and part-time political know-it-all who currently resides in Texas in the good ol' U.S.A.

View all posts by marc →