November 2, 2008
Welcome to my Casbah! I’m David Siegel. In 2005, I wrote about the coming Godzilla Economy, and I’m sorry to see it has happened. Even though I was prepared for it, the economic meltdown of the past few months has been even worse than I thought it would be. Not only did the feet of the monster step through the economy and wipe out the banking sector and commercial credit, but the tail then swashed through and cleared out whatever hadn’t been damaged, reaching into every sector and every corner of the globe. Now comes the tail of the monster – the consumer credit crisis.
Around the world, the debt markets are far larger than the equity markets. Stock markets may power your retirement account, but debt provides the grease that makes (er … made) our economy run every day. Even though we had a real recession in the early nineties and a serious slowdown in 2000, output and interest rate volatility are much less than they were in the post-war period through the seventies. Fed chairman Ben Bernanke calls this the Great Moderation. He gives credit to the FED for managing interest rates appropriately, but the rational management of interest rates really stopped in the late nineties, when When Alan Greenspan and Company reacted to the “irrational exhuberance” of the tech-driven markets and their subsequent correction by dropping interest rates to the floor. This encouraged people to borrow and spend – even on things they couldn’t afford. Your manicurist and personal trainer went from being day traders in tech stocks to becoming condo flippers in the exploding real-estate market. Of course, as with the run-up of the stock market, everyone was hoping to get in on the action and sell to a greater fool later. When that tree didn’t grow to the sky, the real-estate bubble burst pretty much on cue, leaving many people with more debt and inventory than they could carry.
Recently, Representative Henry Waxman, one of my congressional heroes, called Greenspan into his House Committee on Oversight and Reform for a little chat on the record. In that discussion, Greenspan opened by observing, “We are in the midst of a once-in-a-century credit tsunami.” He went on to say:
I made a mistake in presuming that the self interest of organizations, specifically banks and others, was such that they were best capable of protecting their own shareholders and the equity in the firms,
The problem here is that something that looked to be a very solid edifice and indeed a critical pillar to market competition and free markets did break down. And that, as I said, shocked me and I don’t fully understand why it happened.
And this is the central lesson of debt: there are times when it’s appropriate to borrow money, and there are times and situations where it is irresponsible. If you need a loan to help you pay for a computer that can help you make money as a bookkeeper, that’s a sensible time to borrow money. If you have a reliable source of income and you want to buy a home to live in, and you can afford the monthly payments, that’s a sensible time to borrow money. If a business needs money to buy inventory and can pay it back after the selling season, that can be a sensible time to borrow money. Borrowing and lending money is such a good business overall that our entire economy is based on it.
Borrowing money has a flip side, however. When you can’t make your car payments, you learn that the bank really does own your car and will come take it away. When you borrow money from Guido for a “sure fire” business idea, you learn that Guido isn’t such a nice guy if it doesn’t work out. While equity investors can lose their investments, borrowers can potentially lose everything. When President Bush borrows $5 trillion dollars from other countries to run the government, he’s really borrowing from future tax payers – making it seem like we aren’t paying taxes, when we are really paying more taxes than we should, because he is borrowing irresponsibly. This is how Republicans make it look like everything is rosy on their watch, so they can hand enormous amounts of debt to the next administration, whose job it is to tighten belts and reduce spending until the borrowing is back under control.
Republicans do this because voters can see stock market indices much more clearly than they can see national debt figures. This is called paying your Visa bill with your MasterCharge, also known as Reaganomics. As Tom Friedman writes in the New York Times:
Never has one generation spent so much of its children’s wealth in such a short period of time with so little to show for it as in the Bush years.
Direct marketers know that the average person in the United States is vulnerable to advertising that offers credit cards and other scams at prices that look affordable. This is why you see infomercials that say “All for the low low price of just three easy payments of $33.33 plus shipping and handling!” The credit involved in direct-mail scams (especially for credit cards) has been a huge factor in the overleveraging of the American economy.
Alan Greenspan – steady hand at the tiller, or unwitting architect of the 2008/2009 Depression?
During the period from 2001 to 2007, which just happens to coincide with the term of a particular president, and which saw incredibly low interest rates across the board, borrowers and lenders played into each others’ hands, spiraling ever upward to the point where everyone was maxed out and leveraged past the hilt. While there was a ton of speculation by hedge funds, banks, and insurance companies, the average American worker was just trying to maintain a certain standard of living – and that was probably the thing that did the most damage.
During this time, real wages did not increase. Most people’s income didn’t go up. Yet, rather than cutting back and saving, average Americans kept spending. During this time, the television airwaves were flooded with ads from DiTech and WaMu selling cheap money, and those who originated loans collected big fees. And consumers took the bait. They didn’t get lower interest rates to reduce their payments – they got lower rates to move into a bigger, better home they couldn’t have afforded otherwise. Alan Greenspan didn’t expect it, but he shouldn’t look so surprised. Make no mistake: consumer response to low interest rates is a big part of how we got where we are today. Houses got bigger. People bought gas-guzzling cars, even though the price of gas was going up. Jobs moved overseas, because many people didn’t want to do those jobs at that price. Many people took seminars and bought real-estate, hoping to make a killing. Many people paid off credit cards with home-equity lines, then continued to spend on credit cards again. The stock market went up, and several Christmas selling seasons were better than most economists expected. Everyone continued to buy cool gear and new cars, even though the Bush Administration was running the economy into the ground. It was easy enough to see, but we all wanted to keep a decent American lifestyle. No one wanted to admit that the prudent thing to do would be to pay off credit cards, save some money for an emergency, and find a balanced mix of investments that didn’t depend too much on the real-estate economy.
When the house of cards fell, as it did in Japan in the early nineties, everyone had to pull back. Banks are now much more cautious about lending money to businesses and other banks. But what about to consumers? Are they still part of the problem? What about consumer credit? What about the debt consumers owe so they could buy stuff, rather than borrowing for things that would pay back later? Could there be another domino waiting to fall? Could revolving consumer debt take this country from recession to depression?
Let’s investigate further.
Before you continue reading, go to Maxedoutmovie.com, order the movie, and watch it. Don’t worry – I’ll still be here when you get back. If you prefer, you can just read the synopsis, but the movie is really worth watching and it’s a good idea to support the filmmakers, who probably had to borrow on all their credit cards to produce the film. Now you’ve learned that we’re still in a trap and the jaws are about to snap shut on middle-class wage earners, not just subprime borrowers and Wall Street bankers. Middle-class homeowners are on the brink of a precipice that could take them into the abyss. How do we know this?
Amount of bad loans lenders had to write off in the first half of 2008: $21 billion (Source: New York Times)
Amount of bad loans lenders expect to write off in the next 18 months: $55 billion (Source: New York Times)
Number of homes in the U.S. currently under water (worth less than the mortgage): 7.5 million (Source: CNN)
Number of homes in some state of foreclosure in September, 2008: 265,968 (Source: CardTrak.com)
Percentage increase from the same month in 2007: 21
Number of home foreclosures predicted for 2008: 2.5 – 3 million (Source: Truthout.org)
Number of home foreclosures predicted for 2009: Another 2.5 – 3 million (Source: Truthout.org)
Number of personal bankruptcies in 2005, the year the new law on bankruptcy written by the bank lobby and rubber stamped by George Bush went into effect: 2,000,000+
Number of personal bankruptcies in 2006, the first year when it was much harder to go into bankruptcy and seek protection from creditors: 573,000
Number of personal bankruptcies in 2007: 800,000+
Bankruptcy increase in first half of 2008 from one year earlier: 50%
Amount the average American consumer carried in non-real-estate debt in 1997: $4,400 (Source: FED)
Amount the average American consumer now carries in non-real-estate debt: $8,800 (Source: FED)
2007 median amount of credit card debt carried by the average American household: $6,600 (Source: CardTrak.com)
Amount of revolving credit card debt carried by every man, woman, and child in America: $3,000 (Source: CardTrak.com)
Amount the average American household pays per year in interest on revolving credit-card debt: $1,500 (Source: CardTrak.com)
U.S. unemployment in September, 2008: 6.1%
Expected U.S. unemployment in September, 2009: 7.5% (Source: Forecasts.org)
Amount the average American spent on health care in 2007: $7,600 (Source: NCHC.org)
Average out-of-pocket medical debt for people filing bankruptcy in the U.S.: $12,000 (Source: Harvard University)
Percentage of bankruptcy filings caused at least partially by medical expenses: 50 (Source: Harvard University)
Finally, according to the New York Times, consumer spending — which makes up more than 70 percent of American economic activity — dipped at a 3.1 percent annual rate between July and September, after growing at a 1.2 percent annual rate in the previous three months.
We Are Not Down Yet
We have learned the extent of Bernard Madoff’s Ponzi scheme, which vaporized $50 billion of investors’ money, but we still haven’t reconed with the world’s largest Ponzi scheme by far – the US Social Security and Medicare system. If you think we’re borrowing from tomorrow to pay for today, wait until you see what tomorrow looks like. Pete Peterson and his gang have made a very important film that every American and European should see, called I.O.U.S.A. Please go watch it now, and tell your friends about it. The film explains how bad the next ten years will really be when the bills come due on our new pseudo-socialist economy and we are still struggling to get to the end of every month. There are appropriate times to borrow, and there are irresponsible times to borrow, and we can’t just keep solving our problems by borrowing. There is no white knight in sight.
This is not dangerous. This is not scary. This is insane. Americans are deep in debt and paying a significant amount of their income to credit card companies for things they bought five years ago. The U.S. government and the American consumer have both been living beyond their means, and the party is now over. It’s not because we bought Hummers and vacation homes. It’s because we tried to live well when money was cheap, thinking it would stay cheap and prices would keep going up. It’s because we invested in a little piece of real estate and signed for another loan when we needed to pull back and save a bit. It’s because we called DiTech and refinanced. It’s because we bought mutual funds that did really well in 2006. The new Democratic administration can’t put everything back together again in just four years. Things are going to get worse before they get better. The consumer credit crisis is next, and it’s just getting warmed up.
I am reminded of the car trip from Idaho Springs, Colorado, to Denver on Interstate 70. Much of this stretch of freeway descends from the Rocky Mountains to the great plains at a 6% grade. Now, 6% doesn’t sound that steep, does it? After all, it’s 94% flat! But if you go just 100 miles – two hours of driving – on a 6% grade road, you’ll go down six vertical miles – the distance from the top of Mt Everest to the ocean! All along this road are signs for truckers telling them to gear down, take it slow, and not ride their brakes. [All images are courtesy of Mapguy, used with permission.]
The market prices of many things will drop after the election. In the U.S. markets, 2009 won’t be a year to make a ton of money by betting on the price of anything going up. It’s likely that 2009 will end about where it started, and that’s the good news.
Consumer credit could implode in 2009 – it’s another house of cards waiting to come down. Now your credit score is going to drop, not because you are less creditworthy, but because banks won’t loan as much, so your borrowing potential will go down. Companies that issue credit cards, like Capital One and CitiBank, could be wiped out in 2009. Let me repeat that – companies that issue credit cards could be completely taken down by the consumer credit crisis that is to come.
Now your underwater investments won’t come back up for air, continuing the consumer liquidity crisis.
Now your disposable income will drop dramatically. Bonuses will be zero. This Christmas is going to be tough on retailers. Energy prices will stay down as long as the future look bleak, but high energy and commodity prices will be back in 2010. No matter how low interest rates go this time, the real-estate market is not going to save us (7.5 million homes currently under water). The equity in your home has already been borrowed against and isn’t going up.
Because of the past eight years of utterly irresponsible mismanagement of our country and economy, we truly are right at the breaking point. The Obama team is going to have to do microsurgery while making sure the hospital can stand any further aftershocks. We are extremely vulnerable to a terrorist attack, a serious credit shock, yet more insane borrowing (now that interest rates are back near the floor), and continued dangerous speculation by hedge funds, banks, insurance companies, and the world markets.
Truckers, you are not down yet. Another 18 months of economic decline and price volatility to go.
What to Do?
If you have any money to invest, don’t invest in the U.S. market. It’s going to go back up, but not for several years. Gold and commodities are a bad idea.
It’s okay to keep your remaining powder dry and in the savings account. As Warren Buffet says: “Be greedy when others are fearful.” In my humble opinion, you’ve got another year or so to be greedy, so be greedy but take your time about it and find just the right thing.
If you are going to invest, look at Asia. The Chinese middle class is growing and needs everything we already have – cell phones, houses, travel, toys, cars, computers, internet connectivity, etc. India is growing its middle class as well. Asian index funds are worth looking into. The Cambodian market is mostly a cash market, so it’s less affected by the credit crisis. Be smart – don’t think that just because the stock market had a good day your mutual fund will be back above water any time soon. If you find a better investment (like a Chinese index or a Chinese stock or another Chinese stock), make the jump. The Chinese middle class will continue to grow faster than just about anything else, even if Americans buy fewer Chinese goods, because China now trades with everyone. If you have recommendations for Asian stocks and indexes, please put them in the comments below.
The first thing to do is save ourselves and get stable. Now that Barack is president, we’ll have to answer his call to help him make this country great again. It’s up to us more than people in Washington or on Wall Street. We’ve got to put our own house in order and pull ourselves up by our own bootstraps. We’ll have to make smarter choices on health care and spending. We’ll have to pay down our debts and start saving. We’ll have to retrain ourselves for the jobs of the future. We need to get a grip on reality so we can get back to a good starting point (that’s a PowerPoint deck, by the way) before we can make much forward progress.
At the same time, we’ll have to build the foundation for American success in the 21st Century. For example, we’ll need to put a floor under energy prices, so we can encourage investment in alternative energy sources, especially non-carbon-cycle energy. We’ll need to break the health care industry (another PowerPoint, one you should download and send to all your friends) and put a new one together. We’ll need to start using information much more efficiently, and that’s what the Semantic Web is all about (more on that later).
Read Robert Reich’s blog – always.
If you read one book, please read Naomi Klein’s fascinating book, The Shock Doctrine. The book is a bit too fanatical in its criticism of free-market capitalism, but it’s dead on when covering the atrocities and violations of civil liberties so many governments have so often committed in trying to achieve the goal. There are people waiting to put this doctrine to work again right here in the U.S. – let the book be a clear warning that financial shocks provide the opportunity for radical changes, and if they are radical and focused on making a certain small percentage of people rich, the rest of us will pay for it.
Read George Soros’ excellent explanation and argument for regulation of credit markets.
Read Paul Krugman on the Consumer Liquidity Trap.
Read Michael Porter on Why America needs an economic strategy. In this BusinessWeek article, he says:
Lack of regulatory oversight and capital requirements, in the name of liberalization and well-meaning efforts to extend credit to lower-income citizens, has undermined our financial markets. America underregulates in some areas while it overregulates in others.
I am posting this before Barack Obama is elected president, because I am confident he will be. Barack is going to be the next president. Some people have suggested that on the 5th of November, after it’s been confirmed, Barack should demand a recount. But I believe Barack is the right man for the job. I believe he will bring a lot of good people to Washington to help him. I hope Robert Reich is one of them – he’s one of the sharpest economic strategists and best managers we have. I hope Bill Clinton is one of them – we need him. I hope Bill Richardson is one of them – I’d love to see him play a more important role on the national stage. I hope Henry Waxman gets to play a bigger role in the House, and I hope Joe Lieberman goes back to pal-ing around with international terrorists like George Bush.
I also hope you’ll help me in raising awareness of the Fair Tax. It’s something we need right now, and it’s something Democrats should embrace. It’s not a Libertarian scheme for making rich people richer. It’s a smart way to raise revenues for the government. Just as we have one of the most inefficient, ineffective health-care schemes in the world, we also have one of the most inefficient, ineffective income-tax schemes in the world. There are still many political hurdles to overcome, but we in the FairTax movement know that some day we’ll reach critical mass. I hope you can help us get there. If you have any influence with Barack Obama, ask him to set up an income-tax summit and hear from all sides of the table how we can completely eliminate income tax and still raise the revenues we need in a fair way.
No one should have to pay income tax. No one should have to spend time figuring out how to get around paying income tax. We need a consumption tax, and the FairTax is the way to go. Please visit the FairTax web site, learn more, and tell your friends. I’ll write more about that another day.
Michael Porter says it very well in his article. I’m quoting it here in hopes you’ll click through and read the rest of it:
Republicans keep repeating simplistic free-market thinking, even though the absence of all regulation makes no sense. Self-reliance is preached as if no transitional safety net is needed. Some Republicans even argue passionately that the country should have no strategy because that would be “industrial policy.” Yet the real issue is not picking industry winners and losers but improving the business environment for all American companies, something we cannot do without identifying our top priorities. Overall, Republicans seem to think business can thrive without healthy social conditions.
Democrats, meanwhile, keep talking as if they want to penalize investment and economic success. They defend unions obstructing change in areas like education, cling to cumbersome regulatory approaches, and resist ways to get litigation costs for business in line with other countries. Democrats equivocate on trade in an irreversibly global economy. They seem to think social progress can be achieved only at the expense of business.
To make America competitive, we have to get beyond this thinking. Political leaders, business leaders, and civil society must begin a respectful, fact-based dialogue about our challenges. We need to focus on competitive reality, not defending past policies.
I’ve seen what passes for regulation in this country, and it isn’t pretty. Almost everything the SEC does is designed to make lawmakers look like they are acting to protect average investors so voters will re-elect them later, when in fact the SEC’s meddling just creates friction, confusion, and the illusion of security. It hasn’t worked for us this year, and stepping it up won’t work in the future. We may, as Barack Obama says, need a new kind of regulation, but I’m afraid that if government bureaucracies like the SEC oversee it, we’ll just be putting lipstick on a pig. No amount of regulation is going to get Americans to save or banks to loan money to people who can’t pay it back.
In summary, we need to put our own house in order, and we need to be smart about it. Godzilla’s tail is coming. We need to batten down the hatches and save anything we can, so we don’t go off the edge. Each of us needs to get back to basics and recover from our financial sickness. We also need to do that on a national scale, not with bailouts and cheaper money, but with smarter policies and better use of information that will give us a platform for building the economy of the 21st Century. We can’t rest on our past accomplishments. Now that the balance of power has shifted toward progressives in Washington, it’s time to seize the moment. As Barak says, “Let’s get to work.”
[Addendum, November 18, 2008: Today, in the New York Times, Henry Paulson, Jr, the current Secretary of Treasury, summed it up this way:
I have always said that the decline in the housing market is at the root of the economic downturn and our financial market stress.
I could not disagree more. I think Paulson is great at looking in the rear-view mirror and reacting too late. It wasn't the decline in the housing market that got us where we are - it was the rise in the housing market that set up the avalanche that was to follow. It wasn't that hard to see, Henry. But you and the Bush team were too busy trying to privatize the rest of the world to worry about the overextension of America's middle class. And now the rise in the American consumer credit market has set up the next big domino to fall. I hope, for all our sakes, that our next treasury secretary can already see that one coming.]
I used to have a blog that was read by 5,000 people. I’m back online and hoping to share more of what I’ve learned in the past ten years. If you like this blog, please email friends and link back. I won’t post that often, but I hope to keep you informed and entertained. Be sure to see my travel blog as well.
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