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Tuesday, August 16, 2011

Whose Fault is the Next Recession?

The government is tapped out.  The big banks are teetering.  Large corporations are watching their stock prices plummet, then skyrocket, then plummet again, with no idea where they'll settle.  We are on the brink of recession.  And if we go over that edge, it will be the fault of American consumers and small businesses.

At least that's what an article* in the Wall Street Journal suggested last week.

According to an economist interviewed in the article, consumers and businesses who worry about a recession and make spending decisions based on that worry will then, by their cautious actions, trigger that recession.  He called it a self-fulfilling prophecy.

His words make sense, but they--and the article--leave out some very important details.

The United States government has been passing a deficit budget nearly every year since around 1970.  That means that for about forty years, the government has been borrowing money to meet its expenses.  Of course, they eventually had to pay that money back, and they did that by borrowing more money, on top of what they were already borrowing.  And then, when those bills came due along with all the others, they paid those off by borrowing yet more.  It's like someone paying all their bills with a credit card, and when their credit card bill comes due, they get a new credit card to pay it off, and on and on it goes.  The recent fiasco in congress about raising the debt ceiling came about because someone finally questioned whether it was a good idea for the government to continually get a new credit card every time they maxed out the old one.

So now the government is trying to cut spending.  And some of the things they are cutting are the safety nets.  Now I for one see a distinction between a safety net and an entitlement program, but that's an entirely different rant for an entirely different post.  At any rate, I believe that some of those entitlements do indeed need to be trimmed.  But the entitlements benefit so many people that they have powerful lobbies, and it's hard to touch them at all.  So the small safety nets that are still left and make the difference between life and death for a few people (comparatively speaking) are being cut or eliminated, and the backlash against the entitlements when it comes (and it will come) will cut too deeply, and then they will barely function as safety nets, either.  So watch out, citizens!  Don't count on Uncle Sam helping you out if you get in trouble; you're on your own.

Big banks were lending large sums of money to people with small incomes.  Mortgages were great for the banks.  The more money people were able to borrow, the more they were able to spend on a house.  As more money was available to spend on housing, the more expensive houses got.  So people had to borrow more money for less house, and with the availability of that money, houses got yet more expensive, and people had to borrow more.  Anyone not buying a house was cautioned that they'd better do it before they got priced out of the market completely, because home prices were only going to go up.  So more people felt pressured to buy, and took on interest-only mortgages with low monthly payments that would balloon later, expecting that by the time their payments went up, their house would be worth so much more than they'd paid for it that they could just tap their equity and make the house pay for itself.  Free money, free house.  Banks encouraged this by lowering their lending standards to practically nothing.

Then the banks began betting that their borrowers would default with the investment known as Credit Default Swaps (CDS).  These little beauties made it so the banks won either way: if the mortgage was paid back along with the interest due, the bank got a payoff from its investment; if the mortgage defaulted and wasn't paid back, the CDS would pay the bank a lump sum, and the bank got a payoff from its investment.  The losers were the ones who had to pay out the CDS.  And since you don't have to actually be the creditor (i.e. hold the mortgage) to buy a CDS, anyone can get one.  So those made their way into pension funds, mutual funds, etc., as safe investments with high payoffs, which was accurate (provided the mortgages never defaulted).  Of course, once things reached a breaking point and people couldn't pay their mortgages, there was widespread failure across the system.  The banks, who held both mortgages and CDS, found themselves overexposed and ready to fail.  Of course if that happened, people and businesses couldn't borrow money, and the entire economy would seize up (because we've already established that no one can pay for anything unless it's with borrowed money).  So the government bailed them out and covered their investment losses (but did nothing to help the individuals who suffered losses--except make it easier for them to borrow more money to make ends meet) and took more money out of taxpayers' pockets and gave it to the banks.  So watch out, bank customers!  Don't count on the banks working with you if you get into trouble; you're on your own.

Businesses have focused so much on quarterly earnings that they cost-cut their way to short-term profits while sacrificing their long-term strategies and even viability.  They lay off employees (i.e. people who are trying to work for a living and take care of themselves) and expect unreasonable levels of productivity from those who are left.  They shift more of the costs of health insurance to their employees.  They make management decisions that cause the workplace environment to become unpleasant or even unhealthy (I'm aware of one company that has removed every third fluorescent tube from their overhead lighting to save money, making the office just dim enough to cause eyestrain).  They use cheaper quality components in their products while charging their customers higher prices on account of the company's 'increased costs.'  And finally they take advantage of perfectly legal tax loopholes that allow them to post record profits while keeping their federal income tax liability at zero. So watch out, employees!  Don't count on your company to value your job over their shareholders' gains; if they need to lay you off to save a few pennies, that's your problem; you're on your own.  And customers, don't count on prices going down, either.

Individuals aren't innocent here, either.  No one was forced to take on an oversized mortgage.  If you took out anything other than a conventional mortgage with a fixed interest rate, then you contributed to the problem.  If you took out a home equity loan for anything other than major home repairs or improvements, you contributed to the problem.  If you ever used your credit card and didn't pay off the balance in full at the end of the month, you contributed to the problem.  (I'm not talking about the occasional large purchase that took two or three months to pay off; I'm talking about if you can't remember the last time you didn't carry a balance on your credit cards.)  Of course, this was also in an environment when costs were going up, salaries were remaining stagnant or going down, and we were being told that it was our patriotic duty to stimulate the economy by spending money.

No one (that I'm aware of) is spouting off that 'patriotic duty' crap this time around, but putting the responsibility of another recession on the backs of consumers amounts to the same thing.  (It's also notable that the American public is usually referred to as consumers, and not citizens or people--I guess it's clear what our primary purpose is in this country.)  We've learned that prices are going up, jobs can't be counted on to last, banks will gamble with people's money and expect the government to cover their losses, our own individual taxes will have to pay for those bailouts as well as make up for the taxes the large corporations aren't paying, and the government isn't going to help us out if we get in trouble.  But if we practice fiscal responsibility by living within our means, saving for a rainy day, and spending cautiously, the next recession is our fault.

Give me a break.

*The article was "Penny-Pinching Puts Recovery on Thin Ice" by Ben Casselman and Conor Dougherty, in the Wall Street Journal's online edition on Wednesday, August 11, 2011.  I have provided a link, but I believe the article is locked unless you have a subscription.


  1. many things to think about.

  2. Mortgage banks didn't lower their standards to practically nothing, it was well below that. I could tell you stories about stuff Matt saw, and was asked to participate in on a daily basis, that would make your stomach wretch and hair curl on its own. Thankfully I married an ethical man because he wouldn't have been the one contacting the FBI to start the investigations of his co-workers, he would have been one of them being dragged away in handcuffs (and yes, he was responsible for getting the ball rolling on at least 2 major busts in NY). Things in that industry are at least a little more under control now (there is NO more stuff like stated income, no income verification, 100% financing anymore so that cashier at Taco Bell can no longer claim to make $4376.94/mo in order to qualify for an 800k property that they will never even live in because the borrower is completely made of straw to begin with).

    Everything else though? Yeah, all that is still going down by the head. The very real story on my side is we did get a crazy mortgage, we were under enormous pressure because we did a rehab on our house and HAD to refi. We were pushed into something that was a new approach and even Matt being in the industry (at that time) for 9 years still didn't raise a red flag. They were very sneaky about making you think you had no options, that it was a good deal for you. Even he was fooled! In the end it was foreclosure & bankruptcy for us because of so many perfect storm factors lining up. And the bank wouldn't take a short sale at the time because we were about 6 months ahead of the massive wave of others going through the same thing. Seen it from both sides and as someone who reads everything before signing but someone who was still duped I can tell you, sometimes its just the bad things happenning to good people syndrome. We thought we were helping a struggling neighborhood by turning older run down houses into something liveable. Sadly no one cared but us.

  3. Jenn, a lot of people were sold a bill of goods, and took on creative financing with the best of intentions. Others (like that Taco Bell cashier) were just greedy and/or unrealistic. And some did it the old fashioned way, and got screwed anyway. My brother-in-law put 10% down and got a 30 year fixed mortgage on a reasonable house he could afford in 2006. He's never piggy-banked it, just kept paying his mortgage on time every month. If the numbers on Zillow are to be believed (and I have no reason to believe otherwise), his house is now worth just a little more than half what he paid for it. They're still making their payments, but their options are much more limited now if something happens to his job.

  4. Yes and that's the thing that sent so many entire neighborhoods spiraling downward. Your BIL is a good egg, most people in his exact position decided just to let the bank take their house last year (the 2nd wave of the mortgage spiral no one out of the industry really talked about) because the guy down the street got forclosed on 2-3 years ago & the house just resold for, you guessed it, less than thalf what the guy up the street (your BIL) paid for his. Property values "plummeted" because of it (read: artificially inflated to begin with) and everyone who decided to stay ended up upside down. Many people took the hit because they could move into a cheaper house before the auction took place. Those who ended up in strange job situations who couldn't buy another home had to rent and that's why there are still so many vacant homes now. Supply & demand. Demand is there but banks got wise to scams and now no one qualifies because 1/2 the family lost a job and no one is lending to high risk people. Its rampant here in PHX, this city way overbuilt. Will be good for us when we buy our home but won't have a lot of neighbors. The country is balancing precarious on the tip of the pin right now.