Home OwAs we entered the second year of the Obama Presidency it is appropriate review the state of the economy and how the Administration’s policies have affected it. While the economy is no longer the responsibility of Obama’s predecessors, understanding how we got into this deep recession is important in determining corrective actions.
For most of our history, we believed that too much government debt would negatively impact the country’s long-term prosperity. That discipline began to fade in the mid 1980’s, as indicted in this chart showing the growth of US debt as a percentage of Gross National Product (GDP). To support the growing debt, the US borrowed from countries, some who do not particularly like America. Making this relationship even more perverse we then used some of loans to purchase consumer goods from the countries that made the loans.
This next chart indicates that the significant increase in money America barrowed other countries, which started during the early years of the Clinton Administration.
Household Debt & Home Ownership
Americans above the age of 40 will recall a time when it was the price of an automobile, not its monthly payments, that was the focus of a buy decision. During this more rational period consumers also had to save to purchase big ticket items. These disciplines faded in the 1980’s, as indicated in this next chart that shows the US household debt-service. The steep increase in household debt started in 1994 and continued until the housing bubble popped in 2007.
Typically, when consumer debt gets too high, consumer spending slows. However, during the past fifteen years the rules changed. Spending continued to grow even with the increased debt as consumers found new and more dangerous ways to pile on debt. This highly leveraged spending was encouraged by government policies and through aggressively low interest rates controlled by the Federal Reserve (Fed).
The significant increase in household debt also tracked the increase in the number of people who purchased homes. In the 1990’s President Clinton and other activist members of Congress believed that home ownership was an American right irrespective of one’s ability to afford the cost. Congress, with approval from both political parties, went along with this new socio-economic theory.
The government was successful in encouraging greater home ownership, as indicated in this chart. This was accomplished by changing the charters of Fannie Mae and Freddie Mac requiring that a certain portion of their loans be made to those with low incomes. Add to this the cheap money created by the Fed’s low interest rates and we had the recipe for disaster. The consequences of mixing social and economic policies played a key role in creating the financial meltdown that caused the ongoing recession.
Personal savings is the opposite side of household debt. Low interest rates discouraged savings and further enticed consumers to spend. This chart shows that Americans’ personal savings continuously dropped since the mid-1980s’ from about 10% to a negative number. It has since become positive, but consumers have no cushion to fall back on. American consumers had too much debt to dig out of without painful actions. It is little wonder that the electorate voted for “change” without first requiring the definition of that change.
Debt on Top of Debt
By the late 1990’s the American consumer had too much debt. Free-market economic theory dictated that consumers pay down this debt. But, there were forces working against this natural economic correction. Political leaders were determined to avoid any economic downturn. Their policies led to housing prices escalating to unsustainable levels and this allowed Americans used their homes as piggy banks, borrowing even more though the home equity loans.
Bankers accommodated consumer appetite for debt by making home equity loans easier to obtain. But like the Dot.com and Telecom bubbles before it, the housing bubble also popped. Then, those that could not afford the houses and home equity loans could no longer pay for them.
The 9-11 tragedy led to a rapid downturn in the US economy in 2001. The stock market tanked and consumer spending dropped. The United States government and the Fed responded by injecting massive liquidity into the system to avoid the recession that should have been allowed to occur to correct imbalances in the economy.
The government’s efforts to avoid recession worked too well and contributed to the more serious problems we face today, including the housing bubble and its hangover. Housing speculators took over the overheated market and artificially increased demand and home prices even more. The Fed’s low interest rate policies led to low returns for people with capital and this cajoled them into taking increasing risks in search of higher returns. Collateralized debt devices were invented by Wall Street and were also dependent on housing prices continuing to rise.
While Fixed Investment as a percentage of GDP stayed level at about 21% until 2002, increased liquidity in the financial system led to over capacity in many sectors of the economy after 2002.
The government’s interventionist polices led in increased debt throughout our economy and ultimately led to our ongoing economic problems. Government spending increased during the “good times” and that ultimately led to increased public debt as the economy went into recession and tax receipts dropped. Corporations used cheap debt to extract money for their executives, inside shareholders and in some cases, overpaid workers. Consumer’s increased debt went to purchase all sorts of depreciating assets. Now, many of these sectors cannot afford pay for the debt and are clamoring for bailouts.
While the easy money policies started during the Bush-2 Administration, there were no protests from Democrats. No one seemed questioned the potential, but predictable consequences.
Since coming to power, the Obama Administration and Democrats believe that the solution to the economic downturn is more of the same policies. We continue with artificially low interest rates that are already showing signs of creating new bubbles as commodities and equities have appreciated significantly in the past year. In addition, through low interest rates the government is trying to get consumers and companies to add more debt to their already bloated balance sheets. Only the government would try to cure an alcoholic with less expensive booze!
The government continues its attempt to cover up the excessive debt problem by bailing out companies, bankers and individuals who made bad financial decisions. But, moving bad private debt to the public’s ledger is but a short-term cover-up that has not worked in other countries where it has been used. We are already beginning to see problems in the sovereign debt markets with countries like Greece beginning to look insolvent, proof that this alchemy cannot work. These government sponsored Ponzi schemes will cause even more economic disruptions in the future.
It is time that we recognize that our economic problems are the result of excessive debt and other market disruptions caused by governmental interference with market forces. The inevitable corrective actions of the markets; i.e. deleveraging in the public and private sectors are required to bring supply and demand back into balance. This realignment will involve pain, as any corrective actions require. But it inevitably will occur no matter what efforts the governments make to try to forestall it.
For 20-years Japan has attempted to ignore the laws of supply and demand and market forces. Instead of forcing its banks to write off their bad loans, the Japanese government came up with schemes for these banks to delay or ignore this required action. As a result, Japan has been mired in a lost couple of decades, as indicated be it Nikkei index remaining flat during that period. We seem to be repeating Japan’s error.