Olly olly ox unfree!
By Carl
The dynamic of the American economy is a quasi-free market.
Or rather, it was.
The underlying mechanism of a free market goes something like this: I have a need, say, food. Company A determines there's money to be made in supplying me with food, but only at a price a) I'm willing to pay and b) they can actually make some profit at.
If Company A is the only game in town, they can charge pretty much whatever they want, because they know I need to buy food. Company B realizes there's a boatload of money to be made in food, so it opens up a store and competes with Company A. This drives down the price, since Company B and Company A will now engage in a war for my business. It's not a profit until someone actually earns it.
The rational consumer, of course, will pay the least amount of money he possibly can for food, so long as the quality is comparable from Company A to Company B. Meanwhile, Company A and B will try to maximize their profits, either by charging as much as possible or by cutting their costs to produce food by as much as possible, or both. Again, this is rational.
Supply competes to fulfill demand, and if there's not enough demand, Company A or B goes out of business or tries to create more demand for their product by expanding markets or finding some other advantage for their product.
This scenario assumes a few things that may not always be true, and indeed, one basic assumption has not been true for some time now, ever since the late 80s, early 90s.
This scenario assumes a limited amount of money for the consumer. So long as personal credit markets were tight, this was how free markets worked: people had limited income, so voted for products based on whether they could afford them or not.
The twin barrel gun that shot huge holes in the capitalist system were mortgages and credit cards.
Now, both serve a purpose, when used wisely. After all, if it takes 30 years to pay off a mortgage with a reasonable cushion for your day to day living expenses, then it stands to reason it would take about 30 years to save enough to put down cash on a house, perhaps longer, since you'd be paying rent.
Likewise, credit cards allow us to buy things that we need, but can't afford to pay for right now that would take an awful lot of time to save up for, like kitchen appliances or TVs.
All this posits that eventually you'll earn enough money to pay these bills back.
Right now, that's not the case, and we're at the tail end of a cycle that could be devastating to the global economy, not to mention American independence.
Consumer debt, including mortgages, is higher than it has ever been, rivaling the national debt in magnitude.
That's unheard of, but here's the kicker: not only is it higher than the current savings level for Americans, but there's speculation now that, at present income levels, there is no way America (as a whole) will ever earn enough money to pay down their personal debt.
What happened over the past twenty odd years is probably going to go down in history as mankind's greatest economic folly.
First, let's look in the mortgage market. People started borrowing more and more of their purchase price (you used to have to put down 20%, then 10, and then five, and now, nothing), because banks were having a hard time lending money to people after the recession of the early 80s.
The housing market had collapsed, you see.
By lending more and more money, banks were setting up a vicious cycle, where people had little to no equity to lose in their houses. Rather than homestead and be satisfied with the house they had, they would trade up.
Why? It really didn't cost them anything. What this triggered was a housing market that slowly caught fire, as prices scaled upwards when people started to trade up in house size and price. This attracted more and more buyers, who were offered easier and easier credit as banks were forced to compete with cutthroat lending policies.
All this was fine, so long as housing prices continued to spiral upwards. Sure, we'd had adjustments in housing prices, but over the long run, a house was the best investment anyone could make. You were guaranteed to make money.
Over the long term, however. What we started seeing was people taking advantage of some of these teaser loans that banks felt compelled out of greed to offer: five year adjustable rate mortgages with ultralow interest-only payments until the five year adjustment period had passed.
By then, people moved on and bought a new house with -- you guessed it! -- a five year adjustable rate mortgage.
In other words, they kept playing a shell game with the bank's equity.
But notice what else happens here: as people spend less and less income and provide less and less equity in their houses, they are free to spend more and more disposable income on other things: Nike sneakers, iPods, computers, flat screen TVs.
All paid by with credit cards. So long as a consumer was able to make the minimum monthly payment, no one would deny them more credit, despite the fact that not only did they have no real equity to look to in case things fell apart, but they're incomes weren't keeping pace with even the minimal inflation that the economy was suffering.
So people stretched a rubber band in two directions at the same time, and it's only now those bands are breaking. There are a combination of factors, to be sure, as to why the rubber bands chose now to break, but underneath it all, they had to break sometime, so why not now as opposed to two years ago, or two years from now?
The solutions for this are not pretty. It's a little like trying to solve a jigsaw puzzle when thirty percent of the pieces are missing. Bottom line is, there ain't no going back to a time when this nation was healthy, not anytime soon, and certainly, business will never been "usual" again.First and foremost, don't buy any solution that says we can "spend" our way out of this with lower taxes and more economic activity. People can't afford the debt they have already, and they've been conditioned to spend more using debt. They probably don't even remember how to save a buck or two!
Second, keep in mind that bankruptcy laws were changed, with the support of McCain and Obama, to limit individual bankruptcies even further. So that debt relief tap has been turned off, for now. Any attempt to revisit that issue will be met with very stiff resistance by banks.
Third, and most important, keep in mind that with no disposable income, as people try to repay their mortgage balances that weren't covered in the sale of their houses, and have to pay real money to have a roof over their heads and food on the table, there's going to be precious little economic boost to be had. Too, rising gas, food and health care costs will sponge up quickly any left over money.
If we hadn't squandered a few trillion in Iraq, there's a chance we might have the funds in place to have some effective solutions that could speed up and perhaps bolster the recovery, as anemic as it will be. You'll hear a lot of short term hype, but fundamentally, the consumer is ruined.
We owed our children better than we've given them. We've ruined their environment, endangered them with our hubris over global warming, and had until this administration passed along a manageable but difficult economic timebomb.
Which just exploded. In our faces.
(Cross-posted to Simply Left Behind.)
The dynamic of the American economy is a quasi-free market.
Or rather, it was.
The underlying mechanism of a free market goes something like this: I have a need, say, food. Company A determines there's money to be made in supplying me with food, but only at a price a) I'm willing to pay and b) they can actually make some profit at.
If Company A is the only game in town, they can charge pretty much whatever they want, because they know I need to buy food. Company B realizes there's a boatload of money to be made in food, so it opens up a store and competes with Company A. This drives down the price, since Company B and Company A will now engage in a war for my business. It's not a profit until someone actually earns it.
The rational consumer, of course, will pay the least amount of money he possibly can for food, so long as the quality is comparable from Company A to Company B. Meanwhile, Company A and B will try to maximize their profits, either by charging as much as possible or by cutting their costs to produce food by as much as possible, or both. Again, this is rational.
Supply competes to fulfill demand, and if there's not enough demand, Company A or B goes out of business or tries to create more demand for their product by expanding markets or finding some other advantage for their product.
This scenario assumes a few things that may not always be true, and indeed, one basic assumption has not been true for some time now, ever since the late 80s, early 90s.
This scenario assumes a limited amount of money for the consumer. So long as personal credit markets were tight, this was how free markets worked: people had limited income, so voted for products based on whether they could afford them or not.
The twin barrel gun that shot huge holes in the capitalist system were mortgages and credit cards.
Now, both serve a purpose, when used wisely. After all, if it takes 30 years to pay off a mortgage with a reasonable cushion for your day to day living expenses, then it stands to reason it would take about 30 years to save enough to put down cash on a house, perhaps longer, since you'd be paying rent.
Likewise, credit cards allow us to buy things that we need, but can't afford to pay for right now that would take an awful lot of time to save up for, like kitchen appliances or TVs.
All this posits that eventually you'll earn enough money to pay these bills back.
Right now, that's not the case, and we're at the tail end of a cycle that could be devastating to the global economy, not to mention American independence.
Consumer debt, including mortgages, is higher than it has ever been, rivaling the national debt in magnitude.
That's unheard of, but here's the kicker: not only is it higher than the current savings level for Americans, but there's speculation now that, at present income levels, there is no way America (as a whole) will ever earn enough money to pay down their personal debt.
What happened over the past twenty odd years is probably going to go down in history as mankind's greatest economic folly.
First, let's look in the mortgage market. People started borrowing more and more of their purchase price (you used to have to put down 20%, then 10, and then five, and now, nothing), because banks were having a hard time lending money to people after the recession of the early 80s.
The housing market had collapsed, you see.
By lending more and more money, banks were setting up a vicious cycle, where people had little to no equity to lose in their houses. Rather than homestead and be satisfied with the house they had, they would trade up.
Why? It really didn't cost them anything. What this triggered was a housing market that slowly caught fire, as prices scaled upwards when people started to trade up in house size and price. This attracted more and more buyers, who were offered easier and easier credit as banks were forced to compete with cutthroat lending policies.
All this was fine, so long as housing prices continued to spiral upwards. Sure, we'd had adjustments in housing prices, but over the long run, a house was the best investment anyone could make. You were guaranteed to make money.
Over the long term, however. What we started seeing was people taking advantage of some of these teaser loans that banks felt compelled out of greed to offer: five year adjustable rate mortgages with ultralow interest-only payments until the five year adjustment period had passed.
By then, people moved on and bought a new house with -- you guessed it! -- a five year adjustable rate mortgage.
In other words, they kept playing a shell game with the bank's equity.
But notice what else happens here: as people spend less and less income and provide less and less equity in their houses, they are free to spend more and more disposable income on other things: Nike sneakers, iPods, computers, flat screen TVs.
All paid by with credit cards. So long as a consumer was able to make the minimum monthly payment, no one would deny them more credit, despite the fact that not only did they have no real equity to look to in case things fell apart, but they're incomes weren't keeping pace with even the minimal inflation that the economy was suffering.
So people stretched a rubber band in two directions at the same time, and it's only now those bands are breaking. There are a combination of factors, to be sure, as to why the rubber bands chose now to break, but underneath it all, they had to break sometime, so why not now as opposed to two years ago, or two years from now?
The solutions for this are not pretty. It's a little like trying to solve a jigsaw puzzle when thirty percent of the pieces are missing. Bottom line is, there ain't no going back to a time when this nation was healthy, not anytime soon, and certainly, business will never been "usual" again.First and foremost, don't buy any solution that says we can "spend" our way out of this with lower taxes and more economic activity. People can't afford the debt they have already, and they've been conditioned to spend more using debt. They probably don't even remember how to save a buck or two!
Second, keep in mind that bankruptcy laws were changed, with the support of McCain and Obama, to limit individual bankruptcies even further. So that debt relief tap has been turned off, for now. Any attempt to revisit that issue will be met with very stiff resistance by banks.
Third, and most important, keep in mind that with no disposable income, as people try to repay their mortgage balances that weren't covered in the sale of their houses, and have to pay real money to have a roof over their heads and food on the table, there's going to be precious little economic boost to be had. Too, rising gas, food and health care costs will sponge up quickly any left over money.
If we hadn't squandered a few trillion in Iraq, there's a chance we might have the funds in place to have some effective solutions that could speed up and perhaps bolster the recovery, as anemic as it will be. You'll hear a lot of short term hype, but fundamentally, the consumer is ruined.
We owed our children better than we've given them. We've ruined their environment, endangered them with our hubris over global warming, and had until this administration passed along a manageable but difficult economic timebomb.
Which just exploded. In our faces.
(Cross-posted to Simply Left Behind.)
Labels: credit, housing market, mortgages, U.S. economy
posted by Carl at
11:09 AM
2 Comments:
I once thought about subtitling this blog: "Tracking the Decline and Fall of the American Empire."
How apropos.
By
Michael J.W. Stickings, at 11:57 AM
Carl, good post.
I watched New Governor Paterson's inaugural speech today. I think he may be just the ticket to help out the situation as much as he can from his end. He's a fine speaker. Good heart, says he's committed to "public service."
As a Social Worker, I noticed his use of the phrase "upper class and 'consumers of social services,'" rather than "lower class." He had been talking about how everybody was affected by the economic situation, using the above phrase.
By
Carol Gee, at 5:16 PM
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