A Recession Can Clear The Air

The New York Times has an insightful piece on the need for a recession. Charles Morris argues that massive changes are needed to the economy, and the only way this will be achieved is through a recession. It is sad to say that he is likely correct. This past decade, the North American economy has relied on consumers racking up credit card debt to pay for a consumer boom that has swept the United States and Canada this past decade. This cannot continue indefinitely as the piper must be paid. Morris writes:

The arithmetic of our current problem is pretty simple: From 2000 through 2007, U.S. households borrowed $6.2 trillion, nearly doubling their debt. Most of it was borrowed against houses, and about two-thirds was spent on things other than another house or paying down mortgage debt — including SUVs, flat-screen TVs and all the other consumer baubles of an American lifestyle. But when house prices collapsed, the home-equity cash spigot shut tight. U.S. consumer spending has fallen off the cliff, devastating car companies and shuttering factories throughout China.

All these frenzied attempts at staving off recession seem to be aimed merely at jump-starting the consumer borrowing-spending binge that underpinned the ersatz growth of the 2000s. But the real need is to shift to a more balanced system that’s less addicted to high-leverage finance.

Pouring money from the Fed into the banks just delays the day when banks — and now we taxpayers — will have to tally up our losses. The Fed is exchanging Treasury bonds for bundles of subprime mortgages at 98 cents on the dollar. But in the real world, those bundles could barely fetch 30 to 50 cents on the dollar. Does the Fed seriously believe that subprime mortgages are going to recover their value? The Japanese tried papering over bad assets during their 1990s credit crunch, and their economy has barely budged in 20 years.

At the same time, Congress and Treasury Secretary Henry M. Paulson Jr. are insisting that banks increase lending. To whom? House prices are still falling at double-digit rates. Credit-card defaults are spiraling upward. Companies are weak. Banks know how fast their loans books are deteriorating, and they desperately need cash to build up their reserves against all the bad loans they’ve made. Forcing them to ratchet up lending now is just pushing them back into the quicksand they’re struggling to climb out of. It’s financial folly. It would also be political folly for the new Obama administration.

For years now, even Democrats have been drinking the free-market Kool-Aid that the best economy is whatever markets decree it should be. So for most of the past two decades, the U.S. economy has been driven by whatever Wall Street is best at financing — mostly bigger houses, fancier cars and more electronic toys from Asia. We have become a nation where people struggle to make payments on four-bedroom houses with faux-marble bathrooms and two SUVs in the driveway even as they worry about their lousy health insurance, evaporating pensions, shaky Social Security benefits and tapped-out 401(k)s.

The solution, as we have argued, is for the spending necessary to a modern economy not to come from consumers buying more plasma televsions, but rather states investing in infrastructure:

Shrinking the banking sector will curtail bubble-style lending and force the share of GDP represented by consumer spending back down from its current 70 percent to a more sustainable 65-66 percent. It will be very painful, putting many companies in jeopardy, but it is the only way to engineer a transition to a world in which we spend less on houses and TVs and more on infrastructure and health care. Interest rates will be higher to encourage savings and taxes will go up, but debt should go down and the bottom half of the population should be more secure. It will also be very important to shore up our tattered social safety net to cushion the recession’s impact on that lower half.

In other words, we must all become penny pinchers paying off debt and spending less on consumer goods.

Interestingly, this article actually points to Canada and Canadian banks as an example:

The banking system that emerges should be dull — one where credit analysis trumps financial engineering and where everything is on the balance sheet. The big Canadian banks, RBC and TD Bank, have been determinedly dull in the 2000s and have turned in superb profits, far outperforming their supposedly brilliant American cousins.

Dull will rule in the coming decade. Rather than spending money we do not have on consumer goods, we will have to focus on frugality and learning to enjoy the simpler pleasures in life.

This entry was posted in Credit Crisis, Global Credit Problems, Recession and Frugality and tagged , , , , , . Bookmark the permalink.

2 Responses to A Recession Can Clear The Air

  1. Joanne says:

    In Australia, the government is giving a cash bonus to pensioners and low-income earners and they hope we will use it to splurge on Christmas, rather than pay down loans.
    Since the crunch, the amount of advertising literature in the mailbox has doubled.

  2. thepennypincher says:

    Hopefully, some of those receiving the cash bonuses will save be put away for a rainy day. I am not sure whether you have them in Australia, but in North America you have all the payday loan businesses that thrive on lending money at exorbitant rates to the desperate. It would be good if some families could put aside enough to avoid using these loans.

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