The Great American Recession…Cause and Safeguards
“THE DANGERS OF WALL STREET” SERIES
By Bob Kneisley
(With excerpts from David Sington’s production of “The Flaw”)
This is the tale of Dr. Greenspan’s “Wall Street” and the importance of investing in “assets” vs. “goods”. (I’ll explain that later.)
When Alan Greenspan, Federal Reserve Chairman, appeared before the House Oversight and Government Reform Committee after the housing bubble burst, he admitted that he had overlooked a “FLAW” in his ideology. Note that in 1929, income inequality went ballistic…and debt levels paralleled the increase! Too much debt resulted in the 1929 stock market crash…and a very similar problem existed in 2007. A decade of excessive bank lending up to 2007 was as dangerous as the “Margin Borrowing” and easy credit of the 1920’s. Unfortunately, the result was repeated as well.
The lesson: easy credit results in excessive speculation. In the 2000’s, financial sector earnings skyrocketed…with the greatest income growth in the top 1% of earners. Sound familiar? That sector accounted for fully 12% of all income! Upon reflection, in the 1970’s it was manufacturing that accounted for 60% of wages earned and most folks lived modestly. By 2000, the Hampton’s sported homes priced at $900,000 to as high as $20 million! Worse yet, you may recall that our tax laws provided capital gains relief…IF the seller of a home bought a larger home. Larger home construction became a booming industry to match the home loan explosion. The middle class was clearly squeezed.
Robert Schiller then created a home price index dating back to 1890 that clearly demonstrated that there was NO INCREASE in home prices, (inflation-adjusted), until 1990…the birth of the housing “bubble”! Home prices were straight up on the mountain chart!
The Federal Reserve and bankers aided the explosion by providing low-interest rates, or no interest at all, and other ridiculous programs to lure borrowers. The balloon payment and re-finance deals were simply unrealistic…much like the easy credit and margin loans of 1929.
To add to the melees, the Federal Home Loan Act and FHA supported loans through “commoditization” of the loans with the aid of Wall Street. At the time, bank “Red Lining” was prevalent and banks simply ignored whole neighborhoods until the 1990’s…only to provide a flood of easy money later. That flood became a global tsunami as I mentioned in my latest book entitled “The Wall Street Casino”. The effects are still very much with us as is the global impact.
The commoditization I alluded to involved Wall Street developing mortgage “securities”. These securities allowed banks to sell their mortgage loans so that Wall Street firms could create elaborate, and poorly understood, “Collateralized Debt Obligations” (CDO’s) and sell these “toxic assets” to an unwary public. As stated, they sold them worldwide! The structure was comprised of tranches, rather, levels of risk, to “juice” yields to better attract investors. Selling is a worthy profession. And I suspect that the sales “brokers” who marketed these toxic securities had little knowledge of the inner workings of CDO’s…nor did most of the top management staff at the Wall Street firms!
The irresponsibility of the Wall Street banks was reflected in the fact that they were making loans based solely on the credit rating and employment of the borrower rather than their ability to pay! They then leveraged home equity values to make more loans on undervalued assets based on anticipated inflation. Sadly, residential inflation went south!
Actually, 77% of bank loans became “Re-fi’s” that were also sold by the banks to Wall Street to be securitized. The result was that borrowers ate up ALL the equity in their homes in far too many cases. “Predatory lending” became the norm! Owners were then forced to borrow against credit cards and then many re-financed to pay the dizzying high cost of the credit card interest fees.
And what about all those lost jobs America has suffered? Perhaps it is not just our higher corporate income tax structure that sent so many to foreign lands. No bank mortgage financing was so lucrative that banks reduced manufacturing loans or raised interest rates on such loans.
The mortgage explosion caused housing price inflation that trickled down to touch developers of shopping centers, apartment buildings and office centers that remain derelict all around us! Meanwhile, $900 billion in loan money was being spent on CONSUMPTION…until 2007 when reality set in and we all learned that real estate prices cannot ONLY RISE. A painful lesson.
The Financial Meltdown Period
When reality struck, the banks began to take massive losses when homes were foreclosed and new loans were lacking. And why not? The pain for Americans who lost not only their homes and any equity they may have had, but for many, their life savings, college educational opportunities, health care and jobs was most hurtful. That said, banks are not presently making loans because they now suffer losses as a result of their earlier mortgage loan frenzy. What comes around goes around!
Even the “smart money” was caught by surprise when the rating services abruptly downgraded mortgage securities… before the smart money could get out. That is to say…sell their holdings to an unsuspecting investor.
I’ll be gracious here; as I point out that, belatedly, the government (that body that demanded that every American own a home regardless of ability to pay and permitted inadequate legislation to match) was finally forced to respond. Dr. Alan Greenspan, Fed Chairman, claimed that he and others simply, and I’ll quote here, “we’re not smart enough” to reason the problems. I ask you, at the federal level, can you imagine that our leaders could not envision economic similarities between our housing bubble and the collapse of 1929? How could they not?
As for the banks…they are still processing “Loan Modifications” as they’re called and they have very real Profit and Loss considerations to deal with…instead of making much-needed home loans to worthy, highly rated, borrowers. On October 11, 2012, Moody’s Rating Service downgraded America’s credit rating from AAA to AA+ and suggested that they will reduce the rating further if Congress does not act to reduce the deficit by year-end. Remember, this is the fourth year that American’s are burdened with over $1 trillion in debt.
The above facts do have consequences. Food costs, fuel and all commodities will rise in price. All other goods will follow as will interest rates longer term. College loans will default en masse. Owens Community College is already listed as the fifth institution with the greatest number of student loan defaults. Graduates can’t find employment due to our economic failures.
So what have we learned? Well, record bonuses on Wall Street continue and will foster more investment in unproductive “ASSETS” rather than in “GOODS” that would support our economic recovery. Remember my mentioning those two types of spending? Investing in assets is what the wealthy do. What America needs now is more investing in “GOODS” to stimulate production… hopefully in the U.S.
Back in 2005, my late wife and I invested in a website aimed at vetting political, business and education candidates at all levels. Frankly, I was convinced that political candidates would not utilize the free Internet site…even though it could provide important free public relations opportunities as it was accompanied by a nationwide blog site. I was wrong. In fact, 4 out of 5 local candidates that completed the voluntary self-survey were elected in 2005. The “All-Can.org” concept might still be a political asset…in search of a sponsor.
More Negative Financial Consequences
An article by Peter Coy recently appeared in Business Week. The article was salient because it pointed out that, in 2010, student debt for a college education exceeded total credit card debt nationally…for the first time! Remember, there are often no restrictions on the loans.
In 2011, the debt surpassed even auto loans. In March 2012, the Consumer Financial Protection Bureau announced that student debt passed $1 trillion! It grew by $300 billion from the third quarter of 2008…even as other forms of debt shrank by $1.6 trillion due to the economic crisis of 2008.
Young adults are being burdened with monthly payments in the magnitude of $1,400…and they cannot find jobs! Financial Aid.org estimates that student debt is growing at the rate of $3000 PER SECOND! Sadly, many students require 20-25 years to pay off loans.
My firm, Indicator Advisory Corporation, employs college-level interns where we can. We have found that Information Technology majors in their third year often have had only a single hour of education in their chosen field. Worse yet, if they opt to take an Internet course, they still have to pay for student parking, activity fees, etc.
The New York Fed found that people over 60 years of age are still responsible for $36 billion in student loans! (It is unclear as to how many may have co-signed on their children’s loans.)
The overarching macro solution seems to be better federal regulation and leadership to prevent economic downturns that impact our citizens. (That’s the “AllCan.org dream.)
The micro solution is to somehow bring down the unreasonably high cost of higher education.
I must submit that college debt could well be the next economic “bubble”!
The Financial Outlook
Regardless of the presidential election results, it appears that things won’t change dramatically next year; low growth, persistently high unemployment and a huge debt burden seem the rule in America.
Surely the economic recovery is currently borne by retirees who have no safe means of earning interest beyond current inflation and tax costs.
The threat of an estimated $600 billion in tax hikes and spending cuts will hold down business spending and actions by the Fed that have flooded the economy with more fiat dollars will further burden all Americans with higher costs at all levels. They will then share the pain along with our retirees.
China and European economies continue to weaken. The biggest drop in factory employment in two years occurred in August, 2012.
Remember the 1980’s recession? It was caused by very similar problems with real estate loans only that time it was the Savings and Loan bankers. The RTC was another bail-out at that time. At that time though, the ratio of household debt to GDP was 50%. Today it is nearly 90%! And, at that time Americans were saving about 10% of their income versus about 4.2% in July 2012. Back then the average baby boomer was only 25. Today she is 55. We all know what that means to medical costs. Our workforce is much older now as well at 42 versus 25. Young workers cost less, are more flexible and create households that add to needed consumption
The monetary situation is bleaker as well. Paul Volcker, then the Fed Chairman, had increased interest rates to cool inflation. That left him plenty of room to lower rates to stimulate borrowing and rebuild the economy. Mr. Bernanke does not have that ability today.
(Excerpts from Business Week articles by Mathew Phillips and Peter Coy, September 2012)