Tuesday, June 2, 2009

How we got here

This chart comes from the weblog called "Brad Setser: Follow the Money". Notice that household borrowing has NEVER gone negative in the entire 55 year period. Prior to this one, there have been 11 post-war recessions, and none of them caused household borrowing to go negative - Until now.

I have been posting charts from time to time, each showing very long term trends with recent behavior that is highly unusual. This recession is so bad that the financial press has taken to calling it "The Great Recession". What is it that makes this particular recession so different from the other post-war recessions? Let's take a little time to learn, using a video and some charts.

First, the video. It's long, but worth every second. Elizabeth Warren lecturing in 2005, when economic times were "wonderful". The introductory chat ends and the lecture begins at about 6:20. If you don't take time to watch this, you won't understand how your country arrived where it is today.

Link Here

I think that Elizabeth Warren has done a masterful job of explaining how US families managed to arrive at their fragile condition, and how our pathetic medical uninsurance system contributes to it. But I suspect that her results were influenced heavily by the time-frame of her research. She did this research and lecture at the pinnacle of the greatest housing bubble of all time (see below).

I believe that the housing bubble is the primary reason why so many people were (and are) so debt-ridden. They purchased housing that was unaffordable, without ever pausing to question the assumption that their "housing investment" would continue to increase in value. I would go further and say that few of the purchases of overpriced housing were even necessary. Renting was and always has been an option. Just ask those who have been evicted.

People also never questioned that their pensions, jobs, and 401(k)s might be in a great deal of jeopardy either. Why is it that everyone felt so smug about the smooth continuity these things? Why did magical thinking overwhelm financial common sense?

Let's face it: The world is not as stable and benign as we would like to believe, and our leaders would like us to believe. If we are wise, we would be as prepared as possible for events that we cannot foresee. (And the housing bust wasn't even one of these unforeseeable events!)

Check out the chart below. Was it really necessary for Americans to do this to themselves??? As much as I admire Elizabeth Warren and her work, I have to say no. This entire debt orgy was utterly unnecessary.

In reality, things are considerably worse than this. A lot of people are savers (in spite of tax and interest rate disadvantages). A lot of people own their houses outright, so they have no mortgage to default on. That means that the non-savers and people with mortgages are really in VERY bad shape.

We have looked at how US savings deteriorated and debt built up. All the while no one ever worried that the world often is more volatile than we tend to believe. It's now time to share a fable from Aesop:

Once there lived an ant and a grasshopper in a grassy meadow.

All day long the ant would work hard, collecting grains of wheat from the farmer's field far away. She would hurry to the field every morning, as soon as it was light enough to see by, and toil back with a heavy grain of wheat balanced on her head. She would put the grain of wheat carefully away in her larder, and then hurry back to the field for another one. All day long she would work, without stop or rest, scurrying back and forth from the field, collecting the grains of wheat and storing them carefully in her larder.

The grasshopper would look at her and laugh. 'Why do you work so hard, dear ant?' he would say. 'Come, rest awhile, listen to my song. Summer is here, the days are long and bright. Why waste the sunshine in labour and toil?'

The ant would ignore him, and head bent, would just hurry to the field a little faster. This would make the grasshopper laugh even louder. 'What a silly little ant you are!' he would call after her. 'Come, come and dance with me! Forget about work! Enjoy the summer! Live a little!' And the grasshopper would hop away across the meadow, singing and dancing merrily.

Summer faded into autumn, and autumn turned into winter. The sun was hardly seen, and the days were short and grey, the nights long and dark. It became freezing cold, and snow began to fall.

The grasshopper didn't feel like singing any more. He was cold and hungry. He had nowhere to shelter from the snow, and nothing to eat. The meadow and the farmer's field were covered in snow, and there was no food to be had. 'Oh what shall I do? Where shall I go?' wailed the grasshopper. Suddenly he remembered the ant. 'Ah - I shall go to the ant and ask her for food and shelter!' declared the grasshopper, perking up. So off he went to the ant's house and knocked at her door. 'Hello ant!' he cried cheerfully. 'Here I am, to sing for you, as I warm myself by your fire, while you get me some food from that larder of yours!'

The ant looked at the grasshopper and said, 'All summer long I worked hard while you made fun of me, and sang and danced. You should have thought of winter then! Find somewhere else to sing, grasshopper! There is no warmth or food for you here!' And the ant shut the door in the grasshopper's face.

It is wise to worry about tomorrow today.

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