An Economy on the Brink
We are in the first nationwide housing crash since the 1930s, and no one yet knows where it will end
How could Americans not be in a grumpy, even fearful, mood? Every day they are faced with news of plummeting house prices and a collapse in home construction (which created a third of all new jobs in the past few years). A growing credit crunch is closing the spigot of loans so necessary to the health of Main Street. Bank failures are becoming more common. Then there's the rapid decline of the U.S. auto industry—not unrelated to rising oil prices, which are also curtailing the dream of the suburban lifestyle. And millions of Americans are starting to fear losing their jobs—and the family healthcare that goes with them. The American imagination is haunted by the Great Depression of the '30s.
What's more, we don't have confidence in our political leaders—despite the bipartisan passage of the very necessary, if flawed, housing support bill. Polls put the president's approval at about 30 percent and Congress at half that. In one recent survey, only 6 percent viewed the economy positively, while 84 percent of us think we are headed in the wrong direction.
Crisis? We are in the first nationwide housing crash since the 1930s, and no one yet knows where it will end. House prices, the strategic fault line, have plummeted for most of the 68 percent of American families who own one. They are falling at an accelerating rate, while inventories of unsold and foreclosed homes are rising. This has created a spiral where lower prices force mortgage foreclosures (now running at 2.5 million a year), which in turn reduce prices further as foreclosed homes are put on the resale market. Only when this huge inventory is cleared from the market and prices start to rise will we know where the bottom was.
With 10 million mortgages exceeding the value of the homes, that could take a long time. If the futures market is correct in predicting an overall price drop of 30 percent, the value of housing assets will shrink by over $6 trillion, which could permanently lower household spending by about $300 billion a year. The losses to the financial system are horrific. Just a few weeks ago, a major mortgage lender in California failed—the third-largest bank collapse in American history. Banks are struggling to cope with borrowers who are defaulting in droves on mortgages, consumer debt, credit cards, student loans, home equity loans, car loans—you name it. The banks are left without the cash to make enough new loans, robbing the economy of the necessary lubricant to keep businesses expanding. Even worse, the banks still don't know the ultimate extent of their losses on many of the complex new credit securities.
But there are two pieces of good news. We are more resilient today than in the 1930s, and we've learned a thing or two. The economy grew at a stronger-than-expected pace for the first half of the year, in part because of exports. Everyone knows that food and fuel prices are soaring—taking about $2,000 of after-tax money from the spendable income of the average family—but there is a silver lining. Because workers are not able to demand higher wages, greater labor unit costs have not hit the entire economy, so core inflation has remained at about 2.4 percent, even though "headline inflation," which includes food and fuel, has gone up more dramatically.
Perhaps the best news, though, is that the Federal Reserve, led by Chairman Ben Bernanke, whose academic specialization fortuitously was the study of the Depression, understands what it takes to prevent the kind of systemic financial collapse that occurred then. The Fed has reduced the cost of federal funds, recognizing that the inflation in commodity prices is primarily caused by increased global demand, which doesn't respond to federal monetary policy.
The Fed wisely has chosen to focus more on preventing a dramatically deeper recession by lowering interest rates—rather than raising them to combat inflation. The Fed is right not to tighten monetary policy in the midst of a financial crisis. That was one of the many mistakes in the Great Depression. Raising interest rates would pose an excessive risk while the downward momentum in home prices shows no signs of abating.
The fate of the U.S. economy now hangs in the balance. On one side of the high wire is an inflation risk that can beget a wage-price spiral that would in turn induce a powerful contraction by the Fed. On the other side is an economy getting weaker, provoking bank and housing defaults that put further downward pressure on growth. So far, public policy has properly focused on maintaining a functioning credit system and cushioning the home-price crash.
Reader Comments
Debt in America
We are in great perils in a world with an American debt of more than ten trillion, two endless wars and a nearly collapsed wall street and with a main street that can only hope to pay it's bills and keep it’s homes from being foreclosed on.
I watched Senator McCain and my questions remain as to how he is going to help the economy recover, or get more health insurance available to the 47 million uninsured folks, or stop the illegal immigration. He is a genuine hero and his first love is the need for defense, but he needed to assure the nation that the BushCheneyMcCain riff now happening with Russia does not escalate to a new COLD WAR. He failed to address the danger of the national debt and the danger of a new weapons buildup will cause our economy. The WAR mentality I saw all during this convention speaks very loud as to what he intends to do as President. The financing of more debt has to come from somewhere and cutting more corporate taxes will only weaken our defense capabilities. President Reagan is McCain’s hero and his guide on defense, but McCain forgets that the five trillion spent by Reagan for the first COLD WAR is yet to be paid for. McCain supported the “SPEND and BORROW “, policies of Reagan Republicans that we can not continue to afford. We as a nation are being swallowed up by all the debt, both national and personal. At some point the rest of the world will just stop loaning us more money. All one has to do is watch any of the financial news channels to hear the problems that are going to come to ahead and be required to be dealt with under the next administration.
To John McCain where is the BEEF? All I saw is more of the same Bush/Cheney on defense, the economy and the future. Governor Palin is only the VP on the ticket not the POTUS her words are just that words that are pleasant to the ear but quickly fade away as the NEOCONS replace reason with fear and logic with spin.
Overhaul Tax Code
The tax code should create financial incentives in support of America's best interest. Admittedly altering taxes isn't a panacea for our economy but it would promote a better long-term outcome for our citizens.
The tax code should:
1) discourage speculators from the housing market. Speculators (i.e. those that were "flipping homes" for profit only) do not add value to the "home" product. They're middle-men that artificially drive up prices via extra demand pressure. The tax code should encourage long-term homeownership.
2) strongly support U.S. products and manufacturers. There should be a strong tax disincentive for U.S. companies to move off-shore and/or outsource jobs. The tax code should make it preferable for companies to stay within the U.S.
3) put a large tax on gas. This would provide much needed money to improve our infrastructure and improve our public transportation network. Also, it would make finding alternative fuel a REAL top priority. Waiting for the oil companies to come up with an alternative fuel is like asking the fox that is already guarding the hen house to come up with another food source (why would he?). Finally, we're currently borrowing money from China to buy fuel from Petro-dictators. This is really bad fiscal and foreign policy.
The tax code isn't a panacea for our problems but it does affect individual and corporate behavior. The tax code should be written for America's best interest not written by political and corporate lobbyists.
An Economy on the Brink -- the m3 money supply
I have some questions that I never see or hear asked.
According to the US Treasury Department site the federal government has not issued any money, other than coins which make up less than ½ of one percent of the nations total money supply, since 1971 when the last US government notes were retired. Meaning the Federal Reserve and its member banks create 99.5 % of the nations money supply, this moneyis created as loans, in the case of the Federal Reserve to US government and member banks, in the case of commercial banks to corporations, businesses and individuals. These loans must be repaid with interest, but the banks only create the principal of the loans but no money to pay the interest.
My first question: “what is the source of money required to pay the interest on all the loans?”
For example, if the total money supply is $40 trillion and the interest rate is 5% per annum (just to keep the math simple in this example) the interest payment for the year is $2 trillion. The only source of money is the existing money supply. If interest is deducted from the money supply, then there is insufficient money left to repay the principal, making it impossible honor all the loan contracts.
If the banks originate more loans to get the money to pay the interest, robbing Peter to pay Paul, they will have to keep repeating that action to stay ahead of the game, creating an ever expanding pyramid of debt.
My second question: “Are the Federal Reserve and the member banks creating a pyramid or Ponzi Scheme, and blaming the nation’s economic difficulty of their patrons , the government, banking regulations and the people?”
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