John Burns*
February 3, 2009
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
Executive Summary
The U.S. is undoubtedly in the worst financial and economic crisis since the 1930s. Home prices are falling rapidly across the nation, which has resulted in more than $2 trillion in losses in the last two years. The declining stock market has wiped out trillions more. These tremendous losses have created a vicious downward spiral that requires government intervention to avoid a 1930s-style economic collapse. This problem is affecting both Wall Street and Main Street.
There has been a lot of rhetoric and not a lot of facts about the current economic and financial crisis. In this report, we use facts to assess the current situation and provide our recommendations to save the U.S. economy from collapse.
To stabilize home prices, we believe Congress needs to do four things in conjunction with the Federal Reserve and US Treasury Department. Some of our recommendations have already been accomplished, but many of them have not.
- Stabilize The Banking System - Save local businesses by saving the local employers’ bank.
- Continuing insuring deposits up to $250,000 and unlimited amounts in payroll accounts
- Close all poorly managed and undercapitalized banks ASAP
- Keep lending money to stabilize the best and largest banks
- Properly dispose of bad loans, RTC-style, instead of the way it is currently being done
- Finance new banks to create competition for good loans
- Continue supporting commercial paper liquidity
- Continue liquidity guarantees on new bank debt
- Stimulate Job Growth - Bring more jobs to the economy with short-term stimulus and smart government spending.
- Fund infrastructure projects to create jobs
- Stimulate short-term spending while recognizing that long-term saving is also needed
- Allow companies to utilize their current losses to recapture taxes paid over the last 4 years so they can keep enough cash in the bank to meet payroll
- Create government–backed initiatives to help banks lend
- Stimulate Responsible Home Buying – Stop home price declines by stimulating home buying by responsible individuals, to bring demand and supply back into balance.
- Keep mortgage rates low
- Keep Fannie and Freddie lending and FHA insuring
- Temporarily provide a down payment match to all home buyers
- Temporarily double the mortgage interest rate deductions for all homeowners
- Support responsible loan modifications – Stop home price declines by helping keep responsible people in their homes.
- Provide financial incentives for loan servicing firms to modify loans
- Create a vehicle to buy loans that have been responsibly modified
Why We Need to Act Quickly
Key Indicators
The current US recession is turning into a depression. In the following chart, we compare the current economic indicators with the long-term average of each indicator. Many of these indicators are significantly below the long term average and many are at an all-time low. For example, retail sales are falling at a 9.2% rate in comparison to its usual 5.2% growth. Similarly, employment is falling at a 2.0% rate in comparison to average annual growth of 2.2%.
Applying the same methodology, every key index in the US is well-below average, and the leading indicators are all miserable.
Employment losses are mounting across the country. This is no longer a problem of one state versus another; the effects of this recession are spread across every state. As seen in the following map, the red sections show areas of job losses. Most of the major metropolitan areas along the coast and the Midwest are experiencing employment losses today. The areas that are experiencing positive job gains are approaching job losses as well. As oil and gas prices decline, we expect Texas employment to decline.
The Borrowing Problem
The primary issue in the economy, which has been occurring for many years, is that we have borrowed more than we can repay. Since 1992, all categories of debt have grown much faster than incomes, when over time, debt and income have to grow at the same pace. From 1992 to September 2008, personal income (including population growth) has grown at an average annual rate of 5.2% in the US. This compares to the growth of non-revolving credit (such as auto loans) of 6.8%, revolving credit (such as credit cards) of 8.1%, and mortgage debt of 8.5%. This 16-year period where the growth of debt outpaced income has finally reached a breaking point.
As a result of the high levels of debt, businesses and consumers are now saving more than they ever have before. They are hoarding cash to pay down debt because it is the smart thing for them to do. However, this saving, which is called deleveraging, is very difficult to stop and has devastating effects when done quickly and worldwide, which is what is happening today. The collective effect of reduced spending will cause a Depression (a sustained recession), which is highly likely at this point. Looking ahead, it will be policy responses that determine the extent and length of this long recession or even depression.
The Spending Problem
The conundrum is that consumers and businesses need to save, yet we cannot have economic growth without spending. There are two huge obstacles to spending:
- recent wealth destruction and
- demographic trends.
Baby boomer wealth destruction has been enormous. All 401K contributions since 1996 have declined in value if invested in S&P 500 stocks. To further this point, consider the profile of a responsible saver who put the maximum 401K contribution of $231,000 in S&P 500 stock funds since 1987 (shown in blue). The value of those investments was $465,000 in December, 2007. The value on November 21, 2008 (S&P at 800), was only $265,000.
Long-term demographic trends are more favorable to saving than spending. The peak birth year of the U.S. population occurred near the end of the baby boom in 1960. These people are currently 48 years old. The peak spending years for an average adult is in their 40’s when their children are in college. After these years, many people become net savers. As a result, we are heading into a decade long period when spending due to our aging population is going to be trending down. This is purely a demographic shift and does not take into consideration how many people will have to be saving more now that their retirement savings have declined substantially. The demographic shift is similar to what occurred in Japan over the last 15 years, but not nearly as significant.
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