A Recession of Excesses

By Tim Holland

The end result of recessions always seems to be the same: bad. This time around the way things got started though, seems to be a bit different in that the recession didn’t start as the result of the natural business cycle with its quasi predictable ups and downs. No, this time the cycle was triggered by the same people who had been holding it off for at least five years.

It has been made painfully clear that the United States has been living in a bubble over the past ten years and that no one wanted to admit the bubble was there. What has also become painfully clear is that unlike other bubbles this one was carefully and irresponsibly crafted by the recently created (25 to 35 years) financial services industry, the same players we just bailed out with taxpayer money taken from the very people that were drawn into the financial nightmare.

Business and economic cycles, we are told, are a natural event in any quasi free market (since real free markets do not exist and never will). Often governments will intervene on a macro (big picture) level to cushion a market downturn or hasten a recovery. This they do when they see trends which they can deal with. However, this time around the trends were being masked.

Since World War Two, the United States had been an economy that has been driven by the consumer. Historically, 60% of the Gross Domestic Product (GDP) has been made up of consumer spending. However, over the past ten years that number has jumped to over 70%.

How did the American consumer do it? Credit, credit and more credit.

Houses were sold to people who could not afford them. Cars were purchased by people who were not credit worthy. Credit cards were offered to people who could not support the credit lines.

All of this mess points back to one source: the financial services monolith.

Things were trending in the wrong direction even before Citicorp became Citigroup and broke down all the barriers to banks owning insurance companies, brokerage houses and investment banks, not to mention mortgage companies, credit card companies, finance companies and anything else dealing with money they could fit under the old Travelers red umbrella. They also did it in typical Citi style, whereby they have always believed it was easier to obtain forgiveness than approval. And Congress and the rest of the wimpy business friendly administrations of the last 25 years just caved in and, in some cases, applauded and encouraged the deregulation of the industry.

The only thing one can hope for is that all of those executives of the banks that succeeded in the deregulation of the industry they inherited and pocketed those millions upon millions of dollars worth of bonuses and stock options for having succeeded, became friends and confidents of Bernard L. Madoff.

Consider the fragile inverted pyramid that was created. Someone without a down payment, who has never owned a house purchases one with an artificially low interest only, adjustable rate 100% mortgage. The only concern the mortgage representative and bank have is: does the borrower have enough cash to pay the bank fees and commissions? Not to worry, the bank offers a credit card with a credit limit sufficient to cover the fees and charges. But what if he has trouble paying the mortgage next year? Not to worry, the value of the property will increase by 25% a year and the bank will offer a home equity loan based on the increased value. But how do we protect ourselves from all these sub-prime mortgages? Not to worry, the bank will package them into securities that will be AAA rated by the credit agencies they are paying big fees to and can be sold to investors all over the world. And if something goes wrong? Not to worry, they can pass the risk onto the insurance industry which just created an insurance product made just for these securities called Credit Default Swaps.

So what went wrong? The consumer maxed out. John Q. Public found himself with a FICO credit score of 725 (because of all of his credit capacity and obvious assets – the new house, two new cars, ten credit cards with $75,000 in credit lines) but a mortgage and car loans he couldn’t pay because a bank didn’t send him an offer of a new credit card this month to which he could transfer all his outstanding balances (for a 3% bank fee, up front of course) and he just learned that his $50,000 job was being outsourced to the Far East.

Was all of this inevitable because of the natural up and down forces of the business cycle? Yes, but not to the extent that it is happening.

Our problem is that the seeds of our own economic destruction usually occur as a response to a crisis. The savings and loan crisis: “You have to ease up on the regulations in order to help the banks survive, go easy on mergers and acquisitions that you would normally oppose.” The crash of 1987: “You have to ease up on the regulations in order to help the banks survive, go easy on mergers and acquisitions that you would normally oppose.” 911 financial aftermath: “You have to ease up on the regulations in order to help the banks survive, go easy on mergers and acquisitions that you would normally oppose.”

Dear Congress and Mr. New President, is anyone out there listening and learning.