Wikinvest Wire

Still blissfully unware of the real root causes of the problem

Monday, September 22, 2008

Two reports in major newspapers today provide compelling evidence that we are a long, long way from correcting what ails financial markets and the economy these days.

Some writers seem to think they have identified the root causes of recent problems as falling home prices and a skittish consumer when, in fact, these are just symptoms of the real root causes.

In this LA Times report, Michael A. Hiltzik seems to think that if we could just get home prices to stop falling, the world would be a much better place.

The government's $700-billion plan to bail out the banking system may calm panicked financial markets, but its real value may be in buying time to address the root problem: the continuing slide in housing values.
The rescue plan does nothing in itself to shore up the housing market. Rising defaults and foreclosures on home loans, spurred partially by declines in home values, are the cause of the collapse in price and tradeability of the mortgage-backed securities on the books of banks and investors.

But without government action to aid battered banks, financial experts say, mortgages would remain difficult to get and the housing market's recovery would be further delayed. The most recent sales figures for Southern California show that median prices were down 34% last month compared with a year earlier. About half the homes sold were foreclosures.
No. Falling home prices are not the root cause of the current mess. The root cause of the problem in housing today is that, for the last twenty years, the U.S. has had a "bubble economy" where money flows from one asset class to another, inflating prices beyond any reasonable measure of fair value.

By any historical standard, home prices are still too high. To think that if we can just stop home prices from falling and then, maybe, get them to go back up is a child-like view of the fundamental problems facing us today.

Until more people realize this, progress toward real solutions will not be made.

In this USA Today report, Barbara Hagenbaugh views a slowdown in consumer spending as a major threat to the U.S. economy.
Business was already down at the Muddy Cup Coffee House this year. Now, Jim Svetz, owner of nine coffee shops in Upstate New York, fears things are only going to get worse.

Consumers "see the news, it's big news, it ends up being on the major news channels, and then everyone becomes worried, and it affects their spending," Svetz says. "It's very tough out here."
"We're in a danger period for the next six or eight months," until house prices are expected to bottom, Carnegie Mellon economics professor Marvin Goodfriend says.
Consumer spending accounts for more than two-thirds of all U.S. economic activity. Even before the recent market events, consumer spending was slowing. Two retail groups last week predicted the holiday shopping season would show the smallest gain in sales since 1991. If spending were to actually decline this quarter or next, it would be the first time since 1991, when the U.S. economy was in a recession.
No. The popular belief that we, as a nation, could spend more than we made because our home prices or stock investments would rise in perpetuity is in the process of coming crashing to the ground.

That's the real root cause here.

A system where two-thirds of economic activity comes from personal consumption is wholly unsound and, until we begin to move away from a financial system and culture that condones "buying things that you don't need with money you don't have", we'll never have a good long-term solution for what ails us.

From time to time you hear some enlightened discussion of the real root causes of the current mess but, for the most part, the entire nation still thinks that we can turn back the clock and somehow relive the last twenty years.

That's just sad.

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Troy said...

A system where two-thirds of economic activity comes from personal consumption is wholly unsound

I disagree with this to some extent, as the percentage of the tertiary economy depends on the productivity of the primary and secondary sectors.

Well all don't have to be farmers, coal miners, and assembly line drones to have a balanced economy.

Tim said...

I was just about to update that to say "72 percent of economic activity" instead of "two-thirds of economic activity", which, is not that far above the post-war average in the U.S. - too late now.

me said...

I can't wait to hear from the "We don't need to manufacture anything, we do finance" crowd. They seem to have disappeared lately.

Mathlete said...

And where do an entire people get the money to spend more than they earn? The Fed.

Our financial crisis isn't really that grave, in my opinion. Check out John Mauldin's article this week. There are hedge funds waiting to buy these assets at 60 cents on the dollar, the banks want to sell them for 70 cents. It's the difference between solvency and bankruptcy for the banks, but it isn't a wide number. If interest rates increased to cut lending an increase savings, the difference could be made up easily. There would be a sharp recession, stocks and homes would drop again, but then we'd be done with it. Instead...

Anonymous said...

Fueling all that spending was easy credit, esp HELOCs. Mortgage brokers have been incentivized by banks to make deals that, under scrutiny, are basically illegal, but which were so lucrative for the brokers and banks and attractive to investors that regulators chose to look the other way.

Anonymous said...


Speaking of "buying things you don't need with money you don't have..."

That's arrogant bika kaka that applies to less than 10% of households.

Tell that to a retired 75 year old in Brockton, Massachusetts who must heat her home at 55F cause she can't afford more...

"It's the incomes, stupid..." 1982Reagonomics reallocated the marginal value of labor and capital in the US. Those who toil and labor just keep denying that they and their children have been screwed for 25 years now in relative terms.

Welcome to the real post industrial society.

Boomer55 said...

Tim's piece is exceptional in its reasoning and is economically sound. Those of you who choose to poke at his views should also stand up and express your own beliefs. Otherwise, we will have no choice but to view your comments as nothing more than a "cheap shot" by a malinformed. It is not reasonably possible for one person to know "everything" so we must read the views of others, analyze the contents, and incorporate them into our belief structure or dismiss them as we deem fitting. I choose to retain a large nugget of Tim's belief structure because I believe it to be correct.

Anonymous said...

Well said.

Housing prices are on their way back to reality.

To blame the return to reality for the depression is terribly misguided.

The blame belongs on the creators of the bubble.

Knute Rife said...

If a country consumes more than it produces, it is in trouble. For awhile we were able to compensation for our loss of manufacturing by producing financial products, but now those products have acquired the same international reputation our manufactured products acquired three decades ago, with similar results. On top of that, we became a net agricultural importer a few years ago.

As with a house, there is only so much equity you can pull out of a country. When you hit the limit, you become Yard Sale Nation.

Troy said...

Those of you who choose to poke at his views should also stand up and express your own beliefs

I am a Single Taxer who believes taxing land values (actually ground rents) and natural resources (via severance taxes) should be the primary if not only source of revenue for government.

If a country consumes more than it produces, it is in trouble

with this, I of course agree. While it is possible to export services abroad, this is a fragile balance.

I was just saying that if we had magic robots doing all the industrial and manufacturing sector work we could get by with a 99% service economy.

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