Friday, January 22, 2010, AM | 5 Comments
It has been a year that Mr. Barack Obama took over the presidency. Now is a good time as any to do something about the debt in our personal financial lives. We, the American people, voted President Barack Obama in office, as we had done his predecessors, to do what he has to do on a national level. So we gave him a mandate to govern and act responsibly.
The market, the banks and other financial institutions and, most of all, the American public need the same reassurance as Franklin Delano Roosevelt (FDR) – the 32nd President of the United States – who declared in 1933 “The only thing we have to fear is fear itself” – provided 75 years ago to the nation.
The fear FDR talked about was as real in 2009 as it was back in 1933 and will be in 2010 and beyond if we don’t start doing something about it. We must tame the debt beast on both fronts – national as well as personal levels.
Since September of 2008, when bad mortgages toppled the reign of some of the biggest financial institutions on Wall Street, the U.S. economy has moved with unstoppable speed into its worst crisis since 1933.
In a ripple effect scenario, the market went bust as investors ran for the safety of cash, while many banks – suddenly short of capital and long on some “nasty” loans – froze lending. They had been lending money, but were unable to get return on their money.
Now it’s time for us to act and live responsibly in our financial lives.
- The debt beast got created gradually over the years
- The root cause of the debt beast creation
- How do you tame the debt beast now?
- Who is at fault?
The debt beast got created gradually over the years – a catch 22 scenario
First off, let us count the ways how we personified this huge Godzilla look-a-like debt beast. And I mean personified, because many of us have had nightmares about it.
Statistics between 2001 and 2006, according to a report by a U.S. Senate committee, show that an average family’s inflation-adjusted income declined. So what did the American people do? They borrowed and borrowed and kept borrowing to make up for the decline in their so-called quality of life.
On the one hand, they borrowed to raise their quality of life. On the other, they kept getting into debt and more debt that, eventually, lowered their quality of life. Looks like catch 22 to me. This was, and hopefully not in the future, our mindset:
We borrowed and raised the quality of our lives – immediately – without thinking how we would ever repay the debt.
We got into debt
We could not pay back and lowered the quality of our lives – eventually. My friend from the 60s says: “Borrowing was deliberate but in no way intentional.” Go figure that.
When the prices of the homes we owned were going up, it created a kind of wealth effect. We all liked that feeling. So we spent more and more like there was no tomorrow.
When the prices of the home we owned were coming down, it created a kind of poverty effect. We all hated that feeling. So we borrowed and kept spending more and more like there was no tomorrow.
The Feeling effect
Come to think of it, that’s what it was. “The feeling.” Sounds like the name of a horror movie. That psychological shift from one kind of feeling to the other, on the part of the American people, poses a very real threat to an already weak economy.
Loss of confidence
Loss of confidence in the executive branch, the Treasury, the market, and all those other institutions, is perhaps the most dangerous aspect of the entire economic situation.
This has turned into a market concern for the worst. This is a real issue – no kidding – that is related to bad credit policy, on the part of the government as well as the American people, that has been going on for many years.
The root cause of the debt beast creation
During the so-called “roaring nineties” and a better part of the following decade, low interest rates spurred lending. The banks didn’t care much because they were making huge profits. It worked for them for many years, so they never bothered to look at the process and fix it.
In retrospect, even when the defaults on home loans, car loans, and credit card debt started occurring, the banks were still giving out loans to people that could never pay back.
That was the time when Godzilla raised its head. Even if some people saw it on both sides of the spectrum of give and take, they just ignored it.
The banks, for sure, did not seem to notice it. How could banks continue to profit while an increasing number of their own customers were going broke? No one in the banks or anywhere else for that matter ever thought about that.
The answer could be in the collapse of stock market. A fear-fueled sell-off had already diminished $2 trillion in retirement assets. Another $4 trillion had vanished from housing since the bubble popped in 2006.
So, by the time, Congress authorized more than $700 billion rescue package for the banking industry, a damage of $6 trillion had already been done. I cannot comprehend a billion dollars, let alone a trillion. But someone said the other day, a little more than a billion minutes ago, Jesus Christ was alive.
Most consumers had accumulated many credit cards and had owed money on all of them. Many thought their situation was dumb but manageable.
However, another blow to their misery came in the shape of when banks lowered their credit limits. All of a sudden, consumers were maxing out those cards which in turn triggered higher interest rates.
Before long, Godzilla had come into shape and people started having nightmares, not to mention losing sleep.
Some people, and I am sure not all, have learned the lesson that frugality, and not necessarily high credit score, is the key to their financial security.
How do you tame the debt beast now?
The U.S. economy is market-driven, to be sure. Now, how do you restore faith in a market-driven economy.
Many economists, left and right, suggest two things:
Regulation by Congress of the national economy
For banks and Wall Street, regulation means playing by a new set of rules. The party is over and it must not come back if we have learned anything.
We all remember, October 2008, when we heard it from the horse’s mouth. Former Federal Reserve chairman, said: “Those of us who had looked to the self-interest of lending institutions to protect shareholders’ equity, myself especially, are in a state of shocked disbelief.”
Regulation by ourselves in our personal lives
For individuals, self-regulation means developing a new mindset – one closer to the attitude children of the Worst (I don’t know what was so Great about it) Depression grew up with – that says if we don’t have it, we don’t spend it.
We don’t have a choice. On this one point, everybody agrees:
“To relieve the fear that holds the national economy hostage, we must restrain debt. Debt is the toxin that feeds the fear and fear is the toxin that feeds the debt.”
As we all know by now, the individual savings rate is rising. That is, we spend less than we make. That’s good. However, the government rate is at a deficit. We all feel the pain. Long term, economists agree, the pain might be more severe.
Who is at fault?
I think all these three players are at fault.
Securities and Exchange Commission (SEC)
There was no regulation. Even if there was some, no one took the time to implement it. Like they say in a third world country, the government looked the other way. There was no government, period, that was supposed to protect the American people.
Banks and other financial institutions did not bother to check whether the consumers they were lending to were actually able to return that money. The institutions that lent the money should have been more discrete about it.
The American public
Nobody can blame us. As long as the Joneses are alive in our mind, we will borrow and spend to infinity. There is no end to it. The people who borrowed the money should have known better – that they really could not afford to borrow more.
Remember what Mary Ellen Edmunds once said: “We buy things we don’t need, with money we don’t have, to impress people we don’t like.” Just think about it.
In a Nutshell
Think about the fact that your financial situation can change really quickly. It has changed for the worse the last couple of years for most Americans.