Very few of us actually need a debriefing on what went wrong in the economy over the past 18 months.
Real estate construction, primarily precipitated by new housing starts, had gone wild. Fueled by “anyone who can fog a mirror can qualify for a mortgage” mortgage financing, prices for real estate skyrocketed virtually everywhere in the country and certainly in the populated states.
When the real estate prices came crumbling down, they took mortgages with them, at every level—not just sub prime; and the financial markets brought down credit at virtually every level.
With tanking real estate, mortgages in default, and frozen credit markets, businesses started folding or seriously cutting back on capital spending and workforces and consumers seriously cut back on putting more purchases on credit cards.
Not to be overly simplistic, but that is fundamentally where we are today. Consumers continue to cut back on their spending. Businesses continue to trim workforces or provide for wholesale work reductions, and unemployment continues to rise.
It was a little known fact that 70 percent of all economic activity is pegged to the consumer. Think about it. Industrial goods firms provide goods and services primarily to manufacturers or, if you will, “constructors.” They, in turn, build or assemble the things that wind their way through the various distribution channels. However, at the end of that chain is a consumer who is buying (or not) the goods or the services.
If consumers account for 70 percent of economic activity in what they buy to consume, and if they cut back just 10 percent, the broad-based effect is catastrophic. Therefore, while it is serious stuff that in just the month of October alone retail sales dropped 2.8 percent, what is even more significant is that in tangible goods such as furniture, automobiles, high-priced consumables, the corresponding year over year retail decline represented a composite 45 percent.
At the end of the day, it is the level of consumer spending and its further erosion which will continue to traumatize the economy. And it is only when consumer spending once again stabilizes and begins to rise that the road to recovery can begin.
What must we see?
1. As housing starts continue to fall, real estate prices will continue to drop until supply/demand equilibrium occurs with a meaningful reduction in inventories. A 4- to 6 month supply is optimal, rather than what we currently have in some parts of the country that are three times that amount of inventory.
2. Mortgage financing needs to clearly be reintroduced, but with higher down payments and predictable, fixed interest rates. Credit insurance can cover deviations, but the cost of that credit insurance needs to be borne by the lender, not by the after market.
3. Credit card and mortgage balances, for substantial segments of the population, need to be restructured, or at least realigned. While there are numerous contexts for that, one or another has to be adopted before any meaningful recovery can occur.
4. The U.S. Treasury needs to fund the largest employment initiative in the new century, second only to the massive works programs initiated by FDR. It’s a simple fact: unemployed people don’t spend. And the more the unemployed, the more businesses will continue to contribute to that unemployment. While the U.S. government will clearly go into even greater levels of debt for this initiative, it has more than ample capacity. Social objectives and the economic objective of employing people in the process will both contribute and drive the effort.
In any event, I know that we are all attempting to get our arms around what this economic beast looks like at this point in time, and I share these thoughts with you for what they’re worth.
Original writing date: December 1, 2008