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talkpoliticsHere is an interesting article by conservative author and economist David Frum. He rejects the idea that the issue was Wall Street's lack of regulation or greed, but instead a different issue: China and the lag between middle class income and cost of living.
Wall Street didn't cause crash of '08
Financial reform? Not exactly. The bill before Congress does nothing to address the fundamental background causes of the crash of 2008.
Wall Street may have been the instrument of the crash. But the crash was made elsewhere: in Washington's failed policies for middle-class families -- and in China's distorted rush for economic growth.
The story is not a simple one. But I hope you will pay attention to the details. If you don't, you may find that the pocket that has been picked is your own.
As you've heard, the crash begins with the huge excess load of debt built up in the last two decades by American households. Why did Americans borrow so much? Some like to tell a story of irresponsibility: We borrowed too much because we were self-involved yuppies who just could not deny ourselves the latest flat-screen doodad for our McMansions.
Maybe that describes some people. But many millions of middle-class families plunged into debt for a very practical reason. Their incomes were not keeping pace with the cost of crucial items of the middle-class lifestyle: housing, medical care, college tuition. At the same time as housing, medical care and tuition were jumping in cost, the cost of borrowing was dropping to historic lows.
Adjusted for inflation, the typical American family earned less in 2007 than that family had earned in 2000. Meanwhile, everyday necessities such as energy were becoming more expensive: By 2007, the typical American family paid more for energy than it did for clothes and entertainment combined.
As everyday bills piled up, families borrowed to pay extraordinary bills. Mom needs nursing care? Junior got admitted to Chapel Hill? The roof needs refixing? No worries -- just cash out with a cheap refinance deal.
In the 1950s, the total debt of all American households amounted to less than one-third the nation's gross domestic product. In 1980, household debt amounted to less than one-half. As recently as 1990, it was still under 60 percent. In 2000, it was under 70 percent. On the eve of the 2008 crash, total household debt had bulged to 96 percent of gross domestic product.
All this borrowing might look like the road to ruin. And in fact it was the road to ruin. But that's not how it looked at the time. At the time, it looked like a bargain. Between 1980 and 2008, the household debt load doubled as a share of the economy. Yet the interest cost to carry that debt rose much more modestly. In 1980, the average American family devoted about 13 percent of its disposable income to debt service; by 2008, the average family was spending about 17 percent of its disposable income to service debt.
Why was debt so cheap?
This takes us to another fundamental cause of the crisis: the growth of China.
Maybe you've heard that we bought a lot of goods from China and now we are deeply in debt to China. That's true obviously -- but the cause and effect are upside down.
China lent us a lot of money so that we would keep buying Chinese goods.
Export booms do not usually last very long. The exporting country accumulates more and more of the importing country's currency. Eventually the exporting country decides it wants to use some of that currency. It exchanges the importing country's currency for its domestic currency -- and that has the effect of making its exports more expensive. The boom bumps up against its own natural limits.
That did not happen with China. Desperately eager to create more and more jobs to employ the tens of millions of peasants flowing into China's huge cities, China not only accumulated dollars by the hundreds of billions -- it held them. Then it went into the foreign currency market to buy still more billions of dollars, sometimes $1 billion a day.
All that dollar buying prevented China's currency from going up in value, which would have increased the price of China's exports -- and that kept China's factories turning.
What do you "buy" when you buy "dollars"? There are only so many Benjamins in the world, nowhere near enough. Buying "dollars" means buying dollar-denominated debt, and far and away the biggest source of U.S. dollar debt is U.S. mortgage debt.
With China so eager to buy, U.S. bankers went to work to create mortgage paper to sell. It didn't have to be good-quality paper -- the Chinese didn't really care about that. Did you get a great deal on your refi in 2005? Thank the Central Bank of China.
American homeowners borrowed because they could not earn enough. China loaned to keep its factories turning. Money flowed in a frenzied torrent across the Pacific. And somebody had to make it all happen: Wall Street. It created the debt instruments China wanted to buy and packaged the mortgages that Main Street felt pressured to sell. With trillions of dollars changing hands, even a small percentage fee could pay a lot of people a lot of billions in fees.
No doubt some of those fee-takers did abusive things. But the whole dynamic was abusive and dangerous. And so-called financial reform is a petty distraction from that larger, more important, and more urgent dynamic: raising American incomes so Americans borrow less, and redirecting Chinese trade to the home market so that the Chinese lend less. Until we achieve those two things, any recovery will only invite the next disaster.
End of article frum ... David
-----
I think it brings up some interesting issues, issues definitely worth considering. My main criticism though is that he rejects one cause for this other, and I don't think there's anything that explicitly causes one to negate the other. I think all these issues are real issues and aided in causing financial collapse and probably more than these too.
The things he covers are more the issues that set the stage: influx of money, people needing to borrow to maintain a normal life. Yes, this caused there to be lots of debt built up. If people remember, that has existed for a while though, the U.S. economy had been considered a debt economy even back into the 90's. The economy was built on plastic then too, and people were expecting collapse then too.
So in that sense, he's right that we have not addressed those underlying issues: people still are needing to borrow to live normal lives. Frum may not agree, but healthcare reform actually addresses the underlying cause of these problems probably more than finance reform does.
As far as the issues with China goes, I'm not going to address that. Many people have, and maybe some of y'all should, as China is not going away anytime soon and has been very proactive in leveraging their economic abilities and will probably continue to be a chief influence on our economic situation into the foreseeable future.
Lastly, I think Frum is wrong on ignoring the effect of deregulation in banking. The banking issues acted as a magnifier. The influence of Wallstreet pushed the deregulation of loaning and pushed the social acceptance of living in this massive debt economy, through lobbying and advertising they made easy credit a way of life. That can't be ignored in this cycle either. Perhaps the banking reform will help to reduce the reliance people have had on loans, which will make it necessary for middle class income to catch up with cost of living.
Even more lastly, something I thought of. Part of the problem with cost of living is that with our constant inundation of advertising, people often feel they 'need' a lot of things they really don't. What is considered middle class has a lot of pork attached on simply because its part of our social environment. How do we address that problem that is so fundamentally linked to our culture? We may see a reduction in the social acceptance of just borrowing to afford anything, but when that butts up with 'now people believe they are expected to have all these things that they now cannot afford' what is going to happen?
Wall Street didn't cause crash of '08
Financial reform? Not exactly. The bill before Congress does nothing to address the fundamental background causes of the crash of 2008.
Wall Street may have been the instrument of the crash. But the crash was made elsewhere: in Washington's failed policies for middle-class families -- and in China's distorted rush for economic growth.
The story is not a simple one. But I hope you will pay attention to the details. If you don't, you may find that the pocket that has been picked is your own.
As you've heard, the crash begins with the huge excess load of debt built up in the last two decades by American households. Why did Americans borrow so much? Some like to tell a story of irresponsibility: We borrowed too much because we were self-involved yuppies who just could not deny ourselves the latest flat-screen doodad for our McMansions.
Maybe that describes some people. But many millions of middle-class families plunged into debt for a very practical reason. Their incomes were not keeping pace with the cost of crucial items of the middle-class lifestyle: housing, medical care, college tuition. At the same time as housing, medical care and tuition were jumping in cost, the cost of borrowing was dropping to historic lows.
Adjusted for inflation, the typical American family earned less in 2007 than that family had earned in 2000. Meanwhile, everyday necessities such as energy were becoming more expensive: By 2007, the typical American family paid more for energy than it did for clothes and entertainment combined.
As everyday bills piled up, families borrowed to pay extraordinary bills. Mom needs nursing care? Junior got admitted to Chapel Hill? The roof needs refixing? No worries -- just cash out with a cheap refinance deal.
In the 1950s, the total debt of all American households amounted to less than one-third the nation's gross domestic product. In 1980, household debt amounted to less than one-half. As recently as 1990, it was still under 60 percent. In 2000, it was under 70 percent. On the eve of the 2008 crash, total household debt had bulged to 96 percent of gross domestic product.
All this borrowing might look like the road to ruin. And in fact it was the road to ruin. But that's not how it looked at the time. At the time, it looked like a bargain. Between 1980 and 2008, the household debt load doubled as a share of the economy. Yet the interest cost to carry that debt rose much more modestly. In 1980, the average American family devoted about 13 percent of its disposable income to debt service; by 2008, the average family was spending about 17 percent of its disposable income to service debt.
Why was debt so cheap?
This takes us to another fundamental cause of the crisis: the growth of China.
Maybe you've heard that we bought a lot of goods from China and now we are deeply in debt to China. That's true obviously -- but the cause and effect are upside down.
China lent us a lot of money so that we would keep buying Chinese goods.
Export booms do not usually last very long. The exporting country accumulates more and more of the importing country's currency. Eventually the exporting country decides it wants to use some of that currency. It exchanges the importing country's currency for its domestic currency -- and that has the effect of making its exports more expensive. The boom bumps up against its own natural limits.
That did not happen with China. Desperately eager to create more and more jobs to employ the tens of millions of peasants flowing into China's huge cities, China not only accumulated dollars by the hundreds of billions -- it held them. Then it went into the foreign currency market to buy still more billions of dollars, sometimes $1 billion a day.
All that dollar buying prevented China's currency from going up in value, which would have increased the price of China's exports -- and that kept China's factories turning.
What do you "buy" when you buy "dollars"? There are only so many Benjamins in the world, nowhere near enough. Buying "dollars" means buying dollar-denominated debt, and far and away the biggest source of U.S. dollar debt is U.S. mortgage debt.
With China so eager to buy, U.S. bankers went to work to create mortgage paper to sell. It didn't have to be good-quality paper -- the Chinese didn't really care about that. Did you get a great deal on your refi in 2005? Thank the Central Bank of China.
American homeowners borrowed because they could not earn enough. China loaned to keep its factories turning. Money flowed in a frenzied torrent across the Pacific. And somebody had to make it all happen: Wall Street. It created the debt instruments China wanted to buy and packaged the mortgages that Main Street felt pressured to sell. With trillions of dollars changing hands, even a small percentage fee could pay a lot of people a lot of billions in fees.
No doubt some of those fee-takers did abusive things. But the whole dynamic was abusive and dangerous. And so-called financial reform is a petty distraction from that larger, more important, and more urgent dynamic: raising American incomes so Americans borrow less, and redirecting Chinese trade to the home market so that the Chinese lend less. Until we achieve those two things, any recovery will only invite the next disaster.
End of article frum ... David
-----
I think it brings up some interesting issues, issues definitely worth considering. My main criticism though is that he rejects one cause for this other, and I don't think there's anything that explicitly causes one to negate the other. I think all these issues are real issues and aided in causing financial collapse and probably more than these too.
The things he covers are more the issues that set the stage: influx of money, people needing to borrow to maintain a normal life. Yes, this caused there to be lots of debt built up. If people remember, that has existed for a while though, the U.S. economy had been considered a debt economy even back into the 90's. The economy was built on plastic then too, and people were expecting collapse then too.
So in that sense, he's right that we have not addressed those underlying issues: people still are needing to borrow to live normal lives. Frum may not agree, but healthcare reform actually addresses the underlying cause of these problems probably more than finance reform does.
As far as the issues with China goes, I'm not going to address that. Many people have, and maybe some of y'all should, as China is not going away anytime soon and has been very proactive in leveraging their economic abilities and will probably continue to be a chief influence on our economic situation into the foreseeable future.
Lastly, I think Frum is wrong on ignoring the effect of deregulation in banking. The banking issues acted as a magnifier. The influence of Wallstreet pushed the deregulation of loaning and pushed the social acceptance of living in this massive debt economy, through lobbying and advertising they made easy credit a way of life. That can't be ignored in this cycle either. Perhaps the banking reform will help to reduce the reliance people have had on loans, which will make it necessary for middle class income to catch up with cost of living.
Even more lastly, something I thought of. Part of the problem with cost of living is that with our constant inundation of advertising, people often feel they 'need' a lot of things they really don't. What is considered middle class has a lot of pork attached on simply because its part of our social environment. How do we address that problem that is so fundamentally linked to our culture? We may see a reduction in the social acceptance of just borrowing to afford anything, but when that butts up with 'now people believe they are expected to have all these things that they now cannot afford' what is going to happen?
Cheap debt
Date: 26/4/10 20:06 (UTC)You put 4-5-6% loans out there when people are making more than that in other investments or simply watching inflation out pace the loan rate and there's little to stop someone from borrowing now to (perhaps) pay back later with inflated dollars and/or investment returns.
There are a number of reasons for the cheap debt, of course. It was Fed policy, White House policy (over three administrations) and the (former) reputation of mortgage-backed securities as being proof against any and all sorts of economic maladies. Demand from China was "a" factor but before them it was the Japanese and British and...there will always be demand for US debt as long as we have a history of repaying it without significantly devaluing our currency.
If the federal government wants to continue to play in the mortgage game it should drop the zeros (zero down, zero interest, zero docs...) and require 10% down payments and proof of income sufficient to pay the principal, interest, real estate taxes and have enough left over for other debt financing/living expenses.
The government ruined the S&Ls with horrible regulations and oversight and almost did the same thing to the mortgage industry. How many times does it have to fail before it realizes that politics and banking don't mix?
All this will fall on deaf ears in the Obama administration, however. He's cut from the ACORN/lawsuit/forced loan cloth that helped cause the mortgage crisis. The third verse will be very much like the first two verses only the US taxpayer will be on the hook more than ever before.
Re: Cheap debt
Date: 26/4/10 20:09 (UTC)Re: Cheap debt
Date: 26/4/10 20:11 (UTC)Re: Cheap debt
Date: 27/4/10 02:58 (UTC)