By Evelyn Black, on November 10th, 2008
Can the U.S. economy possibly get any scarier or more complicated?
The short answer is yes, it can. The longer, more complicated answer is that the looming (potential) failures of Ford, GM, and Chrysler present long term sustainability problems for a middle class that is already clamoring for short term, emergency solutions.
Ford recently announced third quarter losses of $129 million but admitted to having burned through $7.7 billion in operating costs during the same period. GM announced a staggering loss of $2.5 billion. Chrysler, by all accounts, will be belly up by the start of 2009 if the government is unable to broker a merger with GM, and all three are begging Washington for a second $25 billion in low-interest loans to keep them all afloat until the current economic crisis passes.
The announcement of these stunning losses and the request of additional federal money came alongside industry announcements of even more lay-offs and possible suspension of the plans for research and development of new, more fuel-efficient American cars. Without a more competitive product than the big trucks and SUVs of the past 15 years, it’s hard to see how and when things will get much better for the U.S. auto industry, but unfortunately the problems go much deeper than that.
Retail sales fell of a cliff in October across the board, with the exception of Wal-Mart, which saw a 2% increase in sales. Even sales of luxury items fell; items which in the past have been fairly recession-proof. Stores like Saks and Bloomingdales posted some of the worst figures of all. Job losses for October came to just under a quarter of a million, bringing the unemployment rate to a 14-year high of 6.5%, and this, by general agreement, is only the beginning of the labor effects of the recent credit crunch.
All of this bad news is hitting right before Christmas, a time when retail stores generally expect to be ramping up for the November and December sales that will carry them through the rest of the year. This year, those sales may not materialize at all. Circuit City is shutting down 120 stores for good, right before Christmas, just to stay solvent, and other big box stores that usually hire extra help for the holidays are actually terminating permanent workers to reduce costs.
The fact is that people are not buying anything right now. Even if the Big Three could produce a car that runs on air and then start shipping it to car lots tomorrow, most Americans would be unable to qualify for loans to buy these magical air cars, even if they had jobs or money to put down on them, which fewer and fewer people do with each passing day. The recession is looking like it will be long and hard, with many analysts seeing a turn-around no sooner than 2010.
When Henry Ford first started to build automobiles in the U.S., he made the radical decision to pay his assembly line workers incredibly well. He did this not out of a sense of altruism or social justice, but rather to expand his business plan so he could market his cars to everybody, thereby making more money for himself. In making this decision, he not only enabled his workers to buy the cars they were building, he also ended up creating a thriving American middle class.
Over the course of the past 30 years several developments have increased profits for U.S. corporations and their stockholders, while at the same time putting downward pressure on the mostly industrial middle class. Changes in U.S. trade agreements allowed industry to flee the U.S. rapidly and dramatically, forcing formerly middle class workers into low-wage jobs in the service sector.
As the good industrial jobs disappeared, corporations also began to eliminate middle-management white color jobs with middle class salaries. Most of the corporate jobs left in the U.S. today are entry level service sector jobs, often in call centers or tech support, with little opportunity for advancement or career development. Not much remains between the bottom of the corporate pyramid and the CEO, and what does remain is under constant pressure to produce more profit for less reward.
In fact, in most of these workplaces (the classic cubicle farms of the ‘Dilbert’ comic strip) a management style designed to turn over employees in one to two years remains firmly in place. While this rapid turnover keeps labor costs low, it also creates a very unstable, low-paid workforce with no special loyalty to any one job and not enough annual income to commit to a four-year auto loan.
In other words, the middle class jobs that created the ‘consumer economy’ are largely gone with the decline of the Big Three and the loss of myriad other U.S. industrial jobs, both related and unrelated. Steel, textiles, electronics, computer chips—all of these items are made overseas now. When people don’t have good jobs and can’t get credit, they can’t spend money. When people can’t spend money, more people lose jobs.
Short term, the U.S. will have to find a way to keep people in their homes, keep them warm and fed, and stabilize housing and financial markets. Those challenges would be daunting in and of themselves for even an economic Mozart. Deficit spending seems unavoidable at a time when the national debt is already completely out of control.
But long term, the U.S. will have to find a stable job base that can support a middle class and do whatever is necessary to keep those jobs here. If that doesn’t happen, if we don’t see something on the horizon to replace the dead industrial base, then all the stimulus packages Congress can dream up won’t prevent a long and painful period of poverty and contraction in America.
Gas prices are finally coming down.
Unfortunately we’re running on fumes and our credit cards are being declined.
What happens next will have long and lasting effects, not just on the economy, but on the health and security of the nation.
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By Stephan Zimmermann, on October 27th, 2008
Will companies that issued derivatives based on bundled student loans be the next financial dominoes that will require a government “bailout”? The country’s long dedication to education makes it a virtual certainty.
The emphasis of the role of government in education predates the establishment of the United States as a country. As early as 1642, a year before the founding of Harvard, laws of the Massachusetts Bay Colony broke with English tradition of purely private education and introduced a role for the state. The law essentially suggested that the colony’s government would assume the duty of teaching children if parents failed to do so.
A century later, the new Congress of the United States enacted the Northwest Ordinance of 1787. It set forth the role and obligation of the state in education. Article 3 of the Ordinance stated that
Religion, morality, and knowledge, being necessary to good government and the happiness of mankind, schools and the means of education shall forever be encouraged.
Early in the 19th century, Horace Mann took a leading role in the advancement of public education. Both as a Senator from Massachusetts and later as Secretary of the State Board of Education in 1837, Mann was instrumental in establishing textbooks and libraries, doubling the wages of teachers, and securing state aid for education. He argued that the country’s wealth would increase by educating the public and should be borne by the taxpayer. He was immensely successful in the task. Mann ultimately became president of Antioch College in 1853, six years prior to his death.
The fundamentals for universal public education were established and accepted on both a private and state level. However, it took nearly three quarters of a century, in 1935, for direct federal government loans to be debated. First, government student lending began on the state level when Indiana initiated the waiver of fees to students who successfully competed in statewide tests.
By 1944, the Serviceman’s Readjustment Act (commonly known as the G.I. Bill) was passed. It was the first legislation to provide direct aid for students on the federal level. The bill was amended and expanded following the Korean and Vietnam conflicts. Now called the Montgomery G.I. bill, it forms a crucial benefit to men and women voluntarily joining the military services.
The next half century saw a rapid rise in various federal, or federally-guaranteed, student loans and grants. Loans are to be repaid at subsidized low interest rates, while grants are outright gifts, requiring certain criteria and qualifications.
Some examples include:
- National Defense Education Act was launched after Russia orbited Sputnik I in 1958. It was centered on science, mathematics and language. The federal program is now called the Federal Perkins Loan program for low-income students with ten years to repay at five percent interest.
- The Health Professions Educational Assistance Act 1963 for medical and health program students was later broadened to add scholarships in addition to loans.
- The most significant and sizeable is the Federal Stafford Loan Program. It was initially passed by Congress in 1965 as the Guaranteed Student Loan Program. The program used private banks and other lenders, guaranteed by the federal government.
- Outright grants, such as the 1965 Educational Opportunity Grant Program and the 1972 Basic Educational Opportunity Grant, now known as the Pell Grant, consist of outright gifts to students in low income brackets. Eligibility is based strictly on need.
Later yet, government educational funding started to be offered to middle and upper income families such as the 1978 Middle Assistance Act and the 1981 PLUS loans.
Finally, loan consolidations and the William D. Ford Direct Student Loan Program of 1993 expanded loans available directly from participating schools.
As the population increased, and students availed themselves of the increasing variety of grants and loans, so did defaults on student loans.
A report published in October 2007 by Education Sector, an independent non-profit, non-partisan think tank, shows that student loan default rates were approximately five percent. Twenty percent, the largest percentage of those defaulting, owed $15,000 or more after attaining a four-year undergraduate degree.
According to the report,
Black students who graduated in 1992–93 school year had an overall default rate that was over five times higher than white students and over nine times higher than Asian students. … Hispanic students’ overall default rate was over twice that of white students and four times higher than Asian students. (www.educationsector.com)
The current financial crisis offers some serious food for thought.
Most significant is that, unlike mortgages, student loans have no underlying asset value. While defaults on mortgages have the backing of real estate – no matter if it has depreciated in market value – student loans are unsecured. Recourse to recover default payments may exist through attachment of wages and other measures, including tracking of an individual through IRS records, but has no tangible value except the student’s future earning power.
Despite the high-risk exposure, private firms in the student loan industry, such as SML Corporation, generally known as “Sallie Mae,” realized some $18.5 billion in derivatives sales in 2007. According to Bloomberg.com on October 22, Sallie Mae lost $185.5 million for the third quarter, compared to $344 million year-to-date. The company increased contingencies for bad student loans by some 31%. It also had extraordinary legal expenses in connection to a failed sale of the company to a third party. The stock declined from a high of $48.24 to close at $4.50 October 22, year-to-year.
According to Bloomberg, SLM “is partly insulated from the crisis because the company’s loan portfolio is 82 percent government guaranteed. The U.S. Department of Education is offering funding for those loans through July 2010.”
SLM Corporation owns or manages some 10 million student loans in addition to its ancillary businesses of college savings accounts and collection agencies. It was originally formed in 1972 as a “government-sponsored entity” similar to Fannie Mae and Freddie Mac. It became a totally independent company in 2004.
The question remains: if SLM Corporation’s management underestimates its potential student loan defaults and overestimates its cash and asset positions, will the federal government be in yet another “bailout” mode?
The history of government’s historic and stated position regarding education is clear. It remains for legislators to determine how best to reduce or eliminate student loan defaults. Don’t let the fear of college debt keep you from getting your degree. See the affordable degree options available at Belhaven College.
Stephan is a former department chair for economics and taught at various colleges and universities at both graduate and undergraduate levels. If you would like Stephan to answer your economics-related questions, read his post “Got an Economics Question?” and submit your questions in the comments area there.
By Evelyn Black, on October 27th, 2008
Why, oh why, did the biggest financial crisis since the Great Depression have to hit during a presidential election year?
The ‘Fear Index’, also known as the VIX (or, officially, the Chicago Board Options Exchange Volatility Index) is a financial tool that measures market swings or volatility. The higher the VIX goes, the scarier the market looks, and the more panicky investors feel. Until very recently, few people had heard of the VIX and even fewer cared about it, but ever since the credit crunch took hold a few weeks back, the VIX has been a staple number on nightly cable news channels. On October 17, it hit 70.3, the highest fear rating ever recorded since the VIX was first introduced in 1993.
I don’t know about you, but I don’t really need a VIX rating to convince me that people are scared. Insiders and investment specialists do have a practical use for an exact day-by-day volatility measurement. People like me, however, who write for economics blogs and read the financial sections of the major newspapers for sport, tend to get a general sense of the mood of the country simply by watching how many people in our own communities are completely melting down at any given moment.
Here’s a basic formula I’ve devised that any nonprofessional can use to measure financial fear:
1) Take the number of personal friends and family members who have lost at least 30% of their 401(k), and 2) divide that by the number of emotional outbursts about the economy that you have personally fallen victim to on the day you are measuring, then 3) multiply that final figure by the chocolate available in your household by 10:00 p.m. on any given weeknight, and 4) eat all the chocolate before someone else in your house gets to it.
Perform that equation and I guarantee you will discover that Americans are pretty scared right now.
Sadly, fear is a big stick that can be useful in political campaigns, especially with only days left until November 4th. Think you might need some help with that adjustable rate mortgage pretty darn quick? Socialist! What, do you think the government is supposed to wipe your chin and put you to bed! On the other hand, do you think you deserve the tax breaks you got under George W. Bush for finally, after 50 plus years, making it to a 50% income bracket? Fat cat! What are you, some kind of AIG executive or something? I’ll bet you eat homeless people for breakfast, you scoundrel!
The rhetoric surrounding the already significant economic mess is off the charts emotionally right now, and I submit it does not help the current situation one bit. What can we make of the term ’socialist’ in an environment in which the U.S. Treasury has just admitted it is considering nationalizing the banks? Which is more ’socialist’: a nationalized banking system, or a universal healthcare system? Don’t taxes by definition always redistribute wealth (unless we’re talking about a flat tax, which we aren’t)?
On a related note, if people who earn over $250,000 are actually about to be financially eviscerated by Barack Obama’s plan to rescind the Bush tax cuts, how is it that Cindy McCain paid just 20% of her 2007 income ($2 million of a total income of $10 million) but my household got stuck paying 27% on a microscopic fraction of that amount? OK, I know that question isn’t entirely logical, but it does beg a related question: Are taxes really the central issue here? Or do we just need access to much, much better accountants?
The economic political waters are about as muddy as they can get right now, and that’s useful because confusion and rhetoric throws people back on their own fears and emotional prejudices instead of their capacity for rational analysis of the issues at hand.
I’ll be frank: I have no clue what is going to happen next.
There, I said it.
You know, there are people in the world who spend years and years in Zen meditation practice just to someday, hopefully, somehow, train their minds to live completely in the present moment. Here in America, we’ve suddenly been given that gift free of charge by means of a financial meltdown. If we want, we can choose to simply admit that we are at a completely unrecognized moment in historical time, that no one is certain how this is all going shake out, and then we can just wing it, as it were.
That’s what will ultimately end up happening anyway.
In Zen meditation, when practitioners get caught up in projecting what might or might not happen and in thinking so fast it starts to make a soft whirring noise inside their own heads, the Zen master will often come up behind that practitioner and whap him or her upside the head with a big stick to snap that person out of it. Right now I see an excess of stick wielding Zen masters and a shortage of humble practitioners. If one more Zen master starts in on my own head, seriously, I’m going to…
Well, I’m going to do exactly what I’m currently doing: baking lots of chocolate things and eating them while I still can.
Here’s the scoop (as I understand it): We are either in for the hardest, longest recession in U.S. history or a mild downturn of one to two years followed by complete recovery. We are either about to become a socialist nation with requisite neo-WPA posters in every heavily-taxed home, or else we’re about to give the obscenely wealthy all the rest of our money and stuff, whatever little we have left, even our cats. These dueling outcomes will destroy us by fire or ice, but the important thing for us to understand is that, either way, we will indeed be destroyed.
No wonder people are scared!
I submit we may soon be looking at C) None of the above.
In the meantime, keep your stick to yourself, would you please?
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By G.L.C., on October 24th, 2008
More than 20 countries have set up sovereign wealth funds while a dozen more have expressed interest in establishing them. Many of these sovereign wealth funds are picking up stakes in U.S. companies, which is raising concerns about the need for regulating them. Up until the $700 billion bailout, which effectively is a U.S. Treasury-directed fund, the United States did not have a sovereign wealth fund.
This fund is the world’s largest, beating the $600 billion sovereign wealth fund of the oil-rich emirate of Abu Dhabi in the United Arab Emirates.
The fund has many characteristics of sovereign wealth funds. It endorses the latest trend – the most powerful financial entities are not risk-happy investment banks but state-sponsored investment entities that are more cautious.
So far, the United States government has stayed away from investing in the markets. The fund presumes that the government must play a crucial role in deciding how best to deploy a nation’s investment capital.
Critics have long argued that sovereign funds be allowed the privilege of holding positions in public companies when the U.S. government did not do so. When the fund was approved by Congress, it took the sting out of this argument. But there is a difference between this fund and sovereign wealth funds. Sovereign wealth funds invest surplus funds, and in many cases they are doing so abroad for the purpose of financial diversification. The money for this fund has to be borrowed by the Treasury: $700 billion. It will only be investing in the United States. It will make no investments abroad.
The mandate to the fund is clear - avoid further financial collapse by extending a lifeline to U.S. institutions hobbled by their exposure to toxic mortgage assets. This is similar to the goal of sovereign wealth funds – advancing national economic goals. The only difference is that sovereign wealth funds openly state that their goals are political. This fund on the other hand seeks the best prices for the assets it buys.
There are some who feel that the fund does not resemble a sovereign wealth fund, but some sovereign wealth funds are beginning to look like the fund. The present credit crisis is not restricted to the U.S. alone. It is having a worldwide impact. There is tremendous pressure of many of the sovereign wealth funds to come to the rescue of home markets that have wobbled in recent months.
The U.S. Treasury fund’s mandate will run out after two years. But the government might have other ideas if, at the end of two years, it has more than $1 trillion in assets - it has the benefit of starting to buy at what may well be the rock bottom. It could become a permanent fund, and its mandate could be broadened to allow it to invest abroad. It would then become a full-fledged sovereign wealth fund.
By Evelyn Black, on October 23rd, 2008
In an op-ed piece of October 17’s New York Times world-famous entrepreneur and financier Warren Buffet urged American investors to return to the stock market and bet on the long term future success of the United States. “Buy American,” Buffett’s headline reads. “I am.”
The essay was a vote of confidence from a successful guy at a time when America badly needs a vote of confidence from somewhere, anywhere, for anything.
But is Buffett’s advice valid?
The gist of Buffett’s analysis is that when markets tumble, the best time to buy stocks has historically been before recessionary effects hit the broader economy. As Buffett explains it,
During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.
Or, if you need a more shorthand rule of thumb: “Be fearful when others are greedy, and be greedy when others are fearful.”
It’s hard not to like Warren Buffett, a guy who admitted openly on a recent televised interview that 1) his clerical staff pays higher income taxes than he does, and 2) that’s not right. No, he’s not out pestering the IRS to accept additional taxes from him as a mea culpa, but he does go out of his way to encourage Americans, to back American businesses, and to responsibly critique U.S. government policies, all the while managing to still enrich Warren Buffett in the process.
If there’s such a thing as an Everyman CEO, Buffett is the guy.
Still, many analysts see hard times ahead for the U.S. for many decades, not just many years. While it’s true that ‘buy low, sell high’ is still a decent way to conduct yourself in regard to the stock market, it’s also true (and Buffett admits it in the NYT essay) that the U.S. could be in for a prolonged decline before we see a Renaissance. What that means is that unless you are young and careful with what you purchase, this might not be a great time to jump into the stock market: Not because America will never come back–of course it will come back eventually–but because you may or may not be around when it does, and you may or may not pick the company that will thrive in whatever nation America is about to become.
Because the America that existed up until this month? That nation is effectively gone now.
What we are witnessing right now is for all intents and purposes the decline of an empire. How far will we fall? The most positive estimates have the U.S. going through a severe recession with a continued drop in housing prices, rising unemployment, and frequent government intervention through 2010 at least and possibly longer. Those are the optimists.
Pessimistic forecasts invoke Mad Max movies and survivalist nightmares.
I think the truth will, as usual, be somewhere in the middle, with the downturn being more severe than predicted in the press but less apocalyptic than predicted by the conspiracy theorists. Will some people find ways to get rich during these difficult times? Yes. Some people always do. The Chinese sign for crisis is also the sign for opportunity (whether it really is or not!) and so on and so forth.
But will most of us prosper?
No.
Most of us will be lucky to hang on to what we have, and any little bit of money left over will probably not be spent on stocks. Not for a long time.
What that means is that, while the stock market may be close to bottoming out at this point (who can say?), and while certain stocks might be worth buying right now for that reason (which stocks, even Buffett isn’t saying), the ability of most people to buy anything is going to go away for a long, long time, starting this Christmas if not sooner.
We are likely to see a stock market bottom, whenever it comes, followed by years of flat-lined market activity. Gains will be modest and unpredictable. Old standbys will go the way of the dinosaur and some surprising start-ups will briefly appear like shooting stars. Good guessers with lots of cash will be rewarded, but most people will just hang on until whomever we are going to be as a nation emerges clearly out of the 2008 smoke and carnage.
Many have made a credible case that the housing bubble was really an extension of the tech bubble and that, by replacing one bubble with another, we only forestalled and worsened the effects of an economic crisis that has been building for decades, not years. Manufacturing is no longer the foundation upon which the American middle class builds its wealth and security. We have been hemorrhaging manufacturing jobs, and a lingering distaste among many for the abuses of the labor movement that led to the disappearance of Jimmy Hoffa and the coronation of Ronald Reagan continues to keep us from doing what we need to do to shore up wages and opportunities. It’s fine to have beliefs, economic or otherwise, but here’s a fact that flies in the face of fiscal dogmatism: People can’t spend money they don’t have.
Not anymore they can’t, anyway. Not with credit markets frozen and jobs disappearing into the October mist like so many spectral visitors from America Past. With Christmas approaching, retail chains where I live are laying off employees.
Anyway you slice it, our “consumer culture” seems to be DOA. A victim of fiscal cardiac arrest.
So what does America do now? We don’t make things. We’ve lost the tech battle to China and India. We’ve tapped out our oil. Our young people are uneducated and unwell. And the final death rattle of a declining culture–rampant consumerism–is about to become a morality tale told to children around the wood stoves of the future by grandparents who lived through The Crash of 2008.
I appreciate Buffett’s encouragement, his faith in American business, and his willingness to step forward as a cheerleader right now. But I submit that the crisis we are facing is not so much a financial or economic one as it is an identity crisis, the biggest identity crisis we have faced as a nation since the Civil War.
Who are we and who do want to become?
The answers to these critical questions will determine our future prosperity.
Let’s hope and pray we get them right.
By G.L.C., on October 22nd, 2008
An auction rate security generally refers to a debt instrument with a long-term nominal maturity for which the interest rate is regularly reset through periodic auctions. It allows issuers to borrow for the long-term but at lower, short-term interest rates.
The auction-rate securities market involved investors buying and selling instruments that resembled corporate debt whose interest rates were reset at regular auctions, some as frequently as once a week. They were sold as being safe as cash.
Over the years, auction-rate securities became popular among investors looking for cash-like options with slightly higher yields than money-market funds and certificates of deposit. The investments—in reality, long-term bonds—were considered more like short-term debt because they could usually be sold at weekly or monthly auctions.
In August 2007, investors began pulling out of the auction-rate-securities market. It seized up earlier this year when Wall Street firms who kept auctions from failing by stepping in to buy any unpurchased securities stopped supporting the market en masse, leaving millions of investors without access to investments they believed were nearly as liquid as cash. Tens of thousands of investors nationwide — including institutional and individual investors, cities and towns, charities and small businesses — were left holding damaged, illiquid securities when the market collapsed.
The U.S. Justice Department is now ramping up criminal investigations into the collapse of the auction rate securities market. Federal prosecutors in Brooklyn,New York , are looking at whether Lehman Brothers Holdings Inc. defrauded its clients by dumping auction-rate securities into their accounts before the market broke down despite knowing the market could collapse. The prosecutors are probing Lehman’s handling of investments for two brothers, Brian Maher and Basil Maher. The brothers sold their family’s billion-dollar shipping business and invested some of the proceeds with Lehman. They lost access to $286 million that was tied up in the securities when the auction-rate market collapsed. Another issue being probed is whether the firm used clients’ money to purchase the securities to prop up auctions that might otherwise fail.
Federal Prosecutors are also probing the role of UBS employee David Shulman to decide whether to charge him with insider trading for selling his own holdings of auction-rate securities ahead of that market’s collapse. Shulman ran the auction rate securities business for UBS. As the credit crisis began to scare away buyers for many types of securities, UBS began to buy up the securities so that the auctions, which the firm ran, wouldn’t fail. Shulman was under pressure from UBS executives to reduce the firm’s holdings of the product, and he allegedly helped mobilize UBS brokers to sell more of the securities to customers as safe cash alternatives, despite his knowledge that the market may not hold up. Around the same time, Shulman sold more than $6 million of his own inventory of auction rate securities.
So far, most investigations have been about the role played by institutions and banks. These investigations are among the first to look at whether individuals committed crimes as the market collapsed in the credit crisis – a step in the right direction.
By Evelyn Black, on October 13th, 2008
For at least a year now, ordinary people in the United States (people the press has been referring to as “Main Street”) have known that the economy was starting to slow down at the same time that prices were rising uncomfortably fast.
Now, some economists are finally starting to admit that, yes, the U.S. probably went into recession somewhere around January of 2008. U.S. economic growth is expected to go officially negative by the end of this year, and this negative growth pattern is expected to continue and worsen throughout most of 2009, if not longer, driven by job losses, a continued drop in factory orders, and falling home prices that still have a long way to fall before the housing market stabilizes.
On October 3, the U.S. Labor Department announced that 159,000 jobs were lost in September, much higher than the expected loss of 100,000 jobs. Orders for durable manufactured goods declined by 4%, almost double the 2.5% figure expected by analysts. Even the service sector flat-lined in September, hovering just barely above the 50 point threshold that signals economic growth.
Although the House of Representatives finally did pass the $700 billion credit market rescue package on  October 3rd, by the time the bill was at last on its way to the White House for the President Bush’s signature, that same credit crisis had already pushed the State of California into a $7 billion budget shortfall, with the real possibility of not being able to meet payroll this month, and the State of New York into a shortfall of $1.6 billion, expected to worsen next year. California may have to turn to the Federal Reserve to borrow if credit isn’t available by the end of October or else face a total shut down of state government.
It is not at all unusual for economists to declare a recession in retrospect or for consumers to feel the recessionary effects before the experts do. This is partly because economists have varying criteria for labeling an economic slowdown recessionary (two consecutive quarters of negative growth is just one rule-of-thumb) and partly because it takes awhile to accumulate enough data to analyze and declare a trend. So often the effects of a recession are felt long before it is formally announced.
However, this time the economic trouble feels like it runs much deeper; and the unease accompanying the acknowledgment of this trouble feels closer to panic. While caution is almost certainly wise at times like these (Why create panic if taking care with words can restore calm?), it is also true that, at every step of this current economic crisis, experts have erred on the side of minimizing the depth of the turn-down. With each new catastrophe, someone important was out in front of cameras declaring that the housing market was bottoming out and the economy was about to turn around. Each catastrophe was expected to be the last. Until the next catastrophe. The phrase “a river in Egypt” springs to mind.
Eventually, the public quit believing the experts. Soon the public ignored the experts entirely, believing instead that positive spin was all that was really available from such persons: the hard truth was to be found instead in the price of milk, the number of overdrafts in a personal checking account, a declining 401(k) balance marked with a red double-digit loss percentage. Let the experts spin until they puked: the truth is that when the money is gone a week before payday arrives, you don’t need an expert to explain that times are getting tough.
By the time Henry Paulson and a seemingly exhausted, sincerely frightened Ben Bernanke went before Congress (was it really only a couple weeks ago?) with their request for $700 billion right now and a prohibition on any oversight or prosecution, it seemed obvious to all that Wall Street’s unending font of optimism had very suddenly run dry. Wall Street seemed to learn what Main Street had known all year in the space of only a few days. How can that be? Lots of people were asking themselves this same question, all at the same time.
All of which brings me to the current situation and the grotesque chasm that seems to have opened up overnight to separate the folks on Wall Street from the folks on Main Street and to separate Main Street from its supposedly representative democracy. To paraphrase the famous line from Cool Hand Luke, what we have here is not just “…a failure to communicate,” but rather a total breakdown in trust.
So what are we looking at here? A recession similar to the recession of the early 90’s with a light at the end of an admittedly dark tunnel? Or are we instead, as New York Times op-ed columnist and economist Paul Krugman says, truly on “The Edge of the Abyss”?
If you ask Wall Street that question today, you may or may not get an answer that spins. There comes a time when all that is left for anyone to do is breathe and pray and cross their fingers.
If you ask Main Street this question today, you will probably get an earful.
It won’t be pretty.
Neither will the year ahead. Or the one after that. Let’s hope our new leadership has a strong spine and a better plan. We’ll all be needing both.
By Evelyn Black, on October 10th, 2008
On October 7, American Express revealed that they will begin limiting their customers’ access to credit based on both where they shop and which bank holds their primary mortgage. While there is nothing in the law that prevents American Express (or any other credit card company) from doing this, the announcement is noteworthy coming from what many assume to be the creme de la creme of unsecured personal credit lines.
The credit crunch is about to hit the consumer pocketbook in a big and personal way, starting with credit card companies looking for ways to limit or freeze personal credit lines. The reasons for the lowered limits are not always obvious, and they may or may not have anything to do with the customer’s financial balance sheet. American Express would not reveal the stores or banks that they considered “risky,” but if you happen to have an association with one of them, however tenuous, look to see your credit limit lowered or arbitrarily frozen very soon.
According to the consulting firm Innovest StrategicValue Advisors, banks will charge off nearly $96 billion in delinquent credit card debit in 2009, nearly twice the amount charged off in 2008. Many customers who very recently had access to home equity lines of credit, business lines of credit, or unsecured bank loans are now seeing these sources dry up due to the credit crunch. As a result, they are leaning on the option of last resort: credit cards. Credit card issuers are falling all over themselves trying to get ahead of the problem.
In a worst case scenario, a good customer (as in, a customer who pays on time and has been doing so for years) could see his or her credit limit arbitrarily lowered and then exceeded before even realizing that had happened. Sometimes, just the interest accruing on a large balance will exceed a lowered credit limit before a customer has any time to do anything about it. Once the limit is exceeded, the credit card issuer can and will hike the interest to 32%, charge over-limit fees, and push the customer even closer to default.
Why would credit card companies do this?
Because credit card companies can’t just close an open line and demand payment in full; what they are doing instead is encouraging customers to transfer their large balances elsewhere. Look for balance transfer fees to jump dramatically as well in coming months (or weeks) as banks and other financial firms look to discourage these balances from hopping aboard their own sinking ships.
According to Carol Kaplan of the American Bankers Association,
(Banks) have suffered a lot of losses and they are doing whatever they can to reduce risk. They have people that work all day and all night who try to come up with new formulas to assess risk.
These risk assessment formulas are getting much stiffer and much more conservative almost overnight. Anyone with a credit card balance that is in excess of 30% of the limit will likely see changes to the limit itself and the rate and fee structure in the very near future, and some analysts are recommending that customers carry a balance of no more that 10% of the limit in order to avoid punitive fees and rate hikes.
What this means for consumers who, since 2006, have had to rely ever more on their credit cards to pay for basic services, food, and taxes is that the last well of credit is about to run dry, leaving them with only their inadequate incomes to cover costs this winter and Christmas season. Add this to the fact that home heating oil and natural gas are expected to increase by double digits this winter and the fact that many people still haven’t paid off last year’s heating bills yet, and you have a recipe for disaster.
The Federal Reserve, Congress, and the U.S. Treasury are still intently focused on simply stabilizing Wall Street right now. The $700 billion bail-out package is looking ever more anemic in the face of a world market crisis, the credit crunch has not abated at all at the interbank level (the LIBOR rate is still rising, and commercial paper is still impossible). Understandably, the systemic cardiac arrest is getting the first response, inadequate though it may be at the moment.
But not too far down the road, the same financial credit stroke is about to hit American households one by one, right at the beginning of winter and the start of a holiday season that promises to be one of the most dismal on record.
Let’s hope something works. Soon.
By G.L.C., on October 9th, 2008
The Federal Reserve was created 95 years ago to prevent banking crises as an independent agency whose Washington-based governors are appointed by the president of the United States and confirmed by the Senate. Its officials usually steer clear of the most heated political debates in a bid to protect their freedom to make the tough decisions required to keep inflation under control. There’s a good reason for giving the Federal Reserve so much independence. Decisions about the stability of the financial system often require quick decisions in times of crisis.
Ever since the credit crisis started in August 2007, the Federal Reserve has been engaged in a few political actions involving tax payer risks: asking Congress to approve Treasury Secretary Hank Paulson’s $700 billion bailout plan, agreeing to lend $85 billion to American International Group, taking on $30 billion in illiquid Bear Stearns assets to facilitate its take over by J.P.Morgan Chase, and helping engineer the federal takeover of Freddie Mac and Fannie Mae, which could cost the Treasury over $200 billion.
The political role being played by the Federal Reserve is setting a dangerous precedent: unelected officials deciding, without congressional votes, which companies and industries should be aided by its nearly $1 trillion balance sheet and which should be left hanging. The Federal Reserve is committing so much taxpayer money on its own rather than having Congress or the executive branch commit it. Its new roles of overseeing Wall Street investment banks and the AIG loan portfolio, among them, may bring it into conflict with the job of managing monetary policy.
The Federal Reserve has been using government funds and its credibility in its attempts to end the credit crisis. This increasing political role of the Federal Reserve could put its hard won independence at risk. Its independence is crucial to setting the interest rates that guide the economy.
The Federal Reserve probably did not want to be seen in a political role, but it had no choice – charged with maintaining the stability of the financial system and the economy, it had little choice but to take aggressive action in the face of a potentially devastating crisis. It was watching a falling knife and had to grab it before it landed on somebody’s chest.
Any proposals to change the Federal Reserve’s role would face fierce opposition. Because of the actions it has taken so far in trying to save Wall Street firms, if it comes under attack, Wall Street will be among its main supporters. It will also have the support of an army of loyal bankers around the country.
Everything depends on how the economy emerges from the present credit crisis. If it stages a steady recovery, it will increase the credibility of the Federal Reserve and there will be less concern about its political role.
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