Sunday, October 11, 2009

Life after the bubble

Debt: Life in Oregon after the bubble

The nation is now living through a vast deleveraging. A huge bubble of borrowing, enabled by the financial industry's "don't ask, don't tell" lending policies, is a thing of the past.
The end of the bubble has enormous ramifications for individuals and families struggling with job losses, salary cuts and restive creditors. But it may have even greater significance for the U.S. economy, which some economists argue had come to rely on an artificial and unsustainable surge in consumer debt for much of its growth.
A new era of forced austerity arrived almost overnight last year when lower consumer spending pushed dozens of retailers into crisis. That led to further problems for the commercial real estate sector and banking industry, which in turn led to greater job losses and more mortgage defaults.
So if much of the economic growth of the past 15 years was illusory, fueled by injections of high-octane debt, what happens now that the tank is empty? We could be entering a wrenching adjustment period of lower spending, slower growth, perhaps a lesser standard of living.
"We're not going back to those growth rates; that was a dream world," said Kevin Lansing, an economist with the Federal Reserve Bank of San Francisco who for years has tracked consumer debt. "There could be 10 years where you're going to have this drag on the economy. ... People's living standards are not going to be improving the way they were. It will place a new strain on government as their tax revenue falters."

Household debt doubles
The current economic wreckage has its roots in a sweeping change in American behavior dating to the late 1980s.
Between 1965 and 1985, household leverage -- measured by the ratio of debt to personal disposable income -- hovered between 55 to 65 percent. It more than doubled in the ensuing years, reaching a zenith of 133 percent in 2007, according to a paper issued in May by Lansing and Reuven Glick, economists at the Federal Reserve Bank in San Francisco.
For people who wondered how their friends and neighbors afforded their McMansions, BMWs and high-end club memberships, it may well have been courtesy of their always-obliging debt merchant.
Much of the debt was mortgage-related, the loans backed by escalating home prices. In 1995, Americans took out $3.3 trillion in mortgage and home equity loans. Ten years later, the total topped $10.4 trillion.
The surge in debt is attributable, in part, to what Lansing politely calls "credit industry innovation and product development."
Translated, that means that some lenders dropped any pretense of cautious loan underwriting. In an era when most lenders simply bundled their loans and peddled them to the secondary market, a buyer's ability to make mortgage payments seemed of minor importance. No one could lose, as long as home values were going up every year by double digits.
Many borrowers eagerly joined the free-ride parade, fabricating loan transactions and working with unscrupulous brokers to extract the easy money from lenders.
As Americans borrowed and spent more, they saved less, culminating in the infamous "negative" savings rates of 2005 and 2006.
Some went on buying binges, but millions needed the money just to get by. The huge increase in debt stemmed in part from years of flat incomes and the simple fact that life got more expensive. Even people who took the historically intelligent steps of buying a home or getting a college degree had little choice but to take on increasing debt.


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