Saturday, January 01, 2011

Looking Back At America - Part IV

This is Part IV in the Looking Back At America series, which presents the perspective of what today's America might look like to historians 100 years in the future. This series of articles is most easily understood by starting with the first installment.

For over two decades American prosperity was on the rise. There were minor setbacks. The late eighties and the nineties saw recessions, but they were relatively brief and shallow. Policy-makers allowed the recessions to occur naturally. Recessions are natural and healthy and necessary for organic growth in a free market economy. Excesses are voided from the system, as they should be. The economy burps and feels better afterward.

For two decades, the collective mood of America was also on the rise. It can be said that the collective mood of most of the Western world was on the rise, but nowhere more so than America. Unemployment was low, holding steady below five percent the majority of the time from 1982 through 2000. People felt safe in their homes and safe in their jobs. The future looked bright.

Because people generally felt good about the future, they took their eyes off the ball. They became accustomed to being in debt, with credit cards, car loans, and mortgages, and didn’t worry about their ability to pay their debts, because on paper they looked wealthy.

There was a bit of a disruption in mood when the stock markets tanked in the spring of 2000 and the economy went into its worst recession in two decades, but even then, people knew that the American economy would bounce back shortly. It always did.

This time, however, policy-makers didn’t allow the economy to recover naturally and void the bad debt it had accumulated. The Federal Reserve Bank, under the direction of Alan Greenspan, lowered interest rates to try to force liquidity into the system. It didn’t matter that the system wasn’t suffering from a lack of liquidity, but rather trying to void the waste of excessive speculation, liquidity was viewed as the solution.

The large institutional banks, now free to both create credit and use it, did what banks do and found ways to capitalize on the easy money policy of The Fed in a non-regulated environment. They started lending money as fast as they could find borrowers. This unchecked credit expansion is precisely what led to the bubble in the housing market and the explosion in real estate that occurred between 2001 and 2006.

If Americans felt wealthy in the late nineties, by 2005 they felt filthy rich. A couple in their early thirties who bought a house in 2001 had $100,000 in equity by 2005, in many cases much more than that. They could refinance their mortgage at historically low interest rates, take out $50,000 in cash, and not even see an increase in their mortgage payment. In fact, many even saw their payment decrease.

During the eighties and nineties, America went through a period of de-industrialization. U.S. corporations moved manufacturing operations to other countries with more favorable tax policies, cheaper labor, and few, if any, environmental restrictions. Due to advances in technology, agriculture needed fewer laborers, so employment in agriculture became less significant to the overall economy. The U.S. economy became tilted much more toward services and away from manufacturing and agriculture.

In 2006, America was at the height of her hubris. Americans had become accustomed to a comfortable life that was bought but not paid for. They had fallen in love with false prosperity, living in debt but not feeling poor because no one saw the end of real estate appreciation, and the stock market had been rising for four years straight.

But 2006 was the year that something changed. The first tiny cracks in the real estate market began to appear. High risk borrowers who obtained adjustable rate mortgages (ARMs) in the early 2000’s began to default on their loans as interest rates adjusted higher after the initial teaser period. As these defaults began to show up in large numbers, the real estate market stopped appreciating. Few people at the time thought of this as anything more than a minor bump in the road, and virtually no one understood, or would admit to, the fact that the system had reached the point of credit saturation.

The stock market continued higher into 2007 and people were still optimistic about the future, but perhaps less so. The euphoria was starting to wane a bit. Although the credit market had stopped expanding exponentially, real estate prices had flattened, and America was fighting two wars (Iraq and Afghanistan), people still had jobs and their stocks looked good, so there was no noticeable change in lifestyles. However, the underpinnings of the American quality of life were showing serious weaknesses to the few who bothered to look. The ones who bothered to look saw that the American dream had become a lifestyle based on debt and supported by the illusion of wealth.

Part V continues the construction of the historical perspective.


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