Recs
By Morgan Housel | More Articles September 30, 2011 | Comments (11)
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Mark Twain's saying that "history doesn't repeat itself, but it rhymes," might be one of the most abused quotes of the past three years. The quip is grounded in solid logic, but some took its meaning to a faulty level. After most recessions in the past, the economy bounced back quickly. This time, it hasn't. Thus, we must be doing something wrong. "Had the U.S. economy recovered from the current recession the way it bounced back from the other 10 recessions since World War II," wrote former Sen. Phil Gramm in The Wall Street Journal, "11.9 million more Americans would be employed." He called this the "Obama growth discount."
Truth is, the recent recession wasn't like the 10 other recessions since World War II. Most recessions are caused by a little overheating in an otherwise sound economy. Businesses adjust quickly, rehire laid-off workers in the same jobs as before, and things spring back to life.
The recession that started in 2007 was different. It was caused by an inherently unsound economy driven by debt. That dynamic changes everything, as deleveraging is like molasses in an economy's veins. When you find yourself in a debt-driven recession, the result is always the same: a glacially slow recovery. As a McKinsey & Co. report noted, "Historic deleveraging episodes have been painful, on average lasting six to seven years." More money is going toward yesterday's bills, which means less for today's and tomorrow's.
A new study by the Federal Reserve sheds light on how big a role debt plays in our stalling recovery. The study was simple. It ranked the nation's largest 238 counties by the increase in household debt-to-income ratios between 2002 and 2006. It then looked at how each has fared over the past few years.
The results are clear as day. Regions that accumulated the most debt during the boom are in terrible shape, while those that steered clear of it are doing quite well.
For example, auto sales in regions where debt accumulation was the highest are down some 40% since 2005. In regions where debt accumulation was the lowest, sales are actually up about 30%.
Ditto for housing investment. Regions with the lowest debt accumulation have barely seen any dip in residential investment compared with the boom years. Regions where it was the highest have seen construction plunge as much as 60%.
Same for employment. Unemployment rose only slightly in low-debt-accumulation regions during the recession, those job losses peaked early, and jobs have been rebounding for nearly three years. In high-debt regions, jobs fell off a cliff, didn't stop falling until late 2009, and are still around 5% below prerecession levels.
Why did some regions go hog wild with debt while others avoided it? There could be a couple of reasons. The two states that accumulated the most debt are California and Florida, where geography makes it difficult to quickly increase housing supply, pushing up prices faster than in regions like Texas, where you can build as far as the eye can see. There's also a keeping-up-with-the-Joneses effect where legitimately wealthy people inflate the aspirations of the less well-off, enticing the latter to binge on debt just to feel ordinary. "Trickle-down economics may be a chimera, but trickle-down behaviorism is very real," Nobel laureate economist Joseph Stiglitz writes. This is why a 19-year-old barista in Los Angeles feels justified financing a new Mercedes -- something you'll rarely see in, say, North Dakota.
But here's what matters: "The evidence is consistent with the view that problems related to household balance sheets and house prices are the primary culprits of the weak economic recovery," the Fed writes.
That's incredibly important. The recovery isn't slow because of regulation, taxes, health-care reform, or some vague "uncertainty" boogeyman. It's slow because consumers are still deleveraging. And it's not going to get any better until they're done.
When will that happen? The good news is that deleveraging has already taken place in a big way. Household debt payments as a percentage of income have plunged to the lowest level in 15 years, driven largely by refinancing at lower interest rates. Total household debt as a percentage of income has fallen back to early 2004 levels -- down 12% since the peak in 2007. A good chunk of this is thanks to banks like Bank of America (NYSE: BAC ) , Citigroup (NYSE: C ) , and Wells Fargo (NYSE: WFC ) writing off debt. What's painful for banks is often refreshing for consumers.
Some look at the economy's total debt load, including federal debt, and argue that it'll probably be around 2017 before things are back to normal at the rate we're now deleveraging. Since the recession began in earnest in 2009, that would be about eight years of deleveraging.
Which, coincidentally, is exactly what history shows we should expect after a debt-driven recession. So Twain was right: Today is rhyming with history -- if you look at the right history.
Fool contributor Morgan Housel owns B of A preferred. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Bank of America and Citigroup. The Fool owns shares of and has created a ratio put spread position on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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Very nice article and very true.
Really Morgan? You accept the Fed's word at face value, with no theory behind it. The Fed had no idea there was a housing bubble, and no idea a crash was coming, but now they are experts?
(And they were wrong about pretty much every single thing they commented on over the last ten years.)
You're liberalism is a mental disorder.
Robert Higgs, one of the best economists on the planet, disagrees. I'll go with Higgs.
David
You're = your for the you're your nazis ;)
David
I thought it was a given we're in a deleveraging recession and they take years to correct. Didn't need a Fed study to tell me that.
So the question is, what can we expect from the financial markets for the next 5-6 years, if that's how long it's going to take to get back to normal? Volatility with no net gain? What sectors do well in this kind of environment? How do commodities do? When does inflation appear? Interest rate trends? Any commonalities there? Those are the kinds of things I would like to know.
.
The absence of personal finance education for the vast majority of us not only creates individual financial nightmares, but society wide crisis as well as allows politicians the opportunity to propagate nonsense to a willing populace.
Financial education should start in grade school and junior high, be core in high school along side. Start with a regular reading of Aesops The Ant and the Grasshopper in Kindergarten and go from there.
FM
^+1 to FM
David,
I haven't read much Higgs, but it seems to me that one of his main criticisms of Krugman and the liberal economic theory is the rejection of "aggregates" in macro-economic manipulations. A dollar spent on X is Y location is the same as a dollar spent on A in B location.
"These extraordinarily complex micro-relationships are what we are really referring to when we speak of "the economy." It is definitely not a single, simple process for producing a uniform, aggregate glop. Moreover, when we speak of "economic action," we are referring to the choices that millions of diverse participants make in selecting one course of action and setting aside a possible alternative" From Recession and Recovery
Six Fundamental Errors of the Current Orthodoxy
March 5, 2009
I don't see anything in Morgan's article or the Fed report for Higgs would disagree with. Seems to me what Morgan is stating is exactly what Higgs writes about, aggregate evaluation is glop while local choices made by diverse participants have different consequences in different regions of the country. I'm confounded by your attack on Morgan in this instance.
FM
@ FutureMonkey:
I remember watching a classic Disney cartoon about the Ant and the Grasshopper as a young lad. I'm not sure it taught me anything about finance, though.
http://www.youtube.com/watch?v=wM1DgihKHVI
Moral of the story? If you can play tunes on a fiddle, you don't have to work. Just set yourself up near a bunch of Communists and they'll save you when it gets cold.
Clearly my grammar editor has taken the day off, but my point is financial literacy in America is a disgrace and that Morgan didn't express any ideas in this article that could be even loosly attributed to economic liberalism.
I believe that Morgan Housel's thesis is... "The recovery isn't slow because of regulation, taxes, health-care reform, or some vague "uncertainty" boogeyman. It's slow because consumers are still deleveraging."
To test this thesis, examine the DSR (household debt service ratio, an estimate of the ratio of debt payments to disposable personal income - see http://www.federalreserve.gov/releases/housedebt/) over the pst few decades. For 2011 Q2, the last reported quarter, the DSR is 11.09%. The DSR has gone down fairly consistently since peaking at 13.96% for 2007 Q3.
From 1980 through 1998, the DSR stayed in a range of 10.61% to 12.38%. So the current DSR is already near the low end of that range.
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