Change

Over the course of a year, in what signifies the beginning of the great depression of 1929, the Dow Jones industrial average dropped to 68% of its peak value. That means if you had $100 invested before the crash, you now only had $68. That began the greatest time of economic hardship in our recent history. I say recent because it was by no means the worst economic time historically for the United States, but it is the time we remember today, as remembered by our parents, our grandparents, and our great-grand parents. It was a time when we worried about food and our future, and it still lingers in our memories today.

Over the course of a year, between March of 2008 and March of 2009, the Dow Jones industrial average dropped to 55% of its original value. You now have $55 of that original $100. That is a big deal. Over the course of a year, which can safely filter out some speculative peaks and troughs, the indexed value of our business economy dropped significantly more than before the great depression. That is the reality of our current situation. For all of the predictions of economists, investors, and the news of the state of things to come, that is where we are right now. Faced with the facts, those that do not learn from history are destined to repeat it.

So what went wrong?

It’s actually surprisingly simple. We all got greedy.

The United States economy is considered one of the most stable in the world, due almost exclusively to the concept of private home ownership. That’s it. We own our homes and we pay our taxes. It’s as simple as that, and as a collective group of homeowners, we are stable, reliable, and a lucrative source of income for the United States government. So the government raises additional capitol for big projects, like roads, buildings, military operations by issueing Treasury Bills to anyone that wants to buy them, knowing that we, the stable Americans, will provide the income to the government to pay them back in the future at a nominal interest rate.

But we the stable Americans, weren’t so stable. Despite record economic growth, our collective savings rate dipped below zero for the first time since the middle of the great depression. Despite having one of the highest per capita incomes in the entire world, on average, we were unable to save for a rainy day. Our other savings account, home equity, was being tapped to fund new cars, consumer electronics and vacations. We were living a luxurious lifestyle and stretching our incomes to the very edge. A precarious situation to be in, when there is a chance things could go wrong.

And then there were the homes. Investors, weary of the dot com bust of then new millenium, began looking to real estate as a stable place to earn back their money. It was no help that a global ‘Big Pool of Money’ was suddenly dumped into the hands of our lending institutions, a strange result of formerly poor countries like China and India suddenly becoming rich from American consumerism and wondering what the heck to do with all of that cash. This was a lot of money, and everyone wanted to put it somewhere safe. Like, say, the American homeowner?

So the banks started lending money. They suddenly had more money than they knew what to do with. They lent it to everyone with a pulse. And we bought houses. We bought blocks of houses. And we collected funds and built condos and buildings and gigantic rows of houses for miles on end. And there was no end in sight. Investors wanted houses. Retirees wanted investment houses. We wanted two houses.

Soon enough, they were all bought up, and the number of available houses went down. So the prices rose. Up 10%, 15%, 30% in the course of a year. But we still needed to live somewhere. The young couples, the renter, we all wanted to own our own home, but they were too expensive. Twenty percent down on a traditional mortgage. This may be reasonable with a $80,000 home. Does that work on a $600,000 house? Does anyone have $120,000 in savings? What about $40,000?

The median household income in the United States is about $50,000. That means that we can safely afford a home worth approximately $180,000, roughly what the median home price was in 2003. By 2007, the price was $262,000. Our income hadn’t changed. These were homes we could not afford. That was $82,000 we didn’t have and should not have spent. We should have stopped there, the banks should have stood by their guns and demanded 20% down for every home. If there were no qualified buyers, then the home prices would eventually settle down.

But the banks got creative with the loans. Variable interest rates, interest only. They continued to lend to people outside of their means. The banks had a huge pool of money, and needed to make it earn interest. They sold monthly payments instead of long term responsibility. They got the loans out to anybody and everybody. Some were good, some were risky, and some were destined for disaster. And those risky loans? The 2 years of absurdly low interest to be re-adjusted after two years? Interest only on a million dollar home? Who was responsible for those? The banks?

Well sort of. You see the banks are pretty smart with their cash, and they had this brilliant idea to take all of those loans (their safe and stable, remember?) and sell them to investors as a ‘safe’ investments. They were bundled together as mortgage backed securities and sold to investors. You know, 401k, pensions, and the like. As stable as the U.S government, right? Safe investments for stable investors. The American home owner, the most stable economic contributor in history.

Uh yeah, stable.

So now the average price of homes drops back to what it should have been in the first place. Let’s say $180,000. Which, coincidentally is 68% of the original value (the same loss in value of the crash of 1929). And those risky loans? The interest only loans on million dollar homes? Well, it turns out that the homeowners aren’t real keen on staying there when the value drops. Suddenly you owe $200,000 more than the value of the home. Add that burden to the already low savings rate and you have a recipe for bankruptcy. It’s easier, you will find, to simply walk away. So the banks get the house back, and are suddenly responsible for selling to recoup whatever money they can from the investment. A 20% loss isn’t exactly a stable investment now, is it?

It’s a downward spiral. Banks get scared, they stop lending. Businesses can’t get funds, they fail. Failed business lay off their employees. Unemployement leads to bankrupcy, bankrupcy leads to more forelosures, and more foreclosures are a drain on the finances of the banks. A bad progression that can easily spiral out of control.

So here we are, all wondering what will happen next.

The truth is, I don’t know. We are facing, above and beyond anything else, a massive change in how we function as a country. Our collective greed has driven the economy to shambles and we all want it to return, to bounce back to what it was. I wanted my house to go up in value because I was greedy. I was tempted by the economy. But then what good is economy? Does it make us happy or secure? Despite being taught that money can’t buy happiness, we were drawn to its luxuries. We love to be part of a rich nation for the privilege it entitles us, and the thought of that changing is frightening and unsettling.

So let’s get our priorities straight. Write down the things you truly love. Look at the list.
Is economy on there? What about your job, the one you might lose? Is that on there? Strangly enough, neither was on my list.

What I do know is that we are facing a massive change in our economic foundation. It does not mean we are facing a loss of the things we love. Change. That’s it.

Daniel Ferguson