Saturday, October 2, 2010

Lessons from the Recession

It has been two years since the economy tanked, started to recover, and tanked again.  It will probably be a few years before the economy "recovers" fully back to 2004 levels.

This recession should have taught us all a lot of valuable lessons about life and economics.  But unfortunately, the lessons people are taking away from this event are not useful.  Most people have learned little from the recession, other than:
1.  It's the Government's fault. 
2.  It's the fault of "fat cat Wall Street Tycoons!" 
3.  "But for" the actions of #1 and #2 above, we'd all be millionaires. 
4.  Where's my bailout?
Very few people took this opportunity to look inward to see whether their actions may have contributed to the current recession, and whether their actions amplified or caused harm to their personal finances.  Self-examination is a tricky and difficult business, so it is no wonder that few engage in it.

The real cause of our recession is what I call the conspiracy of 330 million people. We all believed that Real Estate would go up, up up, and people stressed themselves financially to buy homes they could not afford, at onerous terms they could not afford, all on the premise that "someone else" would pay them more for it down the road - or that they would be "priced out of the market" if they did not buy.

Almost everyone bought into this.  No one put a gun to anyone's head and said "sign these mortgage papers - or else!"  And no, it was not some "fat cat Wall Street Tycoon" that caused housing prices to fall back to historically reasonable levels.  It was a law of nature - you can't pump up the price of any commodity without it springing back, eventually.

For all you "gold bugs" out there, re-read that last sentence.  Because you are in for a rude awakening with regard to the price of gold.  Maybe not today, but someday, and soon.

And no one put a gun to our heads and said "take on a lot of consumer debt to finance purchases of cars and toys" or "put a ton of meals on credit cards and pay it off with a home equity loan!"  And yet, many, many middle-class Americans did just that - and are now paying the price.

Looking inwardly, we can see that there are real lessons to be learned from the recession.  The following are the lessons I took away from this debacle:
1.  Being in debt is bad:  Despite what the tax code says, or economists, or even your tax adviser, debt is bad, period.  You have to pay back debt, plus interest.  And usually the interest charged is more than you can make on your safer investments.  The safest "investment" you can make is to pay off debt, as it has a guaranteed rate of return (the interest not paid) and cannot depreciate in value at all. 
2.  Being the only guy with cash makes you king:  When it all went horribly wrong, if you had cash, you could buy a $500,000 house in Florida for $75,000.  Few had cash.  Want that giant penis boat?  If you had cash last year, it was yours, for $10,000 or about 1/10th the purchase price.  The same is true all down the line.  But most people are salary slaves and buy things "on time" using money from the bank.  When credit dried up, suddenly only the people with cash could afford to buy anything.  When the shit hits the fan, you want to be the guy who has cash. 
3.  If you made a lot of financial mistakes, they are amplified in a recession:  If you over-invested in Real Estate or risky stocks, you got hammered.  While most of us lost 30% or more in our 401(k) plans, people who "leveraged" themselves heavily lost a lot more - if not everything.  For most of us, two years later, our investments have bounced back.  For the guy playing the leverage game, he lost it all and never recovered.  Similarly, people who panicked  and sold all their stocks in February of 2010 ended up locking in their losses for good.  Bad financial decisions amplified the effects of the recession for many folks.  Selling it all and buying Gold, for example, will end up being a disaster for many, as they jump on yet another boom/bust cycle just in time for the bust. 
4.  If you kept your financial house in order, you suffer less in a recession:  Those of us who diversified our portfolios and invested in a panoply of things - from high risk to totally safe - ended up not doing so bad over the last two years.  Granted, we didn't make a lot of money - but we didn't lose much, either.  If you didn't have a lot of debt when the recession hit, you ended up better off as well. 
5.  The signs of a recession or economic downturn were there for everyone to see:  At the time, we all saw the signs that the Real Estate business was a bubble (I'm glad I sold!)  But few wanted to believe it.  And the rumblings of trouble at GM were audible long before the stock tanked (I only wish I had sold!).  We all like to say "We never saw it coming!" but in fact, if you were astute and willing to listen to news you didn't want to hear, you could have seen it coming from a mile away.  People who only liked to listen to happy-talk were blind-sided. 
6.  If you are suffering during a period of growth, during a period of recession, it will be far worse:  While the recession has been bad for many people, even during the "go-go" years of financial growth, many Americans complained they were "living from paycheck to paycheck" on $100,000 a year.   If this describes you, then you needed to get your financial house in order back then!  Problem was, people were going into debt and "barely making ends meet" not to provide food, shelter, and clothing, but for big-screen TeeVees, cable, leased luxury cars, take-out pizza, dinners at restaurants, and other extravagances, all financed on a credit card.  Learning to live on less during the "fat" years would have meant more money in the bank - and allowed these folks to survive better during lean times.
The economy will recover, that much is certain. Things will pick up in the next 18-24 months and eventually the economy will thrive. But on a personal level, I learned that having debt is not a "normal" thing and not a good thing, particularly as we age. I am on the threshold of being debt-free for the first time since College. It is a good thing. It is not flashy, like having a new car in the driveway or the latest electrical toy. But it is a good feeling and makes me a lot less stressed out.

It is possible for ANYONE in this country to live within their means.  No matter how much or how little you make, your life will be richer, less stressful, and more profitable if you don't have to pay interest on loans.  And when you spend more than you make, you end up borrowing and paying interest, which in turn means you have less money to spend, so you borrow more and more.  Like a junky on heroin, the debt habit is hard to break.  The more debt you take, the more you want to keep up your lifestyle.  And the further in debt you get, the more you NEED to keep up your lifestyle.

Eventually, of course, it all blows up in your face, with too much debt ever to repay, which means either you have to declare bankruptcy, liquidate your savings, or spend years living like a monk paying off this onerous debt.

A better idea is to not get into debt - for any reason - in the first place.  Buy less house.  Buy a secondhand car and pay cash.  Use debit cards.  NEVER finance your food!

It all takes willpower and strength.  But the truly good things in life are never easy, and nothing ever good comes from "E-Z low monthly finance terms".

Trust me on this!