Monday, May 23, 2011

More Viewer Mail...

More viewer mail..

A reader asks:

"Does the bad economy justify people making bad choices?"

No, actually the bad choices are what caused the bad economy!

Many folks think economics, both on a personal level and a worldwide one, is like the weather. Some days it rains money, and other days, you have a drought.  To them, money and economics is a mystery.

And while economic theories are constantly being modified and improved and tweaked, and trying to model the world economy is a daunting task, there are some very easy observations to make about what happened in the last five years that anyone could have seen coming - and many folks did, at least in part.

For example, the Real Estate meltdown was a no-brainer.  A lot of us saw this coming a mile away and sold out in time.  How did we spot this?  Simple, it was almost an exact replay of the meltdown of 1989.  Not hard to spot.

But this Real Estate bubble was easily 5 times as large, and the consequences far more serious.  And because people were using their homes as banks - taking cash out in refinancing deals and spending it on new cars and boats and other junk - well, bad things started to snowball.

You see, the savings rate in the USA went negative during that period as people stopped saving, started spending in an orgy of over-consumption, and then borrowed more and more money.

And companies like GM, which should have gone belly-up ages ago, kept afloat for another few years by selling wildly profitable SUVs and light trucks for exaggerated prices.  When everyone was "rich" (or thought they were) leasing a new Escalade seemed like a swell idea.

When the Real Estate market fell apart, all the funny money went away quickly, and companies that were basically walking Zombies (like GM) and were thinly financed, collapsed.  And anything related to the overheated home market - such as Fannie Mae and the mortgage-backed securities - fell apart too.  And this in turn took out some investment firms and banks as well.

Oddly enough, the folks who you'd think would be hit hardest - the home builders - seemed to survive.  Many of the large home builders apparently had little actual exposure in terms of unsold homes and are still in business today.  Yea, business sucks, but many of them are still hanging in there.

And of course, the snowball effect drew in people who didn't over-spend on Real Estate or take out home equity loans.  If you worked for one of these companies that went belly-up, you may have lost your job or have taken a pay cut.  And your 401(k) too a hit, at least for a while, and likely you lost money on stocks.

Suddenly, the exuberance of the 2000's is gone and no one feels "rich" anymore.  And psychology drives markets.  Folks who have money think twice before spending it.  So people are cautious about buying a new car or house.

And compounding this is the demographic trend - many Baby Boomers are getting a wake-up call and realizing that their retirement funds are under-funded.   And many lost their high-paying six-figure "dream jobs" and will never be hired back at those salaries.  So they are cutting back on spending, trying to save money, and are thus not consuming as much as before.

And the snowball gets bigger and bigger....

No, the bad economy does not justify people making bad choices.  In fact, we cannot afford to make bad choices today, more than ever.