Credit Death Watch

Recent economic reports show that the economic recovery, if it exists, is limping at best. This article explains why.

Once upon a time a single income household could provide a decent lifestyle. Household income was solid and so was savings. Then something happened. The bean counters took over. My favorite story about that is the hotel chain that allowed their bean counters to save money by not replacing the aging rugs in the lobby, hallways and rooms. In a short period of time, the hotels were empty and the chain was near bankruptcy. But the bean counters received bonuses for (a) saving money and more importantly (b) reporting higher earnings as a result of the “cost savings.” As obvious as that story is, the shareholders, directors, and Wall Street analysts went with the higher earnings and assumed forward earnings would be as management represented. The result was a run-up in the price of the stock at the same time that earnings were already declining because nobody was staying at their hotels.

The problem here is that many factors converge to create a disaster. That starts with the changes in accounting that began in the 1960″s that were described in detail in a long forgotten book called “Unaccountable Accounting”. Gradually management estimates of values on the balance sheet, income items, and projections were institutionalized as real even when they were patently false. And then we switched from valuing stock based upon current earnings to valuing stock at projections of forward earnings. The result is that management gets increasingly bold as to their projections in order to earn extra bonuses. The further result is that the price earnings ratio is twisted beyond recognition and more importantly beyond common sense.

Eventually the period starting in the early 1970’s and continuing to the present and beyond will be known as the period in which the American economy was completely undermined by a simple fact: in an economy based 70% on the spending by consumers, the consumers didn’t have any money. The “fix” was to offer credit on an increasingly stupid basis to replace real earnings, real savings and real household wealth, and real household income. Instead, household debt increased gradually and then more stupendously in the late 1990’s and the lead up to the 2008 crash.

Available credit amounted to an explosion of money into the housing and mortgage market. The result, according to the Case Schiller reports, was that median income and housing prices diverged on a scale never seen in human history. Hence housing PRICES launched suddenly to unsustainable heights (with the banks saying that housing NEVER goes down) while housing VALUE, related to median household income was going down. The whole credit affair was the equivalent as the crazy tulip bubble in the nineteenth century.

So now we have double income and triple income households that still can’t keep up with their expenses. It is all traceable to the decision in most companies to reduce or freeze wages and let the government make up the rest with food stamps or the banks make up the difference in available credit. This insanity looks good on paper at the beginning. But int he end, households run out of money, families break apart, people lose their homes to fraudulent foreclosures, while government adopts a policy that basically says that regardless of how the public was duped into accepting credit (under duress) in lieu of normally increasing wages, it is always the “borrower” who must bear the full weight of these mistaken policies and the failure of the American worker to make ends meet.

So despite lower gas prices and other inducements, people are NOT spending — because they don’t have the money they should have had if they were permitted to enjoy higher wages resulting from the fruits of their labor. They are out of money and out of credit alternatives and now, for good reason, have no faith in the economy, job security, fair wages, and they have nothing but household debt where they should have household wealth.

Hence that 70% consumer economy is falling apart. The consumers have no more money to spend. They can’t earn it and they can’t borrow enough to do anything other than repay the debt, this increasing their household debt without buying anything. Both the Bush administration and the Obama administration missed their cue. The tea partiers were right. The big banks should have been allowed to fail. Elizabeth Warren is right: the big banks should be split up like the AT&T monopoly.

The truth should have been told about the unenforceable mortgages that used sham entities or stand-in nominees to originate loans that were known by the underwriters to be certain to fail. It was a whole sale movement of wealth from homeowners who had homes in their families for generations to banks and servicers who didn’t spend one dime on the loans. And the banks did it using the pension money of the same borrowers they were tricking into loans that were falsely represented to be secured by mortgages.

The ONLY cure to our economic malaise is to actually react to reality, just like Iceland did. At the very least, a reduction of household debt at the expense of the banksters who caused this crisis would go a long way toward producing the stimulus necessary for our economy to really recover. But nothing replaces an honest wage — and that means honest from both sides of the table. Debt has become a cancer on our society. it needs treatment and cutting.

The current trend is to take all the wages that should have gone to the workers who produced the gross income and give it to managers, officers and directors and shareholders — as though they made the product or performed the services that produce gross revenue.

Going back to the previously successful policy of giving workers a fair share of the pie is the ONLY way out of this mess. Henry Ford understood that at the start of our economic revolution in America. He doubled worker wages while other car makers decried the move as suicidal. But he was right. He created a middle class that could afford to buy a lot of cars. By increasing wages, the workers were spending money throughout the communities in which they lived. Ford had both created and tapped into what we would later refer to as a consumer economy that drove 70% of GDP.

But for the mythological “derivatives” (and securitization) the credit market is already dead. It is only a matter of time before the reality of a debt economy sinks in and sinks the ship.

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