Monday, March 9, 2009

How to Fix the Economy

Let's start with the obvious. Throwing a trillion dollars at big companies and Senator's pet projects isn't going to get us where we need to go. Yes, some small portion of it will really help, and some of the psychological shock and awe may help get things going. Other than that, meh.

Fixing the economy is a bit complicated, since it's hard to agree on exactly what's broken. For example, for years we had economists up in arms at our dwindling personal saving rate. In 2005 the average American spent more than he made. It was an outrage, bankrupting the next generation by leaving them no inheritance.

Fast forward four years to 2009. People are changing their spending habits, and have begun once again to save money. The economists (one would hope not really the same ones) are up in arms about how we need to spend money to stimulate the economy, and are outraged that people would be so thoughtless as to save their money in these dire times.

Now, about defining the term "fix." Do we really want to put the economy back where it was in 2006 and 2007? That's like rebuilding a car that flew off a cliff, but putting it back on the top of the cliff with the accelerator held to the floor. No, we don't want to put things back the way they were, or we will end up right back where we are.

The government is currently trying to keep companies from collapsing by subsidising, supporting, and in some cases buying them. Is this necessary? Sime of that help could very well be necessary to get the economy going quickly because of the large part some of those companies play. But the big question is whether it is sufficient. There we get a resounding "no."

Let's take a look at the environment that these companies need to survive. Unemployment is up. Pay is down. Spending is down, with part of that loss in spending going to savings.

Now, just like following puppet strings back to the puppet master, you can follow the money to see what's really going to happen here if we don't jump in.

Is saved money being taken out of the economy? Um, no. Not unless it's going under the mattress. Okay then, where does it go by and large? It goes to banks, credit unions, and brokerage accounts.

What do banks and credit unions do with their money? I mean under normal circumstances. They loan it back out to people and businesses, which is a way of them investing it. Currently they are too scared to loan money like they did in the past. This is good. The government is pumping billions of dollars in, and it's not really helping much. Why? Because they only want to invest where there's a chance of getting their money back! Duh!

They're looking at billions of dollars of losses due to loans they were encouraged to make so everyone could have their own roof over their head. Guess what? Some people are incapable of paying for their own roof, and some of them were speculators that got suckered into buying at a bad time. Not giving them loans is an improvement. So what happens if you stop giving loans to those incapable of making their payments in the long run? More money becomes available to those who have managed their finances properly. I bet those with credit scores over 750 have a lot less problem getting loans, so long as they continue their trend of only buying what they know they can actually pay for. That's how they got the score in the first place.

So now we have lots of people who are losing their houses. Everyone's sad about that. What do we do to "save the children" and feel good about ourselves? Do we put them right back into another mortgage and set them up to fail again like last time? NO! Wrong answer! How about this. Let them rent a place from the guy with the 750+ credit score, who has been out buying up foreclosed properties at discount prices, pulling bad debt from the banks.

Let's summarize so far. We have the foreclosed properties being bought up at a reasonable price by financially responsible people. We have the folks who got foreclosed being housed in rentals or mom's basement until they can get back on their feet. We have banks and credit unions slowly building up their cash reserves. The savings that isn't going into low interest accounts goes into the stock market or other investments where it will have a stablizing effect.

Unfortunately the car companies are in for a hard stretch. The've become used to selling luxury, such as the third or fourth car in a two-driver family, or selling the Hummer when a Civic will do. Americans have tightened the belt and been forced to face reality on personal budgets. That means people will make due with what they're driving for a lot longer, and consider buying from the glut of used cars rather than going for something new as a first choice. But you know what happens when people make their cars last longer without upgrading, and don't have a 2nd or 3rd spare? Maintenance and repairs go up as the cars age. It's not a cure-all, but I'd think seriously about investing in that service department.

Jobs are still missing from my list, so I'll pontificate on that subject next. Did you know that India has begun pricing themselves out of the outsourcing market? It turns out that they caught the entrepreneureal bug in a big way, saw a huge opportunity, bid really low, then discovered they were in competition with each other. Prices increased due to competition, pay increased as they fought for the most qualified employees, and we're now to a point where it's not as economical to hire foreigners to answer your phones or write your software.

So with foreign labor costs higher, there's more incentive to hire locally. Unemployment will go back down. Still, those jobs won't pay as much since labor costs go down whenever unemployment has gone up. Still, since we're going to be paying less for rent and mortgages, and other prices have held reasonably steady (other than gasoline and its whipsaw ride), people can get by on a little less. As they gain experience and seniority, pay goes up gradually over time.

So there are several of the major facets of our current economic crisis. The goal here is that when we put the rebuilt economic car back on the mountain, we point it along the road that goes up the hill and set it up to start out in first gear, rather than perching on the cliff zooming along at full speed.

So, allow me to summarize on how to fix the economy in five easy steps.
  1. Continue to save money and increase your savings rate wherever possible by reducing unnecessary expenses. Trimming the fat goes for both companies and people.
  2. Invest savings in good deals, such as discounted real estate or let the bank invest it for you.
  3. Borrow only when it is responsible to do so.
  4. Accept reduced-cost labor as a part of the cycle.
  5. Wait and watch as we rebuild based on good principles rather than unrealistic expectations.

I'll even throw in another item, although it won't apply to most. It's another one of those 750+ credit score kinds of things. If you're able, now is the best time in recent history to start a business because that will make you the one that is doing the lending, hiring the reduced cost labor, and building up to reap the long term rewards of success through responsibility.

Sorry for such a simple answer. I feel like the doctor telling the fat guy that the answer to all his problems is diet and exercise. It's always easy to say, but hard to do.


Phelonius said...

In concerning the bad mortgage loans, do not forget that the "people's advocates" such as Barney Frank of MA and our current President, took steps to enforce the loaning of money to people that could not afford it. Janet Reno, of fond memory, actually used her seat of power to threaten businesses to make sub-prime loans or suffer prosecution.

In short, we have entrusted the "fixing of the economy" to some of the same people that helped to nuke it in the first place. The Federal Government has no business running private sector businesses.

That being said, I am not advocating less regulation. In fact, the Bush administration was on record of trying to force regulation on the sub-prime market no less than three separate times. Who blocked these efforts?

Why, Barney Frank and a whole cohort of Democratic senators and congressmen. The irony is that while Mr. Frank is on record as having said that there was nothing at all wrong with Sallie Mae and Freddie Mac, only today he was railing about having incompetent people in charge.


He should know what those incompetents are feeling today.

I do say that there needs to be enough regulation from the federal government to keep criminals from being criminals. That becomes a rather difficult situation while the wolves are tending the herd....

John O said...

There are signs that things are going along the right track and the economy is showing signs of recovery, despite our government's best efforts.

The stock market has levelled off and has been improving for several days. If that can turn into a gradual climb rather than manic bouncing up and down, we'll have one of the first typical signs of recovery under our belts.

Loans are generally hard to come by, indicating that banks have figured out they're less likely to go belly up if they only give loans to those who qualify. The government can widen this pool out a bit by reducing interest rates which makes the payments go down, which in turn increases the pool of qualified applicants a bit. But to encourage giving loans to the unqualified is idiocy.

The real term for "unqualified buyer" is "renter" or "living with family."

Phelonius said...

I could not agree more. I still, however, want to issue a warning that the devils that made that brew are still in the kitchen.

The market is going to have a natural response of optimism, because investors like to see positive responses. The Devil, aka, Barney Boy, is still insisting that he and his party has done no wrong.

Tell me if I am wrong, but I do not see this as a good thing.

The market knows full well that this is not correct, and every time one of those D leaders opens their yaps, the market crashes again.

What you are saying is not incorrect, what you are saying is falling on deaf ears. There is no way that the government expenditures are not going to make a major impact because they are indenturing our progeny.