Monday, June 09, 2008

More problems for consumers as the consumption-driven Recession grows

As I have said before, the current economic problems are not like the last two recessions. This one is driven by inadequate consumption, now complicated by the increase in energy costs. It's not part of the normal business cycle, it's a breakdown in the economic system itself.

Consumption can be "jacked up" by expanding the money supply (the Fed) and by expanding credit to consumers (the Banks.) The Fed has been pumping more money into the banking system hand and fist, but the major effect has been lower to international value of the dollar and add to the increase in energy prices. The credit crunch growing out of the mortgage problems and mixed with a large number of "innovative" investment vehicles like Collatoralized Debt Obligations (CDOs) has caused the collapse of Bear Stearns and has required all of the major American banks to obtain more capital in order to avoid a fate similar to that of Bear Stearns. We have been hearing reports that the credit crisis is nearing the end and that things are looking up for bankers and, as a result, for the economy.

If only.

Now we get a new set of problems growing larger.
By Kevin G. Hall | McClatchy Newspapers

WASHINGTON — The credit crisis triggered by bad home loans is spreading to other areas, forcing banks to tighten credit and probably extending the credit crisis that's dragging down the economy well into next year, and perhaps beyond.

That means consumers are going to have an increasingly difficult time getting bank loans for car purchases, credit cards, home equity credit lines, student loans and even commercial real estate, experts say.

When financial analyst Meredith Whitney wrote in a report last October that the nation's largest bank, Citigroup, lacked sufficient capital for the risks it had assumed, she was considered a heretic.

However, Whitney was proved correct: Citigroup pushed out its CEO, sought foreign investors and slashed its dividend. Her comments now carry added weight on Wall Street, and she has a new warning for ordinary Americans: The crisis in credit markets is far from over, and it increasingly will affect consumers.

"In fact, we believe that what lies ahead will be worse than what is behind us," Whitney and colleagues at Oppenheimer & Co. wrote in a lengthy report last month about threats faced by big national banks, including Bank of America, Wachovia and others.

Consumption drives the economy. Consumption creates the markets that investors build organizations to exploit and profit from. Without consumption spending there are no investable opportunities for investors to profit from. And people who want to be consumers are not customers unless they have money to spend. Since bout 1970 that money has come from savings, second family incomes, credit, and most recently, pulling out home equities by refinancing homes that have appreciated because of inflation and the housing bubble. Real wages have not increased to increase consumption because the increased income from greater productivity has been siphoned off in profits given to the already very wealthy who do not spend it on consumption. Sources of consumer income other than wages have topped out, and in the case of home refinancing, been sharply reduced. All that's left is expanding credit.

Only the banks are short of capital themselves, as the article shows, and are cutting back on credit. So don't count on the "strength and resiliency" of the American economy to make this a short recession. The economic happy-talk is being spouted by high-ranking bankers who do not yet realize that the fundamentals of the economy have changes, and their happy-talk is being picked up by mostly economically illiterate reporters who are trying to publish good news in the face of trouble.

So until enough policy makers realize that the bankers don't have control of the situation and that the economy has changed, the Recession will continue, to be followed by inflation. It's going to take wage earners being paid for their increased productivity to change that. That's going to take a while.

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