"Be Prepared" for an Economic Meltdown

"Be prepared for what?" someone once asked the Scouts' founder, Robert Baden-Powell.

For a people raised on that motto, Americans do remarkably little preparation. This is a nation of grasshoppers, not ants.

As the fable goes: All summer, the ants worked hard, busily storing grain. The grasshopper just played. Come winter, the grasshopper begged the ants for some of their corn. The ants asked him why he hadn't gotten ready for winter. He responded, "I was so busy singing that I hadn't the time."

When it comes to money, many Americans routinely don't think past the next paycheck. They're unprepared for things that are utterly predictable, much less the bolts from the blue.

Recent headline: "Consumer spending rises, savings rate dips." The U.S. personal-savings rate in June was the lowest on record. In fact, it was minus 0.6 percent. That means people are not only failing to save, they're dipping into their reserves to spend money -- or just borrowing more. Which brings us to the next headline:

"Debt load makes Americans vulnerable." Outstanding balances on credit cards now average $7,200 per household. That's more than double the level of a decade ago. And that doesn't include car loans, or mortgages.

For the past year, you couldn't pick up a newspaper without reading about the absurd housing prices in much of the country. Ignoring the alerts about a bubble soon to break, people continue to buy in risky markets. And to pay these high house prices, they are taking out risky mortgages.

Over a third of new or refinanced mortgages are the adjustable-rate type. The monthly payments in such mortgages are tied to changes in various interest rates. They are exactly the kind of mortgage you don't want when interest rates rise, which they will surely do.

As a come-on, lenders offer very low initial rates on these mortgages. The temporary low rates let people borrow more money than they ordinarily could or should. What will happen when their mortgage costs go up and housing values go down? Let's just say that it won't be pretty.

The banks pushing these mortgages are also not prepared. Mortgage-related loans now account for 61 percent of bank credit. Banks are in the bubble big-time. Despite these rising risks, banks are setting aside little money to protect themselves against a tide of bum loans. In 1992, their reserves against losses from bad loans were nearly 3 percent. Now, they're 1.2 percent.

A personal finance rule of thumb is to save six months' worth of wages. The object is to protect the family against the loss of a job. How many of you out there have six months' worth of savings? Don't all raise your hands at once.

President Bush inherited a handsome budget surplus. It could have served as a cushion for the near future, when retiring baby boomers put extra strain on the Treasury. But as the swingers say, "Cash is trash." Our so-called conservatives slashed taxes and spent wildly, turning the surplus into a deep deficit.

Bush apologists like to blame "unforeseen events" for the spending: 9-11, the war in Iraq and now New Orleans. How could Bush have known about any of this?

Of course, he didn't know -- but doesn't "stuff happen"? When in history hasn't it?

The Bush administration may be Bible-friendly, but it learns not from the Good Book. It certainly didn't take anything from the story of Joseph -- the government adviser who urged setting aside grain during the seven fat years to feed people in the seven lean ones.

Frankly, the "events beyond our control" excuse doesn't float. "Even after excluding spending on defense and homeland security," a Cato Institute report says, "Bush is still the biggest-spending president in 30 years."

The report adds, "Since Bush took office, domestic spending has shot up by 36 percent." And that doesn't include the enormously expensive new Medicare drug benefit that will kick in next year.

Be prepared for an economic meltdown -- as rising interest rates sink a people floating on debt. This grasshopper mentality is a plague upon the nation.

There are a million things wrong with the article's analysis:

Milken Institute just did a study of Americans "debt load," and found that when all assets are measured, Americans are about where they've always been in assets-to-debt; and that when you measure forced savings like Social Security and include housing, the U.S. saves comparable to almost every other country that does not have social security and where housing ownership is poor.

Further, the "national debt" is somewhat bogus---it likely exists, but not at the numbers usually given, because by law government records must show government assets at the purchase price not at market value. Robert Eisner did an analysis of this and found that just, for example, taking that actual price of gold would substantially change U.S. government asset levels; and certainly a market valuation of LAND would show far more assets on the U.S. books than current "par" valuation does.

When I look at my personal debt, I measure (realistic) asset values to my debt, and I think I'm doing pretty well.

There are several problems with this analysis.
(1) The alleged housing bubble.

There is no housing bubble. There are more people living in America and jobs are becoming more and more concentrated in a handful of states and urban centers.

Then how do you explain the run-up of housing prices in remote areas, where there are no jobs, like Idaho, or the Central Valley in California?

There may be regions not effected by the Bubble, bit it's there, it's huge, and to deny it is insane. We had the SAME denials happening before and during the .com collapse.

"Therefore, in many housing markets prices have gone up considerably - this is not a bubble, it is a natural outcome of the law of supply and demand."

Not true. New housing is going up EVERYWHERE to support the "buy a home regardless of the risk" mania that's been happening. Vast tracts in Arizona are being built up with new McMansions (where there are no jobs).

"In my town, housing prices have gone up 50% in the past two years. This is due to a combination of two factors that are being replicated over much of the country: (a) my town is conveniently located within an hour of NYC by train, bus, ferry and highway, (b) zoning laws limit the amount of land in my town that can still be developed."

That's your town, it's anectdotal and not relevant to the national market or the issues at hand here. The problem is not supply and demand, as much as it's that ANYONE, literally anyone can get a loan right now, under extremely risky terms (no down, interest only, negative amoritization), and the frenzy to flip houses in the rising market brought in the speculators, who drove prices through the roof.

"Demand has grown and supply has remained relatively static."

In YOUR area. Look at the rest of the country, and the amount of new construction, lots demolsihed and rebuilt with 2 houses in the place of one, massive condo development in places like Florida and California. The mantra that's been thrown around of "They're not making any more land" is damning in the face of the amount of new housing available on the market, as developers have gotten restrictions eased and zoning changed. The same thing happened in the RE boom in CA in the late 80's - they built EVERYWHERE, and back then claimed a housing shortage, too.

Inventories have been rising slowly over the last few months. Read the facts. Some areas are still riding a price rise, but many markets slowing, and inventory is rising.

"This leads me to point

(2) America's savings rate is berated as low compared to high-savings countries like Japan.

However, most of Japanese savings are held in postal accounts - the US equivalent of passbook savings accounts. They pay minimal interest and are about the least profitable investment imaginable."

Irrelevant to the atter at hand - and ironically, teh Japanese housing market is a good example of what could happen here.

"A very large number of Japanese and European people rent all their lives and never own a home."

And that applies to us, how?

"In contrast Americans save their money in their homes, which are a good and profitable investment with a higher return than passbook savings accounts."

In the past, sure, equity in housing was king. But now, with refi's and the new "creative" lending, houses are ATMs, and people have been spending their equity on paying bills, buying plasma TVs and SUVs, and buying speculative housing, to flip it a year later. I have 3 relatives who spent ALL their equity in their houses, because they believe in a year or two, their property will be worth twice as much or more - what they failed to see, is the markets have peaked, and now with the Fed raising rates, all those creative loan packages are going to start hurting people badly.

"Yes, there are plenty of Americans who save nothing in a bank or in a home and live off maxed-out credit cards and from paycheck to paycheck. These peopel are not the majority and there are plenty of them in every developed country, not just the US."

I would say the opposite - I'd say that they represent the majority right now in a big way. Everyone, and I mean everyone from CEOs to $10 an hour Walmart employees are trying to play the RE game, and are still buying into the insane markets, expecting huge returns two years from now. RE agents and the reps of that industry have been helping these people to get into the game with inane blather about RE NEVER losing value, and that prices will continue to rise, and "Get in now, or be shut out forever!"

I'm saying we're facing a bigger bailout by the feds 5-10 years from now that will make the S&L bailout look like chump change.

I'm thankful that I saw the light of day this year and refused to be led to the slaughter with everyone else, and signed my soul onto a no-interest loan for a $200K house, but paying 600K. I have decent savings, pay less than 1/3 of my salary in rent, save the rest, and I'm betting your statements will be proven drastically and horribly wrong over the next year. A LOT of people are going to get hurt, but you keep claiming there's no bubble. That kind of talk really helped teh .com burst, did'nt it?

That's not savings, it's an investment.

All savings are an investment. If you put money into a passbook savings account you get a horrible return on your savings. If you put your money into blue-chip mutual funds or high-quality real estate you get a better return.

Remember, if your savings aren't invested at a rate of return higher than inflation, you're not saving money - you're just slowly spending it on nothing.

You don't sell your house to buy groceries when you lose your job.

What a mildly intelligent person does is what I did when I left my last job. I have a substantial amount of equity in my home and I also have a significant amount of tax-sheltered savings in 401(k) and IRA accounts.

What I did was have a home equity borrowing line on my house which I had never used.

I locked the loan in at a low rate.

So when I left my job, I had full access to my home equity through the loan. So if I had needed to buy groceries, I could have spent a couple of hundred bucks of my home equity without selling my house.

It's pretty simple, and I found a new job three weeks later, so I never had to use it.

I'll point out that the usual savings vehicles that most people have - 401(k) plans, IRAs, and CDs etc. have substantial withdrawal penalties if you need to dip into them for groceries.

While I agree that no responsible person does not keep immediate cash around, I disagree that home equity is not savings and is not accessible.

Thanks for the well-thought out reply.

(1) On the alleged parallels to the dotcom collapse: the dotcom collapse was quite different, since the assets in question during the dotcom bubble were shares in companies with nebulous business plans, not ownership of hard, usable assets like homes.

(2) Rising inventories: inventories are rising but so is the population.

While I agree that many people misread the demand curve and believe that a 600K house bought today will be an 850K house next year, this does not mean that the 600K will slump to 300K. Housing demand may grow more slowly, but the amount of people who already want houses will not diminish significantly.

(3) There is a difference between people who speculate on real estate with little or no money down and people who save money by building up equity in high-quality real estate.

While there is a large and vocal minority of real estate speculators, the majority of Americans own their investment real estate for residential or rental purposes and not to flip in the market.

(4) You say that there is overbuilding in FL, CA, etc. - but the fact is, the structure of the job market is changing.

10 years ago a McMansion 75 minutes from Phoenix would be considered ridiculous. Now it may be a valuable home for a wealthy commuter.

I will also add re: the FL, TX, AZ, NC, SC, GA markets that more and more seniors have the money to buy retirement homes and condos in these states. There are employment, immigration and internal migration factors that are creating structural changes in the housing market.

Bottom line: judicious investment in home equity is a sounder savings strategy than a passbook account and will continue to be so. There will be dislocations in the housing market in certain areas, naturally. But the dotcom analogy is quite stretched.

What is left out of the picture is credit unions and 401k plans. A HUGE amount of money being saved that is not tracked by these traditional numbers

This has been a regular topic of discussion on FR and I am certain that 401(k) contributions are included in the government's calculation of the savings rate. I don't know about credit union savings.

The U.S. Commerce Department computes the personal savings rate (which is intended to only track current savings and not previously invested assets) by calculating monthly after-tax income from many sources, mainly wages, dividends, interest, rents and employer contributions to pensions, and then subtracting expenditures.

This method understates income and overstate expenses mostly because it does not count capital gains from the sale of stocks or homes as part of disposable income, but it does count capital gains taxes as expenditures. It also counts the purchase of a car, in a lump sum rather than dividing it up into payments as most people do.

Just because Americans spend prolifically doesn't mean they don't save. The U.S. Treasury data shows that Americans have earned $3.5 trillion in capital gains since 1997. This is more than the combined gains of the preceding 20 years. Household net worth is almost $49 trillion - double what it was just a decade ago - and only about 20% of this wealth comes from homeowner equity.

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