"Be Prepared" for an Economic Meltdown

http://realclearpolitics.com/Commentary/com-9_21_05_FH.html ^ | September 21, 2005 | Froma Harrop

[Maria S]

"Be prepared" is the Boy Scout motto.

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

"Why, for any old thing," he replied.

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.

[2banana]

Savings in a bank - you give them money and they give you a reward (interest) for using that money. YOU CAN ACCESS ALL OF IT AT ANY TIME WITHOUT PENALTY WITHOUT HARMING YOUR RETIRMENT INVESTMENTS.

Savings in a 401K (which could be bonds, stocks, etc). You give someone money and they give you a reward for using that money. BUT YOU PAY A HEAVY PENALTY FOR ACCESSING THE MONEY BEFORE IT'S 'DUE', AND YOU DAMAGE YOUR RETIREMENT INVESTMENTS BY TAKING MONEY INTENDED FOR LONG TERM INVESTMENT AND USING IT FOR IMMEDIATE NEEDS.

Get the difference? It's not insignificant

So you are saying that someone who puts 2% of his pay in a passbook account at 1.3% interest is a better "saver" than someone who puts 17% of his pay in his 401k (in a mix of stocks and bonds)?

[petercooper]

http://www.federalbudget.com/

[wideawake]

I think your scenario is correct - but I also think it occurs on a market to market basis.

Prices for presold lots in a brand-new exurban subdivision will collapse.

But prices for existing homes in established suburbs and city neighborhoods will probably hold up quite well.

[Huck]

So you are saying that someone who puts 2% of his pay in a passbook account at 1.3% interest is a better "saver" than someone who puts 17% of his pay in his 401k (in a mix of stocks and bonds)?

No. I'm saying the prudent person does BOTH. It doesn't have to be just passbook savings. I also use cds, which got about 3% this past year. The DOW has grown 4% this year, so I don't think I've missed out on much. And I put 20% in the 401K. I do both.

[Edit35]

BUT YOU PAY A HEAVY PENALTY FOR ACCESSING THE (401K) MONEY BEFORE IT'S 'DUE',

Not to quibble, but you CAN borrow against a 401K, under most plans, anyhow.

Of course you have to pay the going interest rate, which as of late has been relatively cheap, around 5-6 percent.

My son borrowed against his 401K recently (around $1,000) when he needed money to move, and he paid it back several months later.

Although I wouldn't advise it for most people, it came in handy for him.

[Mase]

I listen to Bob Brinker who clearly explained that rising taxes are not part of the index as well as many other items one would naturally think should be.

What other items did Brinker say are not included? Here is a link to the BLS website and how the CPI is calculated.

CPI: FAQ's

Scroll down to item #7 for a breakdown of what's included. It's pretty thorough. I'm wary, to a certain degree, of government supplied information however, I seriously doubt that Brinker, or your local observations for that matter, know more than the bond market.

[television is just wrong]

that is not a NEW vehicle. I bought a saturn with leather upholster, CD am/fm air power steering and so forth, but not new for 5500.00

[Huck]

You said a basic passenger vehicle. Last I checked, a basic passenger vehicle doesn't have to be new. Paying the additional cost of a new car is elective, not necessary.

[television is just wrong]

I just cannot believe that the homes are going for as much as they are. There are a ton of people investing in Real Estate who know absolutely nothing about it. Carlton Sheets is no help on this one.

A UCLA economist is saying because of this trend, he expects the bubble to burst. For myself, I won't lose, but for many people, It is unfortunate.

[LS]

Housing is savings if, in fact, the purpose of your savings is to buy a house. Either way, it's an asset.

[television is just wrong]

I'm in the same boat. Bought 98 saturn 5500.00 Sure saves on the insurance and so forth. Raising two kids, can't keep affording that cost like that.

PT cruiser is a cool vehicle I hope you're happy with it.

I was referring to the cost of a new car in my statement too.

[Huck]

I love the cruiser. it was an ordeal finding something; i just had back surgery last spring, and i needed a certain kind of ride and seat to be comfortable. it's really worked out and i can't believe how much i like it. they are very affordable too. like your screen name, btw. so true.

[Mase]

The historical average here at home does not take into account the significantly increased level of home ownership in the past 25 years.

Or the new tax law (passed in '97?) allowing for large tax free earnings on home equity. I have to think that had a big impact on money flowing into real estate rather than traditional savings. It would be pretty difficult - and take a long time - for my wife and I to earn $500,000 tax free in the equities market or in traditional savings.

[Mase]

I think I read 35-40% of all homes sold now are purchased by people as 2nd homes or investment properties (flipping). Even scarier

You are partly correct. The National Association of Realtors has reported that 36 percent of homes sold in 2004 were second homes. Of those, 64 percent were for investment purposes."

Ok, now let's look at the facts from that report:

36% of homes sold were for second homes. This means that 64% were NOT second homes but single home purchases. Then it says that of the 36% that are second home purchases, 64% of those are for investment purposes. How is this bad? 64% of the 36% of second home purchases means just 23% of all homes purchased were for investment. So, 77% of all homes purchased are made by people to live in. How this is construed to mean there is a bubble - when looking at the big picture - is dumb founding. What this means is that American's have a lot of wealth and are using it to purchase second homes for rental income, retirement, vacations and yes, speculation.

You may find this scary but it's nothing more than a result of the incredible wealth generated by our economy.

70% of Americans live paycheck to paycheck.- Scary

Wherever did you get this number? You do scare easily, don't you?

[petercooper]

http://www.mdmproofing.com/iym/brokethink.shtml

http://www.metlife.com/Applications/Corporate/WPS/CDA/PageGenerator/0,1674,P250%257ES649,00.html

http://www.inspiredfinancialconsulting.com/default.html

http://www.financialfreedomcoaching.net/snapshot.htm

[Maria S]

"Did you bother to read this crap carefully?"

Nope! I posted it just to annoy the crap out of those so much smarter than I. That's why I try to remember to always say "just my opinion; means nothing to anyone else".

Thanks for your insightful input.

[petercooper]

If there were no Housing bubble, rents would continue to climb like home sale prices have. They have not. This will end badly. I don't scare easily- just using some common sense, and cannot believe most people have no clue about their own finances.

[Bommer]

That's not true. They took in more than they spent those years. It was a surplus. And even if you don't like the accounting methods, it's under the SAME accounting methods now that we are doing far worse.

Your simply wrong about that. The surplus took into account FICA tax surplus from Social Security. It was an accounting gimmick pure and simple! Here is the surplus lie in a better perspective

The biggest lie in Washington is that we have a budget surplus.

When will a politician in Washington have the honesty to admit that we do NOT have a REAL budget surplus? We only have the appearance of a budget surplus because of bookkeeping sleight-of-hand.

Many years ago, a decision was made to include the Social Security Trust Fund transactions within the Federal Budget. Since much more FICA tax is collected than is paid out in benefits, the positive net inflow into the Trust Fund helped offset the huge deficit in all other "accounts" in the Federal budget. This bookkeeping dishonestly helped hide the true growth of our huge national debt. It is, in fact, an "off-the-books" borrowing from the Social Security Trust Fund.

There is no REAL budget surplus until all the other (non-Trust Fund) accounts no longer run a deficit. It is time to separate the Social Security Trust Fund transactions from the Federal budget and reveal the actual deficit in the Federal budget. Then we would see the REAL federal budget surplus or deficit.

It is wonderful that the current budget is finally showing an "apparent" surplus. But let’s not lie to ourselves. It is not a REAL surplus. The politicians should not buy votes by offering a tax reduction that will drastically increase the REAL deficit and the REAL debt that we pass on to our grandchildren. Neither should the politicians squander the apparent surplus on "pork barrel spending" with the same result.

Even if there were a REAL surplus, it should be used to repay the "off-the-books" borrowing before we allow politicians to use it to buy votes. When we finally repay all that "off-the-books" borrowing, we have to get to work on our National Debt. Do we really want to pass this huge burden on to our grandchildren?
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Prof. James T. LaTourrette
2 Candlewood Ct.
Huntington, NY 11743-1827
516-271-6763latour@rama.poly.edu
http://rama.poly.edu/~latour
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Professor LaTourrette is Professor Emeritus in the Department of Computer and Information Science at Polytechnic University. He retired in 1993 after a long career in industry and academia. (The views expressed are his own. The affiliation is mentioned only for identification purposes.)

[Huck]

No, I'm simply right.

It is wonderful that the current budget is finally showing an "apparent" surplus

Using the same accounting as today, there was a surplus. Today, it's far worse.

[chris1]

That was my point. You have these idiots buying rental properties not knowing if they can even cover the carrying costs or are going into the red as soon as a small increase in taxes or insurance costs happen. Forget about deabeat tenants.

Some fools think judges just throw people out immediately. Evicting someone takes months and usually with no payment of back rent.