Tuesday, March 4, 2008

When the dollar falls

Recession is worse than terrorism

From The Statesman


One word that frightens Americans most today is not terrorism; it is recession.

As if trying to stop the spiral of gloomy news, President George Bush told reporters on Thursday that the US economy is not in peril, not on the brink of recession. After expanding for seven long years, the economy is slowing now, he said. During the fourth quarter of 2007 the US gross domestic product, which measures total goods and services, crawled to less than one per cent, while the ranks of unemployed swelled more than the forecast. The mighty dollar has been falling in value and causing pain and anxiety. Of course when a 13-14 trillion dollar economy creaks, it seems like an earthquake. Consumer confidence is down.

Consumers are not spending enough on durable goods such as cars, appliances, business equipment, electronic equipment, home furnishings and fixtures, and house-wares and accessories. People are not buying houses even though house prices have declined 10-15 per cent since last year and the mortgage rates too are down. To stem the slide, President Bush and Congress came up with a $152 billion stimulus plan under which most tax payers will get from the government $300 to $1,200 which they hope would be plowed back to consumer spending and lift the sagging economy. But with gas prices going up with the possibility of $4 a gallon during the summer, extra money in the pocket would be helpful.

President Bush sounded as if he were whistling in the dark when he said: “We believe in a strong dollar policy and we believe, and I believe, that our economy has got the fundamentals in place for us to be, to grow and continue growing more robustly, you know, hopefully more than we are growing now.”

But the market did not listen. In fact, when Federal Reserve Chairman Ben Bernanke warned during the second day of his semiannual testimony before a congressional committee that even some banks might fail due to bad real estate loans, the stock market shrank in fear. It did not help much when he said that the overall banking system is in good shape.

How could he be so brazen when some of the biggest financial institutions like Citigroup and Merrill Lynch have gone begging for billions of dollars of cash infusion from foreign government controlled sovereign wealth funds? The levers of political power in Washington DC have little effect upon Wall Street, which runs on its own convoluted logic, alternating between irrational exuberance and unfounded fear.

It seems to me that Americans’ feelings of prosperity, the collective sense of well-being, is tied up with the market price of their homes, which makes me think further that economics, in spite of all econometrics and data collection and theorising by Nobel laureates, is essentially nothing but the psychology of fear and hope.

Last year, before the housing bubble began to deflate, my hometown Hartford re-evaluated the price of my home by almost 50 per cent, and by golly, I felt suddenly rich and good. But when I realised that I would have to pay more property taxes, which was the town’s (evil) intention for re-evaluation of my property, I felt conflicted and wondered whether I should appeal against the property re-evaluation. I did not want the worth of my house to go down. Nor does anyone else, but that is exactly what is happening in the housing market today. Due to poor home mortgage lending practices, or you might say greed, banks began to give loans on low adjustable interest rates to less credit-worthy people, hoping that since home prices were going up borrowers would re-finance their loans based on increased home equity. But somewhere a domino fell, lenders and borrowers began to lose trust in each other, and what earlier seemed to be a robust housing market turned into a speculative bubble, and hence the resulting panic.

The American dream begins with having one’s own home, so there is nothing more humiliating for a person than losing his home to bank foreclosure. Being driven out from one’s home is like being driven naked out of the Garden of Eden.

Foreclosures have been rising as the low initial interest rates on adjustable subprime mortgages are re-adjusted, which means interest rates for borrowers go up to market interest rates. Falling housing prices create negative equity, which means the mortgage relative to the value of the house is much greater. Some people who bought houses with small or no down payment are simply walking away, because their houses now are worth much less than they originally bought for.

Foreclosures add to the market glut, so home prices keep sliding down; and Americans feel less wealthy. They don’t feel like spending on non-essential goods, going to restaurants, buying a new a sofa, for example; and they postpone buying a new car for another six months or even year. Besides, when the home prices go down, the homeowners’ ability to borrow money against the equity value of their homes in order to buy big items, or go on vacations also goes down.

Banks shrink in fear lest consumers default, so they push up the lending bar thereby reducing credit availability, which adversely affects economic activity further. So when President Bush tells Joe Six-Pack, here’s $1,200, go and spend it, it is on the assumption that these millions of small acts of consumer spending would have a multiplier effect, preventing the much feared recession from becoming the economists’ self-fulfilling prophecy.

George W Bush would not like recession to become a parting gift to the nation.

(ND Batra is professor of communications at Norwich University, Vermont. He can be reached at narainbatra@gmail.com)

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