The Real Reason for the Financial Meltdown

This is a Bottom-Up Problem as much as a Top Down problem.

It’s interesting to blame Wall Street and the exotic derivatives for the economic issues we face, but I see the problem stemming as much from something much more bottom up and basic- fuel costs and high gas prices.

In the beginning…..

This whole financial melt down we’re experiencing started out, primarily, from high gas prices.  When people are budgeted out to the penny, or are living up to their income level, it doesn’t matter if you are rich or poor.  If you have no liquidity in your finances, any unexpected expense can bring the house down.  While as a percentage, the gas price increase was like an excise tax on the less well off -  suddenly, it costs twice as much to get to work, and the costs passed on in terms of increased postage, grocery costs, etc. – it put a further dent in a budget without a lot of room to give to begin with.

But what about the mortgages?

The first wave of foreclosures occurred primarily in people who borrowed the maximum amount of money they were offered, without very much understanding of what this would mean in cash flow terms, on a month to month basis.  This meant people regularly bought  houses they thought they could afford because the bank said they could have up to (insert maximum figure here) , not realizing that somewhat less than the maximum was probably a better decision.  (After all, the bank will lend you money, but they really don’t care if you eat ramen noodles or steak, as long as you make your payments.  And no one says you have to take all of the money they offer you.)

But when you bought a house that was all you could afford, it meant that things like the heating bill for the dream house weren’t included.  Or Taxes and sewer. Or the new mower you’d need for the backyard.  Or the cost to repair the dishwasher.

People got sucked in by the dream.  Reality is often less lovely.  Money being tight is one of the main reasons people fight and get into relationship problems and is a major cause of divorce.  And divorce is always expensive, emotionally and financially.  If you couldn’t make things work financially in one house, how can you do it in two?  We’re going to see a skyrocketing divorce rate, I would bet serious money on it, as a result of the financial crisis, but that is no one’s primary concern at the moment, with the possible exception of one of my heroes, Elizabeth Warren and her interest in the vanishing middle class in America.

So the increase in gas prices and groceries, basic necessities to get people back and forth to work, tipped the fragile financial boats first.  But that also meant that a lot of people, including less vulnerable people, also had less to spend on basic consumption and needs, and began to tighten their belts.  The outgoing rapidly began to exceed the incoming funds.  And people didn’t have any idea when the prices would top out or moderate, if at all.  So they began to save more, almost immediately, starting to understand they weren’t sure what the next month’s bills would bring.

The cut back in consumption meant people started losing their jobs, because not enough people were spending money like the used to, coupled with the fact that transportation costs for everything in the stores went up, prices went up, exacerbating the situation of no one spending.  People tipping over the edge financially, especially after a job loss began to use their credit cards to try to pay the mortgage and more basic expenses like groceries, but couldn’t pay it off at the end of the month.  Credit card companies have begun to worry about these folks defaulting, and have upped late charges and interest rates to help cover their risk and losses.  And the last thing a fragile financial ship needs is a credit card with interest rates approaching 30%.

(Frankly, getting money from your local loan shark probably comes at a better interest rate and with better terms than you get from some of the banks these days- does this mean we are at risk for a resurgance in black market banking?  Maybe.)

So because of the overall slowdown in the economy and the risk of foreclosures along with real ones taking down Wall Street, we have seen tons of layoffs.  People are looking for new jobs, but can’t move as readily, because it’s taking longer to sell their house if they have to move for a new job.  Local jobs may be harder to come by and take longer to find, assuming you can find one that will support your previous level of income.  People who are out of work are trying to make ends meet with unemployent (which will run out), severance pay (which will also run out), and credit cards (which will max out).  And them you will start to see the next large wave of foreclosures happen, for people who were making ends meet rather well, until they had a job loss.  And then unable to meet expenses, they will not only default on their home loans, but on their car loans, credit cards, and any other debt obligations.

So while I want to believe that the credit crunch is over, and the economy will start being productive again, there’s a lot of financial mess to still shake out of this economy.  People laid off are having a hard time finding new work, and even entrepreneurs are finding it hard to start a new business or market themselves in an economy where people are naturally focused on needs, not wants.  (And god forbid you are undercaptialized in your business, because any small problem and you go under, too.)

We’re vulnerable to things like gas prices and health costs which are not fixed, but fluxuating parts of the budget process.  The more volatile the fluctuation, the more people it will take down with it.  Even with lower gas prices now, we see them gradually creeping up from a local all time low around here of $1.57 per gallon to $2.45 per gallon and rising.  While this is far below the $4 plus a gallon we’ve paid, prices at the grocery haven’t gone down much, and we’re vulnerable to additional increases at any time.

So why we all wee the mortgage crisis and banks as the scapegoat for the meltdown, I see them as secondary effects from the rapid increase in gas prices which flodded the ship that has yet to be able to right itself again.

What do you think?

Tags: black market banking, elizabeth warren, financial meltdown, mortgage crisis, planet money

Trust and Transparency

My friend, John Havens and the fantastic Shel Holtz, have written a book on Tactical Transparency, due out in November.  I’m eager to read the book, not only because it’s by two people I know and respect, but also because it’s a subject that I hear more about every day, especially when it comes to election or financial news.

My mom used to tell me not only that honesty was the best policy, but that I was so bad at lying, it wasn’t even worth trying.  Eventually, I decided the WYSIWYG (what you see is what you get) principal really worked out best in the long run. I’ve learned to tell people the truth in ways they can accept it, but honesty it is, and hiding the truth is always a disaster.

This has certainly been born out regarding the current national financial crisis.  I’ve suspected for almost a year now, by the number of homes for sale, the number of local establishments going out of business or heading towards trouble, and the number of people in mid-level management positions at local banks losing their jobs, that all of this pointed firmly towards recession.  And as the situation has worsened, the politicians saying that a recession could not possibly be headed our way seemed to be denial or naivite under the best of circumstances.

There’s a couple of great episodes of This American Life that explain alot of what’s happened with the mortgage crisis, in case you don’t quite understand how the selling and reselling of mortgages and how lending scads of money to people without a concern in the world about their ability to repay it has eviscerated our economy.  NPR has also come out with the Planet Money blog and podcast, explaining what’s going on, and how the SEC failed to do its job, leaving the rest of us to clean up the mess.

I mention this because it’s been the lack of honesty and transparency that’s led to many of these problems, as well as a ton of magical thinking on the part of those who just didn’t want to take a broader look at how things were starting to crumble, long before the crisis actually hit.

I hope John and Shel’s book helps many people see how important honesty and transparency is, even if it’s not always fun and cheerful to tell the truth.  But as I have always told clients- I can deal with the truth- I can’t deal with facts I don’t know.  The truth, even when it’s ugly, is so much better than illusion, especially when the time comes to pay the bill.

Tags: economy, finance, John havens, mortgage crisis, NPR, planet money, Shel Holtz, this american life, transparency, truthiness

Social Connection

This is a follow up to my recent post on the Social Contract.

Humans have a basic need for social connection.  The experiments done by Harlow and others in the 50’s show that primates need touch and nurturing to do well.  In fact, many of the cases of failure to thrive in infants may be due to a lack of love and stimulation in a caring, loving environment.

This does not go away as we get older.   People most prone to suicide are those with little or no social connections; and elderly people become more and more likely to pass away after a spouse passes away as well.    There’s a great book where you can read more on all these phenomena called Connect: 12 Vital Ties that Open Your Heart, Lengthen Your Life and Deepen Your Soul by Edward M Hallowell, MD (well-known for his work on ADHD.)

As this applies to my previous post on social connections, I don’t think the basic need for humans to connect has changed over time.  Even online in social media, we are essentially looking for connections to others for business and personal reasons- other people who “get us” especially when we are not particularly connected to our real world communities.

People still have to deal with the paradox of wanting to be simultaneously recognized for our individuality and value, while contributing to something larger and more important than ourselves.  Essentially, we want to answer those big questions- What Will I Be Remembered For?  What Will I Accomplish?  Why Am I Here?  Where Do I Want To Be?

I think it has become so easy to chase the job, the money, the dream, or whatever, that we sometimes lose patience with working it out where we are.  People leave jobs, relationships and marriages because they are frustrated and have lost patience in trying to get it right with the job/person they’re with.  Sometimes, the situation is unfixable.  Other times, we leave situations because we are bored, and blame other people for not filling all of our needs.  (Often I think some of those needs are things you should expect to fill for yourself, but that’s another blog post entirely).

I hope we are all on a quest to become better people.  I hope we all understand that no one else or no specific job can make you happy – that’s your responsibility.  It’s nobody’s job to make your life easier unless you are specifically paying them to do so.

That being said, I think we have to take a larger view through the lens.  We can’t always look at what’s best for us without considering the impact we have on others, or the downstream consequences of our actions.  I don’t mean this to imply we all need to become Hamlet and have “paralysis by analysis”.  We need to act, we need to protect ourselves and our families, but we also have to understand that there are real benefits that come from being connected to others, nurturing relationships, sharing, and not giving up just when it gets a little hard.

I hope the transiency that exists in our society today is not breeding a culture based on filling only temporary needs and no longer looking past the next quarter’s profit and loss statement to figure out value.  If we remain myopic about the big picture, all the short term churning is for naught.  Just look at everyone who took out big home loans, thinking interest rates would never go up, and are now losing their homes in the mortgage crisis.  This is looking at the short term- What Seems Great For Me without considering downstream issues at all.  And the cost is gonna be pretty high for them, and now for the rest of us with the bail out currently in the works in DC.

So I guess what I am trying to say here, whether we like it or not, we are all interconnected.  What’s good for you may not always be what’s good for me, but maybe if we work together we can both win, as well.

What do you think?  Do you have online proxys for connectedness that take you out of your real life communities?  Is connectedness to your neighbors, social institutions, things outside of your immediate family important?

Tags: connections, Edward hallowell, mortgage crisis, social contracts, ties