Here's What is Really Wrong With the Economy

We are in the eye of a Perfect Storm when it comes to silliness and downright stupidity of assessments regarding the state of the U.S. economy and what should be done to get things back on track.

That’s because we are in the vortex of a high pressure front. We have an election in two months when virtually every public office holder is up for grabs. Those who seek to fill those offices are trying to sound wise. That is combined with the new 24-7 news gathering cycle where every television station, newspaper, and blogger feels under pressure to provide constantly updated factual information and great thoughts regarding the state of things as of this moment.

As a result, politicians say the dumbest things and reporters and pundits repeat them as fact since those reporters—particularly on television—are no longer journalists. They are celebrities with agents and blogs who often make more money from outside speaking appearances than they do at their day jobs.

One of the most troubling consequences of this state of affairs is the foolishness and misinformation that is being spread regarding our economy which has been in profound distress for quite some time now.

First the news media spent months trying to determine if the U.S. economy was in recession—as if that mattered.

What matters is that we have been going through a vicious downturn that is unprecedented in my lifetime. In my 30 years as a wealth manager I have been through severe market downturns and recessions. Most of them have been events based on the unwinding of market excesses or external events. The Crash of 1987, the Savings and Loan Crisis, Hedge Fund blowups, and the attacks on 9/11 were behind a few of those dislocations.

In this case, the meaningless speculation regarding the presence or absence of a recession soon gave way to an effort to label the current snafu as a Sub-Prime Mortgage Crisis. It was a problem affecting a number of mortgage companies and other lenders who had engaged in unwise or unethical lending practices to get low-income and middle class people to buy homes they couldn’t really afford using deceptive loans with teaser rates that had the potential to blow up on them.

Until just a few months ago, that was the conventional wisdom and in some circles it may still be.

But the truth is far more serious and much more pervasive. As I wrote months ago, I have never lived through a period where the value of virtually everything that people own (homes, cars, investments, jobs) has plunged at the same time the cost of all the things we need to buy (gas, energy, food, health care) has gone through the roof.

And for millions of people across the income and net worth spectrum this shift has been so sudden and dramatic that it has left them in a state of shock.

The sub-prime problem has been well documented. But there are now millions of people who have six-figure incomes and seven-figure net worths—including many whom I know personally-who are “upside down” in their homes, cars, credit cards and investments.

Upside down is one of those great descriptive terms that in credit circles is used to describe a situation where a person owes more on an asset than the asset is currently worth. Being in default means that you can’t afford to pay your mortgage or car loan. Being upside down means that it doesn’t make sense to make your payments even if you can because you owe, for example, $800,000 in principal on a house that is now worth only $600,000 or $20,000 on a car that is only worth $10,000.

Right now, there are 9 million homes in foreclosure in the U.S. because the owners were either in default or upside down in their mortgages and gave the houses back to the lenders. A large number of those were sub-prime loans but foreclosures in that category are slowing down. Delinquencies are exploding however in the prime loan area. It is estimate that over the next year another 5 million homes will go into foreclosure with the vast majority of those coming from defaults on prime quality mortgages.

What happened? Nothing that seemed all that dramatic at the time. People with good jobs and houses that had appreciated in value were encouraged by their lenders and the tax laws to unlock some of the equity in their homes. A person that bought a $500,000 home and took out a $400,000 mortgage six years ago was told the home was now worth $1 million and that they could easily afford to borrow another $400,000 against it and still have $200,000 in equity.

Millions of home equity loans and refinancings boosted the profits of lenders and Americans were able to spend more and do more. When that money was gone, many of those people kept living beyond their means and used credit cards to finance the lifestyle they had come to regard as normal.

Then, seemingly overnight, the value of housing began to drop, monthly payments on loans and the cost of everything else from food to gas to energy to health insurance began to skyrocket and the economy began to slow. Many people have lost their jobs or seen their incomes drop or stagnate while the value of their investments—particularly in the home building, financial services, automotive, and retailing companies fell off a cliff.

The sharp rise in the cost of gasoline has been wrongly blamed by politicians and the media for much of it. While it’s true that gas prices spiked sharply, for all but a few people that has meant an increase of $50-$100 in their monthly bills. Much of that increase has rolled back in recent weeks. While that was unpleasant, it doesn’t explain the tens of thousands of dollars in debt that millions of families have run up—debts that they now can’t pay.

The same thing was happening to our Federal government at the same time. As a country, we ran up debts for wars, homeland security, health care, disaster relief, stimulus packages--you name it. Taxes, which are the way we pay our bills for the goods and services our elected officials buy on our behalf, have been framed by Republicans as some sort of evil and pernicious assault on our freedom. Candidates of both parties are arguing furiously about who should pay how much of the tab, but the real issue is that the bills simply aren’t getting paid. Our national debt has doubled from $4 trillion to $8 trillion in the last eight years and that doesn’t count the $5 trillion in outstanding mortgages that the government has promised to back.

As usual, the news media has allowed the politicians to frame an irrelevant bit of trivia—whether the rich should pay more or less in taxes—as the main point when the real issue are the facts that we’re not paying our bills, we’re falling further and further in debt, and the value of our currency has crumbled world wide increasing the cost of every commodity we buy.

Meanwhile, everyday the news anchors keep asking the “experts” every day if now is a good time to buy cheap bank stocks and if the market has bottomed. After all, "blue chip" companies like Citibank, Wachovia, Merrill Lynch, Lehman, Fannie Mae, and Freddie Mac are down 50 to 90 percent in value in just a few months and Bear Stearns has disappeared altogether.

Maybe these price reflect all the problems and maybe they don't But one thing is for certain. We are facing very serious economic problems that we have haven’t even begun to address. The answer lies in behaving like grown-ups--not in arguing over who should pay what percentage of the bill that is not being paid anyway.