Recession, Part 2 of 2

Okay, ya'll lucked out. Turns out this will only be a 2-part series. We conclude things today by looking at the consequences of the housing boom and what political leaders can and should do in the future.

V. The Fallout

As we saw from last time, the Federal Reserve began fueling an unsustainable boom in housing by cutting interest rates to rock-bottom levels beginning in 2001, but eventually had to allow rates to rise back up to contain inflation. As rates began to rise in 2005, a trend which continued up until last year, many adjustable-rate borrowers began to take a hit as their mortgage payments increased. In addition, as rates rose, purchasing new homes became a much less attractive idea. This led to a drop in home prices, making it tougher for short-term borrowers to "flip" their properties as they had originally intended. All of this translated into a surge of foreclosures as banks were forced to recoup what they could as borrowers defaulted.

Beginning in September of '07, as foreclosures continued to skyrocket and many subprime mortgages (loans given out to lower-income borrowers) went into default, investors who normally purchase mortgage-backed securities began to get cold feet and stopped providing the cash necessary to finance these mortgages . This has led to what the media has referred to as the "liquidity crisis" or "credit crunch." It has become much harder for people to get financing as banks are far more cautious about who they lend to.

As a result of the above developments, there have been massive layoffs across the housing and real estate sector. Many employees hired during the boom period have recently been laid off. The "cluster of errors" I mentioned in yesterday's post are revealing themselves, and the market has begun to prune back these unfruitful investments.

VI. Politicians to the Rescue (Lord Help Us)

Just this past week, President Bush told the press he's "on top" of the economic situation. The only small problem with this statement is that it's entirely impossible. The president doesn't "control" or "run" the economy. Heck, he hardly even runs his own staff. For him to suggest he's somehow on top of a $10 trillion entity where hundreds of millions of people enter into countless unseen transactions with each other every day is beyond laughable, yet the majority of voters think this way.

Politicians don't run the economy, and considering all of the damage that government intervention and central planning has been shown to cause, we should certainly be thankful that they don't.

VII. What Bush Can Do

But while the recession is inevitable, there are certain things the President and Congress can do to strengthen the country's long-term economic fundamentals for the future.

1. Call for a large, across-the-board reduction in both income and capital gains tax rates.

This would encourage more risk-taking and would raise returns on investment and work by allowing people to keep more of the fruits of their labor. It would also help keep somewhat of a lid on federal spending by straight-jacketing Congress' spendthrift ambitions.

The Democrats' plan to "soak the rich" (i.e., raise taxes on the people that already pay all of the taxes) doesn't make much sense: it would discourage growth and help finance an even further growth of a federal bureaucracy that's already way too big.

2. Approve drastic reductions in federal spending.

Getting out of Iraq would be nice, as would overhauling entitlements and vetoing any new pork-barrel spending. Freeing up money that would otherwise be spent on bridges to nowhere would be used more productively and efficiently in the private sector.

3. Tell the Fed to keep a tight lid on the money supply.

Inflation corrodes the very seed of economic growth (people's savings) and distorts the calculations entrepreneurs and business owners try to make. Tightening the money supply would slay inflation and preclude the fueling of another unsustainable boom.

4. Unconditionally support free and open trade.

This would unequivocally signal to the rest of the world that the United States is ready to benefit from and contribute to global trade. Welcoming investment and cheap goods from abroad lowers costs and raises living standards; embracing protectionism does just the opposite.

VII. Concluding Thoughts

As we've seen, recessions aren't necessarily bad things: they are the market's way of correcting the mistakes of government (Fed) intervention so that things can be brought back on an even keel. Think of them as economic "fevers": they serve as a painful but short-lived indication that the free market is doing its job cleansing uneconomic investments so that things can be brought back to normal.

Thus, the best medicine for recessions is to sit back and allow them to run their course. Attempting to inflate the money supply further (which is what the Fed has been doing since August) and handing out "stimulus" checks will only prolong and possibly worsen the hangover's inevitably.

In the meantime, the President and Congress could get to work on the 4 proposals I've outlined above. I won't hold my breath.

Recession, Part 1 of 2

This will be the first in a short series of posts (maybe 3, maybe 2, not really sure how long it's going to take) on the current economic situation. Today, we'll look generally at what a recession is, what causes one, and how this applies to the current slowdown we're experiencing. You will also get a general sense of how big of a loser I am.

The headlines are everywhere: there's a good chance the economy is either in a recession or rapidly headed towards one. After 6 years of decent growth, the economy is losing jobs.

I'm proud to say this blog mentioned the possibility of a recession around a year and a half ago, and I agree that we're in some form of a recession now and may be for the next few months. But it is necessary to explain what a recession is, how we got in one, and what, if anything, could be done to avoid another one in the future.

I. Just what IS a Recession?

The word gets thrown around loosely in newspapers, although very few people know how to actually define what it is. And to determine just what a recession truly is, we must also determine what causes a recession in the first place.

The textbook definition of the word is when the nation's gross domestic product fails to grow for at least two consecutive quarters. In other words, when the total value of all goods and services bought and sold shrinks during a 6 month period, the nation has technically experienced a recession. But this definition is flawed in that it's directed more to the effects of the recession instead of its actual causes. Sure, the economy contracted for 2 straight quarters, but how? Why? What made this happen? What causes this sudden downturn in business activity? If we break these things down we can better understand why we're in a slowdown and what, if anything, can be done about it.

II. A Two-part Process

The way I see it, a recession can best be viewed of as a two-part, cause and effect, process:

1. MALINVESTMENT: A situation where firms and their investors collectively make bad economic decisions by pouring $ into projects that originally looked profitable, but turned out not to be.

2. LIQUIDATION: The negative effects are felt as the bad investments must be "cleansed." A cluster of errors is revealed as balance sheets turn from green to red and firms are forced to cut production and layoff workers. These layoffs of course translate into lower incomes for workers and their families, which means people have less money to spend, which can translate into further layoffs in industries that produce consumer goods, and the ripples disseminate further.

So in essence, a recession is an inevitable transitionary period during which investors and businesses pull their $ out of bad investments so it can be returned it to truly sound and profitable ones.

But there is still more to this. To be sure, in a free-market economy, bad investment decisions are made all the time. Business go under, risks are undertaken and many fail (this, of course, is why the are called risks). But a crucial question to ask is just how could so many bad investments have been made all at the same time? Is it just a mere coincidence that, every 8-10 years or so, millions of businesses across the country all happen to get it wrong simultaneously?

The reality is we experience what is known as the business cycle. The reason (and blame) for this cycle and the recessions it creates lies not with any inherent failings of free-market capitalism, but instead with the Federal Reserve Board's ability to lower interest rates, which sends a false signal throughout the economy.

III. How the Fed Causes the Business Cycle

Interest rates are determined by the supply and demand of loanable funds. In other words, when people are saving more, banks have more deposits, making rates low. When people are borrowing more and saving less, banks don't have as many deposits and rates are higher. So the "price" of a loan is simply determined by the supply of and demand for savings. Makes perfect sense, right? But here's the kicker, and this is key to understand: the Fed is able to step in and manipulate interest rates by printing new money out of thin air and injecting it into banks. This lowers the interest rate (at least in the short term) and induces investment and economic activity that otherwise would not take place.

The Fed did this in the wake of the dot-com bubble burst at the end of the 90's to "soften the blow" from the previous recession. Between 2001 and 2004, the Fed's printing presses were in full gear as Greenspan lowered rates to unprecedented lows. This induced all kinds of economic decisions that would have otherwise never taken place: Home buyers took advantage of ridiculously cheap mortgages. People that usually wouldn't have been able to afford a home used interest-only, no money down financing and bought up new houses like they were going out of style. As home prices skyrocketed, homebuilders ramped up production to fill a seemingly insatiable demand for new inventory. Mortgage companies, banks, brokers, contractors, and anyone involved in the housing sector hired millions of new workers to keep up with the boom. Basically, tons of resources (money, land, people) were allocated toward a sector that looked in, say, 2003 or 2004, to be insanely profitable.

Unfortunately, there comes a point where the Fed realizes it cannot keep these "artificially" low rates down forever: by continuing to print more and more dollars, the economy inevitably begins to experience the worst of all economic evils: inflation. The nature of inflation and its harmful effects are for another post, but suffice it to say that the Fed realizes it cannot go on creating money out of thin air and has to eventually allow rates to rise back up to their natural market level. This is what happened between 2005 and 2007.

IV. Concluding Thoughts, For Now

So you can think of the Fed's lowering of interest rates and the inflationary boom it creates like drinking alcohol or caffeine: the good effects are felt immediately, while the bad effects come later. Like Snuffy on St. Patrick's Day, inflation of the money supply creates a period where no pain is felt and you do lots of things you otherwise wouldn't have in a normal setting. But, as we all know, these good times are short-lived, and a hangover is inevitable. This is where we'll pick up next time. Class is dismissed for now.

Congratulations, Will

Former BMBS contributor Will Fleming got engaged yesterday, which none of us saw coming. In the hope that Will still reads this blog, we wish him the best of luck with his marriage. I guess this means no more trips to the strip club or Video Heat.

Snuffy P. Smith's Guide to St. Patrick's Day Style, Vol. 3: Attire

The jacket seems to be the most controversial of all clothing items related to St. Patrick's Day style. My personal opinion is that a green jacket should be worn. St. Patrick's Day is about celebrating Irish heritage, and what better way to honor the patron saint of Ireland than donning a tacky, kelly green blazer. On the other side of the argument are those who insist on wearing suits because that's what their daddies wore, despite the fact that if green jackets existed back then, they probably would have wore them.

Ladies love the green jacket.

Now, let's talk about pants. If you're wearing a suit, you obviously wear the pants that match the jacket. Another option is a navy blazer, paired with green pants, or green seersuckers. When wearing a green jacket, you have a few options. Navy, gray and black are all acceptable, however, I prefer khaki. In recent years, we have seen the emergence of shamrock "critter" pants. J. Parker carries them in navy (w/ green shamrocks) and green (w/ navy shamrocks). I was always disappointed that that Jimmy never had a khaki pair w/ green shamrocks. Well, Orvis answered my prayers. These badboys will be making their debut March 14th.

Mike Is Our Man...

If you haven't heard, Stephen and I will not be attending the parade in Savannah this year, as our dad was elected Grand Marshall of the Augusta parade. If you were not aware Augusta even had a parade, you aren't alone. Sorry guys, no catchy tunes celebrating the Grand Marshall here. This is the only picture I could find, as the Augusta press seems to be lagging on coverage of the event. I need a drink.

The Papparazzi Are After Us

First, the picture of Mike and I at the Grand Marshal election, and now this.

The UK, the EU, and the end of Christian Europe.

Has anyone heard of this potentially devastating news? On March 5, 2008 Britain's MPs have approved the Treaty of Lisbon, which is a disguised "substitute for the Constitution that failed in 2005 after being defeated by the Dutch and French..." For those of you not up to date on current affairs, a big push is being made by the socialists on Europe to create an autocratic type government to encompass all the Euro nations, more commonly known as the European Union. This European Union would in fact become a nanny state, redistributing resources from one country to the next, all the while suppressing each nations right to bear arms, limit immigration, and (most importantly) to protect it's own borders. The EU was first organized as merely a trade union, like OPEC. But, more recently a different animal has been born. With the rise of Islam in Western Europe (notice how I don't say "Extremist Islam" or "Radical Islam" since the whole of Islam is both extreme and radical) this creation of a politically correct welfare state could result in the end of Europe as we know it.

Also, there is a connection here between the conflict in Serbia over Kosovo's new independence. Kosovo is a region of Serbia, and the birthplace of the Serbian Orthodox Church. After years of conflict, Kosovo became a haven for ethnic Albanians, the majority of whom are Muslim. Kosovo has now declared independence from Serbia... throwing fuel to the fire of that region's historical conflict between the Christian and Mulsim population.

On the face of it, a normal American may say "Hey, good for Kosovo to seek independence. We are all lovers of liberty, let's go Kosovo! Those mean Serbians, just let the Kosovar's have their own country." But, dig a little deeper, and you'll find a more sinister motive to the Kosovar's actions. The independence of Kosovo is backed by 1. European Union and 2. Islamic Terrorists. The EU's interest is to create a model state. When Kosovo declared it's independence, the EU practically handed a pre-written constitution to the usurpers. Not only does this constitution permit same sex marriage, but abortion and welfare are so call "human rights" guaranteed to every citizen. The EU has teamed up with the Albanian Muslim UCK terror group, who have been forceably ruling whole areas of Kosovo for years know, much like the Taliban in Afganistan.

With the EU's actions in recognizing and aiding Kosovo's independence, it legitimizes Islamic terror in mainland Europe. The UCK has even been given a leadership role in Kosovo's new life. The sad end to the story is the Kosovo's independence is also backed by the UK and the US. With the support of the West, a precedent has been set for future rogue radicals to establish dictatorships all over the world.

The media has demonized Serbia for it's past conflicts and genocides. Those past evils were a result of a Hilter-like dictatorship. Serbia has been a democratic country for about a decade now. Don't be fooled by CNN. Support the Serbians, they are our Christian brothers.

Below is a once beautiful Christian church, now in rubbles as a result of an EU backed Islamic nation in Europe.

Snuffy P. Smith's Guide to St. Patrick's Day Style, Vol. 2: Undergarments

Irish-themed undergarments are completely optional. Only flair enthusiasts, like myself, would dare to wear shamrock-laced clothes that nobody else will see...unless they're lucky. (J/K, Jennifer. Only you can see my shamrock boxers.)

Snuffy P. Smith's Guide to St. Patrick's Day Style, Vol. 1: Ties

My personal St. Patrick's Day tie collection.

The tie is what makes or breaks a St. Patrick's Day outfit. And yes, ties are mandatory. The tie is the one universally accepted piece of flair for men. Therefore, your tie should be reflective of your own personality. A St. Patrick's Day tie should obviously have an Irish theme, or at the very least, have some green in it.

When choosing a tie to wear on St. Patrick's Day, you should consider the color of the jacket you will be wearing (jackets are preferred, but not mandatory). When wearing a green jacket, you should avoid a green tie. You want contrast. A navy or gold/yellow tie would work best. Orange is acceptable, as long as you understand that the orange in the Irish tricolor flag represents Protestantism (Ryan). A pink tie is unacceptable, fratastic, and makes you look like a watermelon. When wearing anything other than a green jacket, or no jacket at all, a green tie should be worn.