The Economy - What Happened?

Prelude to Recession

No, this isn't an "I told you so" piece. Nor is it an explanation of how things would be better if I'd been calling the shots. It's just an observation of our current reality, how we got here and what I expect going forward, based on observation, personal experience, data and anectdotal evidence.

In the beginning....there was much liquidity. Home prices were going up every year. This allowed people to tap into extra cash flow by rolling over their mortgage every year or two and cashing out equity. This went on for quite a while, allowing people to safely spend 10k, 20k, 30K or more above and beyond their income. Suddenly, housing prices stopped going up. That extra cash flow went away. Some got behind in their mortgages as they were no longer able to roll them over. Mortgage lenders got more restrictive on lending.

The housing market, already in decline, suddenly saw half the potential buyers disappear as they were no longer able to qualify for mortgages. The mortgage brokers got hit, the realtors got hit, then the home builders, construction workers, suppliers.

Meanwhile, back at the ranch, consumers begin to consume less. First off the shopping list: big ticket items. People held on to their cars longer, their appliances, put off home improvements. With rising home equity no longer available, they turned to credit cards, which soon became overextended as well.

Now we are near the end of the cycle. Credit card deliquencies go up. Bankruptcies skyrocket, retail sales tank. This may sound like a doomsday scenerio, but wait...the good part's coming up.

Some businesses try to compensate for lower revenues by raising prices. This goes over like a lead balloon. Many of them fail. Others recognize that they need to go in the other direction. They find ways to cut costs, increase productivity and offer lower prices. Prices of goods, services and commodities all head downward. This creates new opportunities and sets the stage for a vibrant recovery.

It's the circle of life in a free market. Good times lead to over-indulgence. Over-indulgence leads to recession. Recession leads to recovery and the return of good times. Some remember and learn from the past, but there will always be newbies and declarations of a "new paradigm" in which the old rules don't apply, so many continue to get caught up in the cycle, and it continues. In the process, new ideas are developed, new discoveries are made and generally speaking, life gets better.

The only potential monkey wrench in the system is when government panics and decides to "fix" it. A sure way to prolong and even institutionalize a slow down is to raise taxes, increase regulation and increase government spending. There is plenty of room for improvement in the US business model, but they all involve less regulation, lower taxes and less government "assistance". We need to make it easier for low income individuals to find the way up, not by giving them money, by giving them freedom. People need to be encourage to try and they need to be allowed to fail.

The prescription for the future is more information, less regulation, fewer barriers to entry, more flexibility, less paperwork, more encouragement. Above all, it's important to recognize, going into a rough patch, that this is a normal part of the business cycle. Step one in dealing with it: DON'T PANIC!