The business cycle can also be expressed in an emotional format. The Khan Academy came up with the diagram below:
When we believe things are looking up economically, we get a sense of optimism which gives us confidence everything will be all right. That turns into excitement when things keep going well. Gas prices drop, we hear that there is less unemployment, and other factors. That turns our excitement into thrill and that increases our confidence. We start looking what our contribution may have been to this movement, or how we can contribute. Now we can buy that dining room set we always wanted, or maybe even that car as advertised on TV! Our thrill turns into euphoria. Companies start investing capital in more tools and machines to expand production. Then we see prices rising, first because production cannot keep with demand, followed by an overheated economy. The Fed already has reduced interest rates to almost 0% and now is redirecting it upwards again to take the steam out of the economy. People are laid off here and there, causing some anxiety among the rest of us. It becomes clear that we have an overproduction and people are getting into more debt. Industry and governments are still in denial if we have to believe the fervent advertisements: “Now is the time to buy your dream house before interest rates go up again!” is the slogan. “Don’t worry if your mortgage payments are a bit high, your home value will only go up, so you’ll be ok.” But more people are losing their job and gas prices are creeping up. The population is getting fearful. People are pulling back and delaying that couch set purchase. Production is decreasing a bit more with all the consequences that come with it. People who lost their job can barely keep up with their mortgage payments and are becoming desperate. Banks are starting to issue notices for those who are 2-3 months behind in their mortgage payments. All of a sudden housing values are not so important anymore because no one can afford to “upgrade.” The richer among us also stop paying mortgages, because those prices “were ridiculous to begin with”. The banks don’t dare evacuate them for fear of property being destroyed or stolen so they can stay in their “castle” even if they do not pay the mortgage for 6-8 months, or longer! Panic sets in, interest rates drop to zero % and housing prices start to drop. More foreclosures. Some capitulate, just leave their home and drop off the key at their bank. Despondency sets in and the homeless are becoming more visible. The editorial pages have more articles about depression. The Fed buys up mortgages to keep the economy going, banks get all kinds of relief. No matter that the banks contributed to this mess in the first place by offering mortgages to just anyone at the peak of the cycle, they are not held responsible; no CEO’s are fired!
Gradually we see a glimmer of hope. Companies have cut back enough to survive the recession, Wall Street is showing some growth again and international markets are following. We may not like it, but China’s economy is surging because they don’t want to lose the dollar value, since they have a lot of them. They can now invest them in California properties 🙂 Relief sets in followed by optimism, and the cycle starts all over again.
Realtors are telling us the housing market is “booming” again. The graph on the left of new housing construction does not seem to support that. Ever since coming to the USA in 1967, realtors always say: “Now is the best time to buy!”
What emotional stage do you believe we are in, at the end of 2014?
“In my day if we earned a quarter, we spent 15 cents and saved a dime. Your generation earns a quarter, spends the quarter and then borrows another quarter at 25% interest!”
I really identified with that saying by Jeanette Pavini in Market Watch. Wondering why it spoke to me so profoundly, I drilled deeper and came to the following conclusions:
- The thought processes are totally different between generations. When I was a kid, the concept still existed, that you can spend only what you have and no more. I would receive an allowance each week, but only after I showed the balance, and how the difference with last week was spent. It was not a matter of “checking up on me” as to how I spent my money and whether is was done wisely. My dad never evaluated the wisdom of my decisions, only the record keeping: that my physical amount of money matched my records. To give an example: A 10-year-old’s version of “living within one’s means” might include financial decisions like choosing whether to buy a new video game or saving their money so they can eat at the concession stand with their friends at the next field trip.
- Today’s generation is taught that you can have it all now. To sweeten the deal, the idea is that you pay-for-it-as-you-go, enjoying both your new video-game and a good time with your friends. This concept is permeated throughout our society: with lower interest rates you refinance your house, as your family grows you purchase your next bigger house, when you get a loan the payment plan conveniently shows the “minimum payment” (because the longer you draw out the payment the more interest your friendly banker makes!). Immediate gratification comes with a price, but “oh well, the house price will go up anyway, right?”
“Our financial habits rub off on our children and influence their relationship with money later in life. But what may be surprising is just how young children start to form financial habits. Adult money habits are set by the age of seven, according to a study by behavior experts at Cambridge University and published by Money Saving Advice.
Many children are growing up in debt-ridden households. As of September 2014, the average household owed $7,281 on their credit cards, according to NerdWallet.com’s analysis of Federal Reserve statistics. Looking at just indebted households, that number rises to $15,607 in average credit card debt per household. That’s a collective $880.5 billion in credit card debt that American consumers owe.” (from an article by: Jeanette Pavini’s Buyer Beware, in Market Watch).
Do you know the meaning of these terms? They have been common in US newspapers, but I believe very few people know what they mean, including myself 😦
Egbert Kalse and Daan van Lent have written a book called Bankroet, which means bankrupt in Dutch. It is fascinating to read the perspective of outsiders. They wrote the book, starting with the Great Depression in the ’30s and following the course of events, mainly with real estate in mind. The book emphasizes the US economy for the most part, because that is where the above terms and consequences came from. But they also use European examples on how it affected there and the whole world.
From the early ’70’s, the Savings and Loans industry was looking for new mortgage markets for less credit-worthy people. Out of that came the “sub-prime” mortgages. Sub-prime does not mean “less than perfect”, or any other idealistic form. Sub-prime mortgages are issued to people with a lesser credit-worthiness. Often people already have so much debt, that they cannot afford a mortgage on top of that. In the USA (credit-worthiness) points are called “credit scores” or “fico-scores”, varying from 300-850. Potential home owners with a reasonable score of 620 or higher qualified as “Alternative-A” clients; in short: Alt-A. Under that qualification mortgagee’s did not have to prove anymore they had a reliable income source. It also became known as a “liars-mortgage”. Sub-prime mortgages were issued to people with a credit-score between 500-620 points. Below 500 points, in principle, no mortgages were issued.
When we returned from the Czech Republic in 2009, we were in the market for a house. We had been out of the country for seven years, and had to “re-learn” what it was like to buy a home in California. What a shock! “Short sale”? What was that? Never heard of it before. A house in foreclosure? We had heard of it, but so many? … almost every house that was on the market? You had to bid on a “short sale”, and do that four or five times. Then the bank would notify you if you qualified and for which one, … after 3 months?… or more? And you want a mortgage? Good luck.