Whatever Became of Thrift?

January 30, 2006, should have been a day that was seered into our collective consciousness. What happened on that day, you ask? Well, on that day the Commerce Department announced that the savings rate in the U.S. was negative for the year 2005. This marked the first time since 1933 that we had a negative savings rate.

Did our President go on TV and urge the country to return to the fvalues of thrift which our forefathers practiced? Was there a national outcry in the media and in the churches? No, of course not, it passed almost unnoticed.

One of the reasons for this is the idea that spending is a good thing. Monthly figures are put out showing how much consumer spending rose from the previous month. It is always assumed that rising consumer spending is a good thing. Never is this assumption challenged by those who would question whether increased spending is really a positive.

It is important to note that the great majority of this spending consists of purchases on credit. Since the first major credit card was introduced in 1958, it has become a way of life to buy on credit in this country. All purchases are counted equally in the consumer spending figures, whether done with cash or on credit. Buying things becomes almost a patriotic duty.

Of course with the recent collapse of the financial industry, it seems appropriate to take a step back and look at how and why we use credit. The major item credit is used for by the average family is the purchase of a house. But does every family really need to own their own home? It is usually assumed they do, but I submit that the pros and cons are not well thought through by most folks before making this purchase. Owning a home ties you down to a particular location, thereby limiting your job possibilites, and often necessitating long commutes which waste time, use limited fossil fuels, and damage the environment.

There is a myth that home ownership is a good investment for the future. But, as we have seen, what goes up must come down. The housing boom of the '70's gave way to the savings and loan crisis of the '80's, and the boom of the '90's gave way to the current crisis. I recall a piece on "60 Minutes" years ago about the housing boom in California. They reported on how many speculators would buy a property with the idea of selling it in a year or two, and then taking the profit and buying another house, often not even living in the houses themselves. This was fine as long as housing values kept skyrocketing, but, as stated, what goes up must come down.

When I was doing foreclosure work in the '80's, I saw mortgages for as high as 16.5%, and I may even have seen some at 18%. Obviously it makes no sense to pay this kind of interest to buy a house, but this just illustrates how pervasive the notion is that one must own his/her residence.

While having lunch during the '70's with two former co-workers at the Wichita Community Action Program, they tried to tell me that the average length of time people own a house is 18 months! This is ludicrous on the face of it, but they insisted it was a good figure. The only way one could afford the costs of buying and selling this frequently would be if there was a huge increase in home values during that year and a half period. But why anyone would want to move that often is beyond me.

The economic/mathematical illiteracy of the public leads to a lack of awareness of all the costs associated with owning a home. You have interest, maintenance, taxes, insurance, utilities (which are much higher in a single-family residence compared to an apartment), etc. The phrase I have heard used is that if you are renting you "have nothing to show for your money". Well, neither do you have anything to show for all the expenses mentioned above when you own.

The next big item bought on credit would be the family car. Here again, some of the same analysis applies as mentioned with home ownership. There are many costs associated with owning a vehicle, and the car companies often sell you on the concept more than the usefulness of the car. That is, you need a car to attract the opposite sex, you need a car to show how important you are, you need a car to feel the power which you are controlling when you drive, etc.

One sobering statistic I heard in the car CEO's testimony thkis week is that the total number of workers, both direct and indirect from suppliers, is about 3/4 of a million, while the number of workers in car dealerships is about a million. This horribly upside-down situation just illustrates what a sleazy racket this car business is. There are more people trying to sell us a car than there are making them! Actually this might be a slight exaggeration, as some of that million doubtless includes mechanics. But the principle holds, we as a people just are too infatuated with having the biggest, the fastest, the best-looking car to assuage our fragile egos. This is why the car companies build too many big cars and not enough little cars. (In fact, I heard someone say that the Big Three sells more trucks each month than cars! The only months this was not the case were when gas was at $4/gallon.)

My son in Portland uses the "flex" rental system, where you rent a car as needed, even if it is only for an hour or so. Certainly Portland is light years ahead of the rest of the country with ideas like this. It has a great public transportation system, and is bicycle-friendly.

Another common big-ticket item is a boat. The same reasoning applies here. If the cost of owning and storing a boat are realistically considered, I maintain that no rational person would own one. Why not rent a boat for the relatively few times that you actually use it, instead of hauling it around at great expense?

I say there should be a mandatory high school class in personal fnance. How buying decisions are made could be discussed, the importance of having a budget could be studied, how to responsibly use a checking account and credit card could be studied, how interest accumulates when you don't pay the card off each month could be calculated, etc.

And now to the current crisis, caused by poor decisions by consumers coupled with irresponsible lending practices by lenders. I have heard a number of panels of experts testifying on Capitol Hill about various aspects of this crisis. The first which caught my attention was a collection of CEO's of credit rating agencies. I didn't even know what a credit rating agency was, but through listening it became obvious. These are folks who rate finanical entities, or financial packages, much like a real estate appraiser would appraise a house to determine its market value. The opinon of these credit rating agencies is sought by players in the secondary mortgage market.

But what happened was similar to what happened in the '70's with the real estate market, when appraisers would routinely give inflated appraisals because this is what everybody wanted. The buyers wante it so they could get their loan, and the lenders wanted it so they could make the loan. The lenders didn't care if it ever got paid back, because they turn around the next day and sell the loan off to some out-of-state entity, which then assumes the risk of default. As long as the paperwork looked to be in order, the loan orignator got paid and could go on to write another bad loan.

Similarly, what hapened was the credit rating agencies failed to appreciate the toxic" (seemingly the word of the day) nature of some of these securities, i.e., the securities were inadequately secured and thus not worth their face value. In short, the agencies were lazy, plus they were telling the people paying them what those people wanted to hear. Everybody turned a blind eye.

Well, not quite everybody. There was another panel consisting of hedge fund managers. In that testimony it was pointed out that not a penney of bailout money had gone to hedge funds. What is a hedge fund? This was a term I had heard but didn't know anything about. An internet search reveals it is a private investment fund open to a limited range of investors. When asked why they were so much more successful than other finanical entiteiss, the answer came back that they put considerable work into investigating a company before investing in it. Many months of study typically go into any major investment decision. Thus, they stay on top of things and are usually successful. One aspect is that the pay of the manager of the fund is largely performance-based, which avoids the ugly problem we are seeing of ridiculous amounts of money being paid to CEO's of failing companies.

Now this week we have seen the latest round of witnesses, as the CEO's of the 3 car companies came to testify. Along with them on the same panel was the head of the UAW, and an economist. Guess who made the most sense? The CEO's and the union guy all were begging for a $25 billion bailout. But there was no plan, no assurance that they wouldn't be back in 2 months with their hands out again. This is what Congress has asked them to do, go back home and come back in 2 weeks with a plan for how to spend the money.

The economist was very knowledgeable about this industry, and had obviously studied it intensely for a long time. This guy, Peter Morici, advocated letting the carmakers go into bankruptcy. He stressed that Congress was not expert in reorganizing companies; rather, that is the province of the bankruptcy court. That's what a Chapter 11 reorganization is all about, reorganizing to become leaner and more competitive.

The economist stressed that merely giving away 25 billion will solve nothing. There are systemic problems which need to be solved. He kept saying that until Detroit can be competitive with "Honda in Indiana", there is no hope for its revival. He kept mentioning that it costs the Big Three an average of $105,000 for each worker who retires--that is the cost of the severance package. Oklahoma Senator Tom Coburn was on C-SPAN the next morning, and he stressed another similar stat, that the hourly labor cost, considering everything, was $73 an hour for the Big Three, vs. $48 an hour for Toyota. Until the $73 is brought down to Toyota's level, there is no hope of them being competitive. Another thing Morici kept mentioning was "work rules"; apparently the big Three suffers from onerous work rules that Honda in Indiana does not have to deal with. I'm not sure exactly what these work rules are, but they seem to be quite important to the issue of competitiveness.

The union guy mentioned that they have made conscessions, like cutting by 50% the starting pay for new hirees. Big deal! When down-sizing and induced retirement are the norm, there can't be many new hirees in the picture.

One huge burden for the Big Three is the health care costs, which are estimated at $1,200-1,500 per car. If we had a national health care system, like all other devleoped coutnries do, then this would go a long way to making the Big Three competitive again. If Congress wants to provide real help, rather than a temporary band-aid, it should enact a national health care system!

I must say the Republicans are on the correct side of this auto industry bail-out issue. They generally oppose it, while the Democrats are pushing for it. In the long run, giving them money solves nothing. As the work force shrinks, the percentage of their income going to pay the early retirees will go up and up, and until they get out from under this burden, there will be no solution. The union will never agree unilaterally to this, so Chapter 11 seems the only hope.