We're Repeating the Mistakes That Created the Recession (Great News!)
Next year's economic growth will be strong -- and the drivers will be the same things that crashed the economy four years ago: housing and debt
Financial crises are sometimes lazily compared to hangovers. But the cliché is more useful than you'd think. When things get rough, sometimes you need a little of the excess that got you into trouble in the first place -- what alcoholics call "hair of the dog." Today the economy seems to be sampling the greatest hits of the Bubble: more debt, a resurgent housing market, risky bets on Wall Street, and households borrowing to their max. Those might sound frighteningly familiar, but they could also drive economic growth to better levels than we've seen in recent years.
Everything starts with housing, the largest and most important asset on the balance sheet of most households, and in recent months we've seen upticks in both housing starts and home prices, with the Case-Shiller home price index now showing year-over-year gains.
Because of some combination of having already reduced debt levels, more confidence in house prices, and more confidence in the job market, households are no longer paying down debt. In two of the last three quarters households have added more debt than they've paid down, and if the pattern repeats in the third quarter it will be the first time in four years that households have shown a year-over-year increase in debt outstanding.
Belt-tightening is coming to an end in the public sector as well. State and local governments cut nearly 700,000 jobs since their peak in 2008, but they've added workers in three consecutive months, and a fourth would mark the first year-over-year increase in state and local government workers since 2009.
(Year-over-year change in state and local government workers)
Next year, with housing starts and home prices on the rise, households borrowing money again, state and local governments adding workers instead of cutting them, and the uncertainty of the election and the fiscal cliff behind us, corporations are going to take advantage of record-low interest rates to invest in their businesses, buy other assets, and, in the case of private equity companies, pay themselves dividends.
Should we be worried, and are we just repeating the mistakes of the last cycle? Not yet. As Larry Summers has argued, the irony of financial crises is that they're caused by too much confidence, borrowing, and spending, but they're only resolved by re-surging confidence, borrowing, and spending.
Fixed investment, especially residential fixed investment, remains well below normal levels. Unemployment remains high. Inflation is low. Credit markets may be frothy, but compared to a year like 2006 where households added over $1 trillion in debt, private sector debt growth remains subdued.
Part of the reason is it's still very hard for households to get financing to buy houses. In August, at Fannie Mae and Freddie Mac the average credit score of borrowers purchasing a home was 763. It's a far cry from the bubble days when all one had to do to get a loan was fog a mirror.
And for better or worse, the Federal Reserve has told us that interest rates will remain low for several more years. As we saw during the last crisis, it's not the borrowing that gets people in trouble, it's servicing debt loads after interest rates have gone up.
We may be brewing trouble for 2015 or 2016, but for now, in the words of one former chief executive of Citigroup, it's time to dance.
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