The Price of Recovery

On Wed, 25 Feb 2009 05:34:26 -0800, "klunk" <...@theothershoo.org

The Price of Recovery
by Robert Hormats
February 24, 2009 | 4:42pm

http://www.thedailybeast.com/blogs-and-stories/2009-02-24/the-price-of-recovery /

Changing economic policies isn't enough, says Goldman Sachs executive Robert
D. Hormats-we also have readjust core American values. The government needs
to stop borrowing, start saving, and beef up socioeconomic programs.

In a widely reported address to the Commonwealth Club in San Francisco in
1932, New York's Governor Franklin D. Roosevelt, campaigning for the
presidency in the midst of the Great Depression, asserted that the crisis
"calls for a re-appraisal of values." Over 70 years later, the same can be
said of our current crisis. Changing economic policies without changing
values will only lead us back to the same problems we are confronting now.
Indeed, policies rest on a foundation of social and economic values, and so
if the latter do not change, neither will the policies over any sustainable
period of time. But frequently the crisis itself is a "value changer" and
this one promises to be just that. One thing is virtually certain: the
economy that emerges from this crisis will not be, because it cannot be, the
same economy we went in with.

There are encouraging signs here, too. The recently passed stimulus
legislation contains billions of dollars for physical infrastructure: from
roads to bridges to dams, and an extensive program for better utilizing
information technology.

Of all the changes underway, the most obvious is that, for the moment at
least, Americans are reassessing the value of saving versus borrowing. In
recent years too many of us appear to have forgotten how to save-or why we
need to. We have become a short cut society as far as money is concerned. If
the government wants to finance a program or fight a war (as vividly
illustrated by the case of Iraq), it takes the easy way out: borrowing
money, rather than explain to Americans why they should pay higher taxes to
finance it.

Large numbers of Americans who want to buy a car or a house have fallen into
a pattern of borrowing as much of the price as possible-even, in some cases,
if we cannot afford the terms-rather than saving to buy them. (That was not
the case with out fathers and grandfathers.) Remember all the ads on TV a
couple of years ago telling us how we could get whatever we wanted,
particularly mortgages, with "no many down" and "easy credit"? Our financial
system was geared toward selling such loans and otherwise engaging in highly
leveraged transactions. (What this industry needs to do to change merits
much more space than I have here, but suffice it to say significant lessons
can and should be learned-and many already have been-that will lead to
important improvements.)

There is a pervasive myth that Americans are not good savers. But throughout
much of the early (and mid-) post-war period, savings as a portion of
disposable income hovered around 8 percent; they were well over 10 percent
as late as the early 1980s. In recent times, however, the figure has
averaged a paltry one percent-and occasionally has dipped below zero. Not
only did people spend all the money they earned, but they also dipped into
savings or increased borrowing to finance purchases. And many financial
transactions were based on a high degree of debt issuance. Taken as a whole,
the private sector (households and businesses combined) ran a financial
deficit of nearly three percent of GDP last year. At roughly 300 percent of
GDP, private sector debt is nearly double the once-staggering 160 percent of
GDP it reached on the eve of the Great Depression (as the result of the
excessive borrowing spree of the "Roaring 20s").

Low or negative household savings removes the cushion families need to get
through a sharp economic downturn or cope with emergencies. It ultimately
will cause enormous pain to retirees who have small or no nest eggs. In
Japan's decade-long recession the pain for most families was mitigated to a
considerable degree because the average savings rate was 20 percent.

The practice of borrowing against the value of one's house was especially
dangerous for the economy and for many American families. Between mid-2005
and mid-2006, Americans withdrew nearly one trillion dollars in mortgage
equity from their houses, much of it through home equity loans or mortgage
refinancing. About half of the withdrawal went into added savings or paying
down other debts. But the other half went into spending of various kinds,
helping to fuel a surge in consumption, which rose from an average of around
88 percent of disposable income to over 96 percent. Withdrawal of mortgage
equity left many people with much larger debts and greater exposure to drops
in home values than in past downturns. Even during the Great Depression the
exposure was not as great because large mortgages based on small down
payment to those with poor credit were uncommon.

And the government hardly set a good example. Washington has generated large
deficits before, but these were generally during major wars (namely, WWI and
WWII) or during deep recessions and depressions. In any case, the pattern
was to reduce the deficit and pay down the debt when the emergency was over.
But in middle part of this decade, during years of relative prosperity and a
booming market, the deficit remained high. Federal debt largely rose due to
big tax cuts, unchecked domestic spending, and war costs. They eroded a
budget surplus inherited from the Clinton administration. Thus, on the eve
of this financial crisis the government was burdened with a sizable budget
deficit and a considerably larger debt than in 2001, giving it less fiscal
flexibility to respond.

For many individuals, this crisis has underscored the importance of saving
more and borrowing less. For the country as a whole, it has underscored the
point that economic growth and prosperity based on consumption, and
government services financed heavily by debt, are not sustainable. Private
savings are now rising sharply and Americans are bringing debt down to more
manageable levels. Financial markets are doing the same thing. This will put
individuals ,companies and financial institutions on a more solid financial
footing. (Of course, the drop in consumption also slows economic activity,
forcing the government to become the spender of last resort.) Over time a
better balance must be found in which the private sector generates a savings
surplus and the economy does not have to rely on a borrowing spree for
growth.

And the federal government can use this experience to recognize why, after
this crisis, it should return to a practice of fiscal discipline, lost for
most of the last fifty years. Like average Americans, the government can't
borrow its way out of problems indefinitely. It now needs to a public
consensus, and the political will in Washington, required to put Social
Security, Medicare and Medicaid on a sound financial footing-to avoid their
having to engage in unsustainable levels of borrowing (amounting to
multitrillions of dollars) in coming decades. Otherwise, we will be in an
even worse financial crisis a generation from now.

To sustain robust growth not based on excessive debt creation, we need to do
things the old fashion way, and focus on the fundamentals. And those
fundamentals must include constantly upgrading our capabilities in science
and technology, making far more productive use of our formidable human
resources, funding more research in health care, modernizing our
deteriorating public infrastructure, and building a clean energy economy for
the twenty-first century.

There are encouraging signs here too. The recently passed stimulus
legislation contains billions of dollars for physical infrastructure: from
roads to bridges to dams, and an extensive program for better utilizing
information technology to digitize medical records, which will save
countless lives and enormous sums of money. Both are vital steps that
require sustained follow-up. If health care is the greatest single human
challenge for our twenty-first century society, and the value of expaanding
access to it increases in our country, harnessing modern science and
technology is critical. Breakthroughs in genomics, regenerative medicine, as
well as personalized drugs and therapies are all within our reach. None of
these initiatives need to be put on hold during the recession-as President
Obama has frequently emphasized. In fact, more effort is is needed in these
areas to ensure a healthier and more productive society now and when
recovery resumes.

Stimulus funds for increasing the supply of clean energy, a top item in our
emerging set of national values, also represent an important step toward the
kind of economy we want after this recession, especially when combined with
other government programs already underway and ongoing work in the private
sector. The transformation requires sustained effort: one that cannot lapse
just because energy prices have collapsed. If the recession is permitted to
derail the drive toward clean energy and improved consumption
efficiency-which were beginning to get a full head of steam when oil prices
were $140 per barrel-then our national energy policy can be counted as one
more casualty of this crisis. It is worth noting that even during the Great
Depression technology moved forward-one vivid example being the television.
It is also worth bearing in mind that if progress is not made in this area,
huge amounts of funds that could otherwise go toward investment and job
creation in the US will go abroad and we will have to borrow it back.

Finally, funding for education in the stimulus legislation, chiefly to
modernize schools and ease the ability of families to send their kids to
college, is essential to the kind of society and economy and we need to see
after the recession ends and to getting out of the recession as well. In
reassessing values, the value of education needs to be elevated at all
levels. But lots more money and, more importantly, innovation, will ne
needed. The knowledge-driven jobs of this new century will require men and
women who possess sophisticated technical skills. And these cannot be just
university graduates. The widening gap between the wealthiest Americans and
those in lower income groups has largely come from a difference in education
and skill levels. And this addresses another value that needs to be
reassessed-the importance of narrowing the income gap in this country.
Focusing more attention and resources on broadening access to quality
education (especially for minorities and immigrants) is an investment not
only in national growth and job creation, but also in a less bifurcated
socioeconomic structure and improving opportunities for a greater number of
Americans to succeed and be productive participants in our economy .The
single most important piece of economic legislation in the post-war period
was not a stimulus bill but the GI Bill-because it invested in our own
talent. It helped to prevent a decline in the U.S. economy after the surge
of wartime spending ended and gave an enormous boost to the productivity for
decades. That is the best lesson for today.

Bob Hormat is vice chairman of Goldman Sachs (international). His
publications include The Price of Liberty: Paying for America's Wars from
the Revolution to the War on Terror; Abraham Lincoln and the Global Economy;
American Albatross: The Foreign Debt Dilemma; and Reforming the
International Monetary System.