Have you considered lately how similar the U.S. economy is to the pesky bedbug?
A bedbug packs a remarkable amount of activity into a sliver of time hatching, molting, biting, mating, laying hundreds of eggs and maybe even hitching a ride in some laundry before dying all within the span of about four months. Four months can feel like a lifetime in economics too. Just look where we were back in July. The financial world seemed ascendant. The stock market was chugging along, and there were champagne toasts as the Dow Jones industrial average eclipsed 14,000 for the first time.
But today that feels like ancient history. The markets are trembling; consumer confidence is crumbling. The Dow has bounced back down to around 13,000, and the dollar has slid to a historic low against the euro. Oil prices, meanwhile, have flirted with $100 a barrel. In short, as Fed Chairman Ben Bernanke confirmed last week, the economy is deader than a 5-month-old bedbug.
So what happened?
Simply put, the immutable laws of risk kicked in and pricked the financial bubble that had been overinflated by years of financial partying. And as is so often the case when parties end, the hangover is painful. We're only beginning to face the serious and potentially long-lasting ramifications of our delusional behavior.
The truth is that much of our recent economic surge was built on a fantasy of unsustainable borrowing. Using various forms of easy credit, countless people bought houses, cars and other big-ticket items they really couldn't afford. As a result, Americans are paying off more than $10 trillion in outstanding home mortgages, up from $6.4 trillion just five years ago, and $920 billion in credit card debt, up from $750 billion.
Corporate America indulged its own frenzied shopping spree. In 2006 and 2007, companies spent a record $3.6 trillion buying different businesses. The binge, fueled by lenders eager to relax their credit terms just to get in on the lucrative acquisition game, peaked in February when a consortium of investors agreed to take over the Texas utility operator TXU Corp. for $45 billion, the biggest buyout in U.S. history.
The problem is that all this borrowing was based on the idea that the historically low interest rates engineered by former Fed Chairman Alan Greenspan could continue in perpetuity. But as our debt piled up, a rate increase was practically inevitable. It's central banking 101.
Interest rates climbed, and financing suddenly wasn't cheap anymore. A middle-class family with an adjustable rate mortgage saw its $1,300 monthly payment balloon to $1,800. A company that planned to buy another business found that the deal would be far more costly than expected.
Then, in August, major international lenders started revealing how many U.S. subprime mortgages they were holding. Subprime is the riskiest edge of the mortgage business because the loans are written to people who previously wouldn't have qualified for the money. Once the markets realized how many bad subprime loans there were, panic set in. A Bear Stearns hedge fund imploded over the summer, and then a few months later, Merrill Lynch and Citigroup fired their CEOs as the companies booked massive losses because of subprime loans.
From where we stand now, a recession is practically a foregone conclusion. If it doesn't happen, we're still likely facing a period of prolonged inflation or worse, moribund stagflation, which is when growth is stagnant but inflation is rising. The only question seems to be how long the tough times will last. And here's where things get tricky. Because the fact is that we could be cleaning up this mess for a while.
It's no secret that foreign interests have been carrying us economically for some time. We're the biggest debtor nation in the world. All told, we owe more than $12.3 trillion to foreigners, up 86 percent from 2003. More than $2 trillion in U.S. Treasury securities are in foreign hands. Since 2006, China alone has purchased at least $350 billion in dollar-based assets.
However, foreigners are starting to diversify their investments away from the dollar and into other currencies. China, especially, is a new target. Last December, China fully opened its banking market to foreign competition, and since then, international lenders have been rushing into this virgin territory with credit cards, mortgages and auto loans to finance a population of more than 1.3 billion.In other words, we may be on our own, a frightening reality in a competitive globalized economy. So fasten your seat belts and get ready for a long, bumpy ride. After all, as every adult bedbug knows, the good times don't last forever.
Eric J. Weiner is the author of "What Goes Up: The Uncensored History of Modern Wall Street as Told by the Bankers, CEOs, and Scoundrels Who Made it Happen."