Washington DC, February 10, 2009 --  

The downturn has given America a chance to steer its economy in a more promising direction. Short-term thinking and grandstanding politicians are squandering this opportunity.

Pain. It's one of the most successful inventions in evolution, and a powerful part of the body's defense system. People in pain instinctively and immediately avoid its source, and through its strong influence on memory, quickly learn to avoid similar situations in the future.

So it is with economic pain. One of the silver linings of an economic downturn is the power it has to set things straight. When excessive behavior from boom times causes a painful collapse, the blessing of the recession is that it forces change and makes people learn from their mistakes.

Foreclosure teaches people not to buy a big house they can't afford. Job or income losses force people to re-evaluate their spending. Of those who keep their jobs, many boost savings in case times get worse. Those who lose their jobs are often forced to acquire new skills or seek new jobs in sectors that are more valued by the economy. In the long run, America's economy becomes stronger than ever before.

Such an economic re-evaluation is sorely needed in America. Consider the following persistent problems that are long overdue for a correction:

• Housing Bubble - While American home prices have dropped by 25 percent since the peak of the bubble in 2006, prices will have to fall another 35 percent to reach the levels before the bubble began in 2000.¹ Even an optimistic assumption that values will stabilize at a 5 percent rate of historic appreciation² suggests that the market is still 10 percent overvalued.³ Prices therefore need to keep going down to reach a healthy level.
• Current Accounts Deficit - While Americans were riding high on the housing bubble, consumers used home equity loans to retire credit card debt and finance new spending. This fueled imports and, as a result, the trade deficit. The 2008 current account deficit was $614 billion according to the International Monetary Fund.⁴ This drain on American wealth cannot continue forever. While it's too early to confirm that the recession has reduced this drain, Bureau of Economic Analysis statistics showing reduced personal spending strongly suggests that the deficit will be lower this year.
• Nonexistent Savings Rate - America's personal savings rate has hovered around zero for years, and actually went negative for the only time since the Great Depression during the peak of the housing boom. Spending more than your earnings in good times is unbelievably irresponsible. But now that times have turned bad, there is some evidence that Americans are starting to change their profligate ways. The personal savings rate ticked up for the last three months of the year to 3.6 percent in December.⁵
• Credit Overextension - Total consumer debt was a crazy $2.5 trillion in December⁶ -- over $8,000 for every man, woman and child in the America. These numbers may have reached a turning point. In each of the last three months of 2008, after the financial crisis hit full tilt, consumer credit declined slightly for the first time in years.

In each case mentioned above, there is some evidence that Americans are actually setting a better course. This is a testament to the incredible power of pain to change behavior. The recession has provided a fantastic opportunity for Americans to set these problems straight.

Trouble is, pain is unpopular. And populist politicians just can't keep their hands out of the mix. Intervention in the form of the enormous $800 billion stimulus package threatens to destroy every single beneficial aspect of the economic downturn in order to lessen Americans' short-term pain.

Consider the Senate version of the stimulus package, which grants a $15,000 tax credit for home buyers as a means of propping up the housing market.⁷ If enacted, this measure would artificially re-inflate housing prices above their still-frothy levels. Why on earth would bringing back the housing bubble be a good idea?

Then there's the main goal of the stimulus package -- to encourage consumer spending to boost the economy. This, also, is a terrible, terrible idea. Irresponsible consumer spending -- driven by temporarily skyrocketing home prices -- is what got America into this mess in the first place. If Americans hadn't spent all the money from their home equity loans and real estate investment returns -- if they'd simply saved it -- then the economy wouldn't be in trouble.

Now that Americans are slowly starting to change their ways -- saving money again, reducing their credit card debt, and bringing down the trade deficit by buying fewer imports, what happens? Along comes the federal government to nip this responsible behavior in the bud.

Tragically, politicians are utterly incapable of letting the recession run its course. "People are hurting," says Sen. Kay Hagan (D-NC), in justifying the stimulus package.⁸ Yes, the American people are hurting -- and with good reason. By seeking to numb the pain, politicians will enable Americans to ignore the underlying causes, and resume their irresponsible ways. America's long-term economy will suffer greatly as a result.

Stagnation's New Decade, September 16, 2008

Yawning Toward Disaster, September 2, 2008

Aggravating the Hangover, August 5, 2008

House of Cards
The Collapse of Credit-Driven Spending, November 27, 2007

Notes:

1. Standard and Poor's, S&P/Case-Shiller Composite-20 Home Price Index, January 27, 2008 (January 2000: 100, June 2006: 206, November 2008: 154)

2. Office of Federal Housing Enterprise Oversight, House Price Index Second Quarter 2002, September 3, 2002 (1980-2002 housing price increase: 177.70 percent -- 4.8 percent annual appreciation)

3. Sandard and Poor's Ibid, Office of Federal Housing Enterprise Oversight, Ibid. (Case-Shiller Composite-10 index of 80 in 1997 would have risen to 140 in 2009 at a 4.8 percent rate of annual appreciation (note 2), meaning values would have to fall from the current level of 154 on the 20 city index to 140 - a decline of 10 percent.)

4. International Monetary Fund, World Economic Outlook Database, April 2008

5. Bureau of Economic Analysis, Personal Income and Outlays, February 6, 2009

6. Federal Reserve Board, Consumer Credit G.19 Release, February 6, 2009

7. Washinton Post, Not So Much of a Stimulus for Some DC Home Buyers, February 10, 2009

8. WNCT, Stimulus Plan Passes Senate, February 10, 2009