By Dwight Owen Schweitzer June 17th , 2010
In its most basic terms the relative health of the American economy is measured simply by how fast a dollar changes hands; sounds too easy an explanation to be true but it is. It is all about spending and in our economy much of that spending is with money obtained on credit. In fact, in every period of our economic expansion there was a common denominator; spending, especially consumer spending increased while interest rates remained relatively stable and much of that spending was with money obtained on credit. Whether it be for housing or cars or household appliances, the list is as long as the items one can think of but that dollar needed to keep moving. A buys from B who now has the money to buy from C and so it goes. Conversely if A worries about buying from B and doesn’t, B doesn’t have the money to buy from C so C has no incentive to produce more goods to be sure that B can buy what he wants and in virtually all of those cases that money comes from the ability to borrow most if not all of it.
The best lesson of the power of credit (for good or ill) is the housing boom that was initially driven by banks no longer having to hold the mortgages they offered but were able to sell them to investors replenishing their capital enabling them to make another mortgage loan and so on. It is not a perfect system as we have learned to our regret in recent years when the excessive availability of credit drove up prices requiring higher levels of borrowing until, once again, as has happened often in our economic history, the bubble burst and recession teetered on depression. Stated differently money moved slower and, to attract it prices fell and the economy contracted.
The difference between the present recession and past recessions since the great depression of the 1930s is threefold and highly significant. First it is deeper than those in the past, second it affects consumers more directly because the ‘bust’ was in the housing sector, which acted as a stabilizing effect on the vicissitudes in the rest of the economy and thirdly and most importantly, it has had the effect of removing millions of people from being credit worthy. The seriousness of this cannot be over emphasized because an economy based on credit that has suddenly made millions who were credit worthy before this recession not credit worthy now. They cannot buy homes or cars, or home appliances or any of the myriad of things that need a credit score they no longer have. In effect the buying population of the country has declined due to the methods of credit scoring which are a mystery to the most educated of us and which will likely keep them from the pool of borrowers for a considerable time. That is the real cost of this economic downturn, the removal of consumers who, as confidence improves, could come back into the market place and turn things around but can’t due to the credit score they now carry with them.
What is needed is not the ‘credit repair’ scams that are so prevalent or the good faith efforts of agencies both public and private that offer credit counseling. The entire credit scoring system keeps those whose scores have fallen significantly (and tens of millions have) from ever seeing a return in the absence of strict fiscal discipline which the recession has made a goal out of reach as families try to struggle from day-to-day with late credit card payments and defaulted bills. Ironically, the scores presently necessary to get credit have actually gone higher as the average credit score of the American borrower has declined. Therefore the smaller the number of credit worthy borrowers, the greater they will have to spend to keep that dollar accelerating through the economy while those who cannot help fuel the economy due to lack of access to credit have the opposite effect of draining consumer confidence thereby prolonging the recession.
Nor is there a self-correcting mechanism in the system; that is to say that no one knows what they have to do to become ‘credit worthy’, how long it will take, what things they need to be aware of, or careful not to do, or to do and so on. The plethora of opportunities to buy your credit score from one program or another to ‘monitor’ it offers little help in showing how to improve it other than paying everything on time all the time, keeping your debt to equity ratios in the right balance whatever that is, and living within your now diminished means for some unknown time. Sounds pretty easy until you get to the reality that few people are able to do that especially when the loss of their credit worthiness is not their fault and the years of score decline generally need years of score increase, a goal that will be out of reach for millions of Americans for the foreseeable future if ever. More significantly, the absence of the availability of credit requires such a major change in lifestyle that once access to credit is lost, few have the incentive, let alone the ability to regain it.
What the government needs to do is to get together with the banks and the credit scoring agencies and begin a nationally sponsored credit repair program with some government guarantees to incentivize lending so the government shares a part of the risk of loss but also provides guidelines for lenders and borrowers alike of how to truly rehabilitate themselves. This approach alone will have the effect of adding people to the roles of the credit worthy, albeit slowly but at least the average borrower who was ravaged by this economy not only knows that there is a light at the end of the tunnel but also how to get there. The program I envision would be a plus and minus menu that would have a 3 or 4 year ‘life’ and show people exactly what they need to do month by month to reinstate themselves into the capitalist system and in the process help grow the nations economy.