Editorial for Tuesday – May 31, 2005

• U.S. economy: Pop goes the bubble?

U.S. economy: Pop goes the bubble?

St. Louis Post-Dispatch May 29, 2005

America faces a housing price bubble. Consumer debt is rocketing skyward. The United States is borrowing massively from overseas. If those nasty factors come together in just the wrong way, they’ll whip up our next recession. How’s that for taking the joy out of spring?

Let’s start with consumers. The typical American behaves like a pie-eyed optimist living in perpetual springtime. That optimism helped build a great nation. But it’s also why we Americans save a puny 0.6 percent of our income. The Germans, who learned different lessons from history, save 12.5 percent; the Japanese 6.5 percent.

Confidence in the future, combined with bottomless materialistic cravings, explain why we pile on debt as if hard times never will come again. Over the past 15 years, median household spending has jumped by 30 percent, while household income is up only 11 percent adjusted for inflation, according to a study by Economy.com, as quoted in The Wall Street Journal.

Lots of that debt is on credit cards. The average household credit card debt was $9,205 in 2003, up from $6,618 five years earlier, according to Cardweb.com. But an astounding amount is on home equity loans. Americans borrowed $705 billion in home equity last year, up from $266 billion in 1999. As Jack Naudi of the Post-Dispatch noted on Sunday, mortgage debt now equals 104 percent of personal income, up from 75 percent through the 1990s. In fact, one local lender’s current marketing campaign is called just that: “On the house.”

That gets us to our second big worry: a price bubble in residential real estate. Nationally, average prices for existing homes were up 15 percent in April from a year earlier. After several years of sharp increases, more people are buying houses on speculation that prices will go even higher, rather than as a place to live. One third of all residential property bought last year was purchased for investment or as a second home. Such speculative fever is a symptom of a market bubble. St. Louis is looking somewhat less bubblish; prices here have risen a bit more slowly than the national average.

Alan Greenspan, America’s reality-checker in chief, is taking notice, although he’s not ringing alarm bells. “At a minimum, there’s a little froth in the market,” the Federal Reserve chairman said this month. “We don’t perceive that there is a national bubble, but it’s hard not to see that there are a lot of local bubbles.” More tellingly, the Fed and other bank regulators are tightening the reins on mortgage loans.

This frothy market would go flat quickly if mortgage rates rose, and that gets us to our third concern: America’s profligate buy-now, pay-later approach to the rest of the world. America last year imported $666 billion more than it exported. That gap equals a frightening 5.6 percent of gross domestic product. The $412 billion federal budget deficit adds to the problem.

A family that spends 6 percent more than it earns year after year is headed for trouble. The economy of nations works somewhat differently, but the final destination for a country on a debt-financed consumption binge is the same: trouble.

Those twin deficits are financed largely by borrowing from overseas. Foreigners have been glad to lend. Nations like Japan and China busily buy up Treasury debt in an effort to keep their own currencies cheap relative to the U.S. dollar.

Foreign appetite for long-term American debt goes a long way toward explaining why mortgage rates haven’t changed much in the past year, while the Fed has pushed short-term rates higher.

But America can’t keep borrowing forever. Sooner or later, foreigners must reduce their lending. America already is pressing China to raise the exchange rate for its currency, which might lessen China’s need to hold U.S. Treasury debt.

That gets us to our recipe for the twister of doom. If our foreign creditors suddenly should become stingier, America would face rising long-term interest rates, seriously slowing the economy. The housing price bubble would burst with a loud pop, creating deep trouble for speculators and possibly parts of the lending industry. Home-equity lending would shrivel up.