The Personal Financial Crisis

It’s a recession when your neighbor loses his job, the saying goes, and it’s a depression when you lose yours. Over the last several years, as the global economic recession has wreaked havoc upon the traditional understanding of financial stability for many people, a lot of things have come into question. Who is to blame? What can be done to prevent this from occurring again?

Many solutions have been proposed, some of which have been effective, at least in the near-term, like the IMF bailout to Greece. Some have been controversial, like stricter US Immigration laws designed to play off the fear of citizens losing jobs to immigrants.

But none have attempted to cut to the heart of the problem: what I call the Personal Financial Crisis. It refers not to the results now, as expressed in foreclosures and personal debt levels. Rather, the Personal Financial Crisis took place during the late 1990s, as people across the world began to step up their spending, and begin to rely on credit in a way that would not have been considered before.

It was 1992 when the US Congress required Fannie and Freddie to ramp up their participation in mortgages for low and middle-income borrowers, the infamous sub-prime market. But what followed extended greatly beyond mortgages, or beyond the Federal Government.

People started spending. It’s impossible to trace exactly where the breaking point occurred, as the rise in consumer spending, at least in the US, began in the 1970s. By 2000, however, consumer spending had reached 67.8 percent of GDP.

For each year of the 1990s, consumer spending grew an average of 3.4 per cent each year, which was ahead of the growth of GDP, at 3.2 per cent. This was where the problem began to occur. The broader economic situation ran parallel to what was happening in many consumers’ homes. As people began to spend more than the economy was growing, so too did they begin spending more than they were making.

It was a perfect storm. Personal debt became easer to attain as credit became easier to get, and the attitude of the consumer had shifted towards a spending mentality, bolstered by a solid economy and, frankly, the spending patterns of their neighbors. And it was this event that led nations down the path to financial disaster first and foremost, before any investment bank, or before any hedge fund.

So what can be done to correct this problem? There are several things that could be done. One is already occurring: a Depression-era mentality among consumers, where saving money becomes the prescient and intelligent thing to do, and spending is seen as frivolous and wasteful. However, I believe the effects of this change in behavior will be limited to the duration of the recession.

The Great Depression was a long-lasting period of economic upheaval, which we will likely not experience again, as most signs point to a nearing recovery. The late 1980s were unpleasant for many parts of the world, and a mere 10 years later we had the Dot-Com boom. People have short memories, and without a cataclysmic event such as the Great Depression, there is little to get people to change their ways.

Unbiased financial guidance might help. If consumers could get more broadly educated about the implications of their financial decisions, then perhaps they would spend less. This, also, is unlikely to be successful.

I serve on the board of a financial education firm that tried to advertise unbiased adult financial education. Out of 5,000 leads, with excellent sales staff, only one person expressed any interest. The fact is that personal finance is simply too much an issue of shame for most people to allow themselves to admit they need education.

But I am getting ahead of myself. Running even deeper is yet another question: is such a change even desirable?

Even if the problem of the Personal Financial Crisis is solved, the question remains if it will do anything for the broader economic recovery. In fact, this forms the crux of debate between the United States and the European Union: stimulus vs. austerity. Neither one is ideal, of course, and the ‘correct’ approach would be a controlled and budgeted spending plan.

And therein lies the problem. The economy surged ahead based on out-of-control spending, and it now needs to feed of at least partially out-of-control spending in order to avoid collapse. So for the conceivable future, it is our best hope that consumers, in the U.S. and abroad, continue to spend in as controlled an out-of-control fashion as possible.

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