In: Root » » Loans and mortgages
The subprime financial shock hit in summer 2007 and by early 2008 the U.S. economy had come unhinged. Economists and policymakers debated whether the nation was in recession, but for the majority of Americans, there was no debate. They were worth measurably less and their incomes didn't stretch nearly as far.1 For them this was a recession. As summer 2008 approached, Americans' anxiety regarding the economy and their own financial affairs was as high as it had been in more than a quarter century. Surveys of consumer sentiment concurred that the collective psyche had not been so fragile since the early 1980s, when inflation and unemployment were both in double digits.2 Though both were still relatively low, it was telling that people felt as bad as they had in that earlier dark period. Little was going right: There were fewer jobs available, and parttime work was replacing full-time. The stock market was down and, for the first time in a while having trouble getting back up. Gasoline prices were rocketing past $4 per gallon. The cost of bread, milk, and other staples was rising quickly as well. Millions were losing their homes to foreclosure; and house prices were in free fall. American consumers, whose collective spending might had powered the global economy since World War II, had no choice but to tighten their belts. For the economy to be pushed into recession by scared consumers was unprecedented. Historically, recessions had been caused by businesses that had overextended in the good times and had to pull back when things didn't go as planned. An event such as 9/11 or the Gulf War could trigger a recession, as they had in 2001 and 1990. Disruptions in oil supplies did the trick in 1973 and 1980. Those downturns began when firms had been forced to lay off workers and cut investment. But that wasn't the cause in 2007 and 2008. First, homeowners stopped paying their mortgage bills and other debts; then they stopped spending altogether. Economists had long counted on the American consumer to power the economy's growth; to never, as they put it, underestimate the hedonism of the American consumer. That old adage no longer appeared to hold true. Yet the subprime financial shock's significance goes beyond the recession it started. The shock was, in fact, an inflection point in the nation's economic history. Before it hit, most households saved little, and many borrowed aggressively and spent beyond their incomes. Between 1980 and 2005, the personal saving rate the percent of aftertax income that is not spent fell steadily from 10% to essentially nothing. The decline was due in part to wealthier households saving less. Affluent Americans had built up their nest eggs during years of strong stock and real-estate gains. The 1987 stock market crash, the tech-stock bust, and the housing crash had been only temporary setbacks.3 Millions of families didn't have to worry about paying for the children's college education or their retirement, they were set. Why save? Saving also declined as the borrowing power of poorer households increased. Steadily falling interest rates since the early 1980s and financial innovation had made credit available to households that had not previously had access to credit cards, car loans, or mortgages. By going from a 3-year to a 5-year car loan or taking on a 2/28 subprime mortgage, these households could add debt without seeing their monthly payments rise, at least for awhile. Borrowing allowed them to maintain a level of spending despite having tenuous jobs and volatile incomes. The subprime shock signaled an end to all this. No longer would wealthier families be able to count on outsized gains in the stock or real-estate markets to do their saving for them. No longer could poorer households easily get another loan when the cash from the previous one ran out. The subprime shock marked the denouement of a half century of global economic history driven by the American consumer.
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