By David Post

This recession is very different. It is complicated, difficult to understand, has no foreseeable solution and is going to be a slow slog.
Theoretically, the recession is over, but with unemployment hovering around 9 percent and housing values continuing to decline, it doesn’t feel like it’s over.
Historically, recessions were driven by inventories. Manufacturers produced products and sold them to retailers who sold to consumers. Innovation and new products also entered the market. Because of the lag between innovation, manufacturing and consumption, inventories would gradually build up.
Manufacturers would then lay off (not fire) employees who had less income and consumed less, pushing retail sales, and jobs, down. As unemployment rose, consumers spent less, and, poof, a recession.
Eventually, retail inventories got low enough to need replenishment. With new orders, manufacturers called workers back, and the system self-corrected. After most recessions, the economy enjoyed a “sling-shot” effect, that is, higher than normal growth because rehired workers with money in their pockets bought what they couldn’t during their unemployment.
During these corrections, some companies would go out of business which, as all consumers know, means lower prices. But consumer savings mean losses to creditors. Imagine a company with $1,200 of assets (inventory and buildings) and $1,000 of debt. If that company can’t pay its bills and sells its assets sell for half, or $600. The creditors get that $600, but they lose $400.
But this recession was not caused by cyclical inventory fluctuations. It is rooted in banking problems.
Banks are different than most businesses. Bank debts are customer deposits. When you put money in a bank, you make a loan to that bank. That money is loaned to someone else and that loan becomes the bank’s asset.
Because the law requires banks to be “safe and sound,” the government takes over a bank that lacks the money to repay the depositor, that is, your bank account.
If a bank has $1,200 of loans and $1,000 of deposits, it looks like it has equity of $200. But if those loans go bad and collect only $600, the creditors, or your bank account, does not bear that loss. The government makes sure you still get your money. That’s called a “bailout,” one of those poisonous political words.
When a manufacturer goes bankrupt, the market quickly figures its property’s worth and how much creditors will get, but a bank’s assets — its loans — are very difficult to value since their value depends on the financial health of the borrower. It’s a big ball of tangled string.
Suppose you buy a house that costs $120,000 with a $20,000 downpayment and a $100,000 loan from the bank. The bank lends you the $100,000 you need, but then sells your loan to an investment bank and gets that $100,000 back. Now it can make another loan.
Otherwise, your bank would need to wait until it received new deposits to make another loan. If that happened, few people would own houses. Banks earn fees both making loans and selling them. Investment banks combine your loan with thousands of others into a big pool called a bond, and sell pieces of that bond to investors around the world.
Beginning in 2000, bank lending standards were relaxed so that almost anyone could get a loan with no downpayment and no income to repay it. (Why? That’s more complicated and beyond the scope of this column.) That happened millions of times until 2007, when the market realized many borrowers were not repaying their loans. Banks began foreclosing and that drove down the value of those houses. And yours. And the value of the bank.
In the past four years, banks have foreclosed approximately 2 million homes but have put only about 25 percent of those on the market for sale. Today, one-third of homeowners owe more than their houses are worth. The banks know that if they dump more than a million homes on the market, the values of those houses — and yours — will drop further. And it might push the banks themselves into bankruptcy.
For example, Bank of America reports equity of $230 billion on its books, but investors think the bank is worth only $110 billion. In other words, investors believe the nation’s largest bank has $120 billion in additional potential bad loans.
Banks are reluctant to foreclose since a decline in the value of their loans — their assets — could push them into bankruptcy. The government is reluctant to close banks because that would drive values down further and require the government to take over the banks. Buyers are afraid that the house they buy today will be worth less tomorrow.
Efforts at a recovery are complicated by other economic forces. The nation’s manufacturing base is smaller, so new production plays a smaller role in the economy. Approximately 70 percent of all economic activity depends on consumer buying, but for the past three years consumers have been saving more, paying down credit cards and spending less. If consumers spend less, businesses sell less, need fewer employees, and the unemployment rate remains high.
This recession is very complex and difficult to understand. It’s even more difficult to fix. And, it’s going to take a long time, despite the political rhetoric and blame game.
• • •
David Post lives in Salisbury and is one of the owners of MedExpress Pharmacy and Salisbury Pharmacy.