Can America Be Fixed?

I gave a speech last week and was asked what we need to do to fix/remedy the devolution of not only our economy but our societal standards as well. I shared my answer with two of our senior partners and have included their responses.

I said three things are necessary: pain – we are insistent on a pleasure only principal. We have convinced our political leaders that it is their role to deliver no pain and all pleasure and to endorse our view that painless pleasure is our birthright as Americans. We have long ago stopped asking what we can do for our country. Economically periods of expansion normally cycle to periods of contraction. As government now views its role as saving us not only from crisis but consequence, those elements that normally lead periods of contraction are muted by government intervention (like Quantitative Easing by the Federal Reserve) and allowed to compound for a grimmer reckoning at a later date. I liken it to always repressing emotional issues that will at some point implode to a nervous breakdown.

Second, culpability and consequence have become decoupled. This is the simple definition of “moral hazard.” When a parent uses her influence to keep a child from enduring the consequences of the child’s poor behavior, the child learns that she is above such pedestrian things and that normal consequences do not normally apply to her. This is a key point in my new book The Arrogance Cycle which will be out in September. For example if the teen is caught driving 60mph through your local neighborhood, and the parent implores the small community constable to merely issue a warning, do you think that the teen is more or less likely to speed again?

In recent years big banks leveraged their capital as much as 44 to 1 and brought the world’s banking system to the very precipice of collapse. The government bailed them out citing they were “too big to fail.” The officers and board members of these institutions were at most chastised. Each walked away with millions upon millions of dollars. The rest of the world observed and saw that there was precious little downside to reckless behavior that endangered the world’s well-being. And in the wake of the financial crisis, the government imposed stress tests to determine solvency standards. WHY IN THE HELL WOULDN’T A BANK AND ITS DIRECTORS CONDUCT THEIR OWN STRESS TESTS AND BE CONCERNED WITH THEIR OWN SOLVENCY??? If they’re not concerned with solvency standards, what the hell is it that bank directors do?

Mortgage owners are being bailed out. Banks can’t foreclose because the government says it’s unfair. As a result, higher down-payments are required to get a mortgage. This is actually a very good example of mistrust leading to higher cost. There are credit cards offered across the internet right now for those with less than perfect credit at 59.9% interest and $30 monthly fees. Can you imagine it?

We have to directly and publicly punish wrongdoers commensurate to the crime if we want to discourage criminal behavior.

Third, we as a nation have to redefine our moral code. Newsweek profiled an out-of-work woman in Las Vegas. Maria Diaz was evicted from her apartment in 2009 for not paying her rent and is now living with her mother and step-father. “After a while, I just decided, ‘Screw it. I need some new clothes. I’m going to get them.’ My mama’s not happy, but I don’t care. YOU STOP SPENDING AND YOU STOP LIVING.” Is this what America has become? Gone are the days of can-do Americans who gave birth to Rosy the Riveter. Gone are the “ask-what you-can-do-for-your-country’ Americans of the Kennedy era. Forgotten is Ronald Reagan’s America that was a shining city upon a hill, a beacon of freedom and hope and strength and fairness and responsibility for all the world.

For America to return to better days we have to start by thinking better of ourselves and hold ourselves to a higher standard. We have to stop searching for the material things we deserve and focus on those greater things of mind, body, and spirit that we praise in “the greatest generation” and hope to foster in our children. In short, we need to lift our eyes from the pavement in front of us to the hills of boundless possibilities of nobility and honor and achievement. We need to recover our pride in innovating, achieving, and creating and forget what we deserve and who we might blame.

My partner Taylor McGowan responded:

I don’t think our behavior changes until we are forced to change it. This only occurs through a really bad, long lasting recession/depression that scars an entire generation and completely changes the American psyche. The government is not only unwilling to allow this to happen, but it actually continues to do everything in its power to keep Americans spending.

Letting the housing market find its natural bottom and pulling back fiscal and monetary stimulus is all well and good in theory. The reality is that without the government’s help, we would probably be in awful shape because the banks would have failed and the stock market would have gone down a lot more. The average person gets hurt much worse under this scenario and poor people no longer have access to food under this scenario. In other words, we need to sort of be careful about what we wish for..

And our partner Keith Davis followed up with:

I liked Taylor’s comments about not doing things until forced. I also was thinking about the three key variables to watch to determine the consumers’ ability and willingness to spend discretionary income (and therefore the strength of the recovery). I believe these variables are the level of stock prices, gas prices and interest rates. I believe that the “recovery” we have seen so far has been driven by higher stock prices, which has led to higher spending by well-to-do Americans. This type of unbalanced recovery is not a healthy one. In the process of driving stock prices higher (through QE2), the Fed also caused oil and other commodity prices to spike. This hurt moderate income Americans and is likely one of the major causes of the “soft patch” we are now enduring.

Low interest rates are imperative to support housing prices. As rates rose over the past few months, we saw housing prices begin to fall again. I personally don’t think low mortgage rates are enough to stop further prices declines. There is simply too much supply in the pipeline. However, low mortgage rates can certainly limit the magnitude of price declines.

So the recovery looks like it may wax and wane based on stock prices, oil prices and interest rates. Now that interest rates have declined dramatically and oil prices are off their highs, we may begin to see better economic data over the next few months. However, the overhang of falling housing prices (as huge inventories are worked off) will likely limit the voracity of the recovery in even a best-case scenario. In addition, I think there is a ceiling on how strong the recovery can get because improved economic indicators will likely be met with higher interest rates and higher commodity prices.

Another point that I haven’t heard anywhere else is that the end of QE2 may turn out to be a good thing. Rates have declined dramatically in the face of the imminent ending of QE2. At the same time, commodity prices have declined. So as long as rates stay low and stocks don’t plummet, the economy may benefit by a decrease in gas prices (which I believe is a major factor in predicting consumer spending).

Tough to tell when a rally will come, but we’re due for a short-term bump. I think indexes may languish over the summer and into the fall. As much as I hate saying “it’s different this time”, we have to recognize that the financial crisis that brought us here was different, that the government’s response was different, and therefore; the recovery is different. Housing markets have not been allowed to clear, and while that may have been necessary, they have yet to reach a bottom unassisted by government funds and policies. Investors are worried about jobs and endless government spending.

Individual consumers who are dealing with years of accumulated debts are loath to see government spend them and their children into perpetual indebtedness. I don’t think we can look for a fundamental upturn until we are done with the fundamental downturn. We need to bottom (economically, not share prices), capacity needs to shrink to meet demand, and then demand needs to outpace capacity. A lasting, sustainable recovery will come only when driven by higher demand.

While inflation will be a problem whenever the US Debt comes front and center, we expect interest rates to remain low for quite a while. Though the Fed has provided lots of liquidity, it has not led to meaningful job creation or the sort of resilience that may be expected from any type of multiplier effect. With such meager results, Americans are questioning the efficacy of government dollars. Capitalism is ultimately the answer. Business and innovation will create growth and jobs, but at a point the government has to step aside and let free market capitalism do what it has always done. Good old American capitalism, determination, and hard work will lift us from this mire and return us to the path of prosperity. How long are we willing to wait to take the hard necessary steps?

Peace.

Michael