In Praise of Recessions

Here is the funny thing about recessions, including the one we find ourselves in. We know what they are, where they come from, and how to get out of them.

In simple terms, they are a reduction in total economic activity, the negative growth of the economy.

Recessions are caused by the fact that an economy is a dynamic, not static, system. That means it will oscillate around the mean, the mean being somewhere north of zero growth. In my home state of Georgia, there are sometimes days in spring that are so cold as to be indistinguishable from those in winter, but no one supposes for a moment that the vernal equinox has somehow reversed itself. Temperature is dynamic, and as cold as it might get, everyone knows that it is only an aberration from the mean spring temperature, not a substitution therefore. So too with recessions: they are a natural aberration from mean economic growth, not some new level of economic activity unrelated to the historic pattern of growth.

And we know how to cure recessions. One thing we can do is nothing. If you want to catch a pendulum, you can either chase it as it goes by or you can simply wait for it to come back to you. So too with the economy: if we just wait a while, the economy will eventually swing back into the positive.

But if we can't be patient about it, we also know how to hasten the rebound. Simply follow one rule that always works: stop doing what we were doing before the recession started. In this particular case, that means stop pumping up the money supply in vain attempts to avoid recessions; stop spending more money than we have; and avoid situations that are just too good to be true.

All three of these were particular excesses that lead to the housing crisis. People kept buying ever more expensive homes because prices were just going to go up forever. Well, they didn't and a good part of the reason was that rising house prices was not real market activity but a result of an artificial balloon of credit the Federal Reserve and Congress were providing in order to keep the good times rolling.

This same credit balloon also brought down the banks, which were sucked into buying too-good-to-be true mortgage backed securities. You see, banks are required to keep a certain amount of capital in reserve, held in the safest of investments. This usually means government bonds, but anything as safe as government bonds will pay a very low interest rate (currently about zero). But at the dawn of the 21st Century, salesmen of the Federal government's largesse made banks aware that they could buy mortgage backed securities
from a couple of quasi-government entitities, FNMA (Fannie Mae) and FHLMC (Freddie Mac), that would give them returns of anywhere from 5 to 8%. Although technically not guaranteed by the Federal government, government salesman (wink, wink, nudge, nudge) and most financial industry insiders were sure that the Federal government would de facto guarantee the obligations of the dynamic duo. So, seemingly without taking on any more risk than with government bonds, banks could load their capital reserves up with securities that more than tripled their normal return.

Too good to be true, and it was. When the real estate market turned, as it had to, the de facto guarantee of the government the banks depended on in their calculations evaporated like a mist at sunrise, and some of the largest components of our financial sector collapsed.

So, if we know how we get into recessions and how to get out, why is everyone in such a stew over this one?

Because what a recession really does is demand that we change.

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But not the change promised in this current political season which invokes such a happy, joyous feeling in so many, but real change, change that hurts because it involves giving up many things that seem so important, including some of our deepest held values and priorities. With real change, we have to gain a new heart, and getting a new heart is a complicated, dangerous and ultimately painful operation.

In real life, courage, self-reliance, a drive for success and with them a little bit of pride are actually noble virtues and necessary to the health of any society. But like all things human, after too much success for too long a period of time, these things degrade into mere hubris, and the only antidote for hubris is humility. That is what recessions provide.

When things are going well, when the economy is humming and your net worth is climbing like an Apollo rocket, hubris becomes epidemic in society. People start thinking that they are invulnerable to bad times, that they have the system figured out, that their wildest imaginings are solidly grounded in their well-earned self-confidence. And what's worse than all, people start believing that they are somehow entitled to all this success.

In successful times, buying a $45,000.00 BMW on credit rather than a $15,000.00 Kia for cash makes perfect sense. What is $45,000.00 anyway? It's only a couple of brilliant ideas superbly executed by these Masters of the Universe (h/t Tom Wolfe).

When I grew up, a $500,000.00 house was something, at least 10,000 square feet with a landscaped yard that most municipal parks would envy. But, just prior to the recession paying less than $500,000.00 for a house in certain parts of the country was embarrassing, regardless of its size or utility.

Hubris like this will not change of its own accord. It needs the proverbial whack in the head that the mule got, because first "you must get its attention."

This is what a good recession does, and why I take this moment to sing the praises of recession. It is the whack in the head that makes it possible for us to learn to become better people. It is a moment in which courage, self-reliance, a drive for success and pride will take a back seat to perhaps the noblest virtue of all, humility. It s a time when self-reflection is more important than self-assertion and we might begin the process of re-prioritizing our lives around a better set of values.

It is a time when, perhaps, we might actually attain some of that which all to often has alluded mankind, wisdom.