I believe that Bush’s proposal to drill offshore is almost as bad as his proposal to increase ethanol content in gasoline. I see two major problems with his proposal:

1. It will not help in the short run
   In the short term, gas prices will remain high. It takes time and tremendous capital investment to get a new oil platform up and running. It will take too long to build the platforms for it to impact gas prices this year.
2. In the long run, increased production will lead to increased consumption
   As a modern industrialized nation, we need to work towards developing and utilizing cleaner sources of energy than petroleum. Just as individuals and corporations poured money into developing the petroleum infrastructure many years ago, this needs to take place with renewable sources of energy. Increasing production to lower the price of oil will delay the evolution of better methods for harvesting energy. As limited resources continue to be consumed, it will need to happen anyway. It is better that this happen sooner than later, otherwise the effects it will have on the global environment could be catastrophic.

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I read a TechCrunch article today about how much it would cost to convert all fuel vehicles into electric vehicles. According to the article, Philip Greenspun calculates it will cost us nothing to convert to electric cars, but I beg to differ. He deduces that for the cost of annual vehicle fuel consumption, everyone in the U.S. can have an electric vehicle instead of a gasoline-powered one. I do like the math and it would be great if it were true, but there is one major problem with electric cars. Current battery technology cannot support it, because the range that an electric vehicle can travel on a full charge is quite limited. Another problem with current battery technology is that batteries take a relatively long time to fully recharge.

What do you do if you’re on a road trip and your battery is running low on charge? Even if battery technology improved to allow for a five-minute full recharge, where would you go to recharge? You can recharge at home for intracity commuting, however, you still need a recharging station when you travel further distances. Unfortunately, there will be no incentive for entrepreneurs and corporations to build recharging stations because electricity is so much cheaper than gas. It would take pennies to recharge your electric car so it will be up to the government to provide public recharging stations. There would be significant capital investment and there would never be a return on that investment. I think the cost to put an electric car in front of every house is much higher than Philip has calculated.

Although there won’t be anyone rushing to build recharging stations, there is definitely a bright future for improvements in battery technology. It will be the key to improving hybrid vehicle technology as well as fully electric vehicles. The electric double-layer capacitor is one type of technology that shows a lot of promise. Eventually someone will start to mass produce a highly efficient energy storage device and it will change the world. When this happens electric cars will be much more viable and it will open up new markets. At a minimum, the majority of vehicles (if not all) will be hybrids that incorporate the new technology. Only then will we be able to wean ourselves from our addiction to petroleum.

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There are many lenders currently under investigation for fraud, perhaps most notably the nation’s largest mortgage lender, Countrywide Financial. Even if Countrywide is found to be guilty of fraud, one company alone (even if it is responsible for 20% of the mortgages in the U.S.) cannot be to blame for the woes of the credit and housing markets. If anything is to blame, it is the market itself.

As mortgage rates began to fall towards all-time lows early in 2004, real estate prices skyrocketed. Thus began an insatiable appetite for home ownership, and lenders began to offer all kinds of mortgage products that would allow consumers to finance as much as possible for as low a monthly payment as possible. It was a snowball effect that caused a housing bubble that eventually popped.

Unfortunately, a lot of time and money will now be spent with investigating lenders. Time and effort will also go into the development of new regulations to prevent such a calamity in the future. At this point there is little that can be done to rectify the problem, other than to simply let the markets take their course. The reality is that the banks have already paid the penalty with the increasing number of defaults they are experiencing. Most of the new regulations will probably be unnecessary, as the banks have learned their lesson and have become very restrictive with their lending practices in light of what is taking place in the real estate market and lending market.

If you still insist that someone should be to blame, you could point the finger at the Board of Governors of the Federal Reserve and former chairman Alan Greenspan. Although mortgages do not directly follow the Federal Funds Rate, they do tend to trend along with the Federal Funds Rate when it experiences rapid and drastic changes. From January of 2001 to June of 2003, the Fed Funds Rate dropped from 6.5% all the way down to 1%. They remained at 1% for a year, until the Fed began raising rates again in June of 2004. There are others that also share my view that Greenspan is partially to blame for the credit crunch.

Not only did the Fed’s monetary policy help fuel the fire for the spike in home prices, but remarks by the Fed chairman did as well:

American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.

I think it is outrageous for the Fed chairman to make such remarks when fixed rate mortgages are at an all-time low (that remark was made on February 23, 2004). Certainly the banks were more than glad to oblige him, and they offered all sorts of exotic products to allow borrowers the highest mortgage balance possible for the lowest monthly payment. If you combine a high mortgage balance, an interest rate that is adjusting upwards, and little (or negative) home equity, you have a high probability that a default will take place.

Not only will a homeowner have a difficult time with the higher monthly payment on an adjusting rate, but with little or negative home equity, they may not be able to refinance into a fixed rate mortgage. Even if a borrower somehow manages to pass the strict requirements that lenders now have, the new fixed rate is very likely to be higher than the rate they had previously. The new payments are likely to be higher because of the higher rate as well as the principal component, which may have not been present in their prior mortgage if they had an interest-only loan.

The Fed may have prevented a recession in 2001, but the housing and lending markets are paying for it now. Now the Fed is lowering the Fed Funds Rate again, in hopes to prevent a recession from taking place. Sound familiar? Fortunately, this time there won’t be another housing bubble since the last one is still deflating. I think this time the actions of the Fed will result in the cheapening of our currency. It has already begun to happen, and is likely to get worse. Because the U.S. economy depends so much on foreign exports, the current actions of the Fed will most likely result in inflation.

Adding insult to injury, the bursting of the housing bubble has also contributed to the decline of the dollar. Foreign investors hold trillions of dollars in mortgage-backed securities. The problems with the housing and lending markets have led to a huge sell-off in these securities, lowering the demand for the U.S. dollar. If it wasn’t for foreign monetary policy, the decline of the dollar would probably have been much worse than it has been.

I think some moderate inflation will be necessary to allow household incomes to catch up with home prices. Even with the deflation of the housing bubble, home prices are still very high relative to incomes. If one is to purchase a home today with a traditional fixed rate mortgage, either their income needs to rise, the price of real estate must fall further, mortgage rates need to come down, or some combination of the three. Rising incomes will also help to lessen the blow of the problems with foreclosures and defaults. Lower foreclosures and defaults will improve the problems with the secondary mortgage markets, which will restore some confidence with foreign investors in that market. Eventually when things settle down the U.S. dollar should stabilize as well. It will certainly be interesting to see how things play out.

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I was reading cyncurry’s article Personal Debt - Is excessive shopping due to peer pressure? the other day, and she asks a thought-provoking question:

is it our moral duty to carry on building debt to keep the economy alive?

I don’t know about it being our moral duty to carry on building debt, but it is definitely a part of the economy that is here to stay. The practice of financing spending isn’t limited to consumers. Year after year, the U.S. Federal Government operates with a budget deficit, and on very rare occasion ends the year with a surplus. The amount of consumer revolving debt pales in comparison to the federal government’s. Of course, being the analytical type that I am, I decided to take a look at the numbers.

U.S. consumer revolving debt increased from $850 Billion in December of 2005 to $902.3 Billion in December of 2006. An increase of $52 Billion or 6.15% (Source: Federal Reserve Board G.19 Release - Consumer Credit). By comparison, the U.S. federal debt increased from $8.17 Trillion in December of 2005 to $8.68 Trillion in December of 2006. An increase of $510 Billion or 6.24% (Source: U.S. Department of the Treasury, Bureau of the Public Debt’s Debt to the Penny History Search). The U.S. consumer does have an appetite for credit, but it’s not nearly as big as Uncle Sam’s!

U.S. consumers do love their credit cards, but credit card spending is actually quite minimal in terms of its contribution to the economy. In 2006, personal consumption expenditures were $9.2 Trillion (Source: U.S. Department of Commerce, Bureau of Economic Analysis). That means that credit cards only contributed about 0.57% towards the gross domestic product (GDP) in 2006. The federal government contributed $2.5 Billion to the GDP in 2006, so the increase in federal debt from 2005 to 2006 represents 20% of the government’s contribution to GDP in 2006.

As demonstrated by the huge amount of debt it has taken on, the federal government has supreme confidence in the sustained growth of the U.S. economy. The debt of the federal government represents a huge portion of its spending, but contributes less to the U.S. economy than consumers do. Although consumer revolving debt does seem like a huge problem, I think we are just fine as it relates to the overall economy. However, I didn’t mention non-revolving consumer debt. As you would expect (since it includes mortgages), it is much higher than revolving debt. At the end of 2006, it stood at about $1.5 Trillion. If there is any trouble with the economic outlook it lies therein, as many Americans have adjustable rate mortgages that are adjusting. But that is another story for another time.

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