Why the Recession Will Be Good for Us as a Country

Good Things Can Come From Difficult Economic Times

How dare I make light of economic conditions that are forcing people out of work and out of their homes, but everything isn’t all doom and gloom with the recession. If you’ve lost your job recently, there is probably little optimism in thinking that the recession is somehow a good thing. And it’s true, these economic periods are painful for individuals, corporations, and the country as a whole.  But this isn’t the first recession we’ve ever had, it won’t be the last, and it’s something that has to happen on a regular basis.

The Business Cycle

Without going into a complicated economics lesson, it’s important to at least understand the basics behind the business, or economic cycle. The economy isn’t static, and we regularly experience periods of growth and decline. The economic cycle is broken down into four basic components:

  • Expansion - A period of increasing growth and economic activity.
  • Peak - The apex of an expansion period.
  • Contraction - A period of decreasing growth or slowing economic activity.
  • Trough - The lowest point during a contraction period.

While the length and severity of each of these economic periods vary, the general cycle holds true. The economy will grow and expand for some time and eventually reach a point where it can’t continue that level of growth and it peaks. From there, it will experience a period of contraction. This may last a few months or a few years. After a period of a slowing economy, things bottom out and will again resume growth. And the cycle repeats.

This isn’t a new phenomenon. Looking back at just the past 50 years, we’ve dealt with 10 periods of recession. Some were short-lived, others lasted longer, and of course, some hurt more than others. While this recession is caused by factors different from past recessions, it was bound to happen, and was even expected. We didn’t need a crystal ball to predict that. But what we can’t predict is exactly how long it will last, and who will be hurt by it the most.

Extended periods of growth can create excess in the economy, and eventually this has to be purged from the system. Unfortunately, this usually results in job loss, businesses closing, and a declining stock market. But the bottom line is that an economy can’t just continue to grow and grow non-stop. Would it be great if we had zero unemployment and our stock portfolios marched along earning 10% every single year? Of course, but that isn’t how the world works.

Americans Are Saving More

Americans have one of the worst savings rates in the developed world. We are one of the richest and most prosperous nations, yet we can hardly save any money. Part of this has to do with having a consumer-driven economy. If people are spending money, businesses are doing well, expanding, and creating jobs. That’s a good thing, but it also creates a situation we’ve experienced lately where people have very little money saved since they are basically encouraged to spend.

Even with dismal savings rates barely above 0%, this recession has done one thing, and that’s boost our savings rate as a nation. While it still lags far behind many other countries, an increase in savings is good. People are starting to realize the importance of having money set aside. Whether it’s for retirement or just an emergency. Of course, that’s also bad because it means people are spending less, which in turn doesn’t help stimulate an economic recovery.

And the even better news is that if people begin to save more, they will have that cushion in place when the economy shrinks again at some point in the future, because it will. Of course, this is assuming people don’t go back to their old spending habits as soon as the economy begins to recover.

Back to Common Sense Spending

Frugality is making a come back in 2009. In recent years, spending got out of control, in large part due to easy access to credit. Virtually anyone could afford a brand new luxury car, buy a home out of their price range, and charge anything on credit cards. When times are good, you’re making money, and can keep up with the bills, that seems like a lifestyle you can afford. But as soon as the annual raises stop, you lose a job, or something else happens, suddenly you can’t make the car payment and can’t keep up with the monthly credit card bills.

This isn’t to say that everyone was spending wildly or using more credit than they could afford, but since the banks were basically handing out money, a lot of people took advantage of it. Now, it’s coming back to haunt a lot of people. Those who were relatively frugal over the past few years are not being affected by this economic downturn as much as those who have lived beyond their means. So, more and more people are beginning to revert back to common sense spending — buying only what they can afford, and not relying on credit.

It always amazes me to see stories in the news about how people are making so-called drastic changes to their spending habits in these difficult times. Most of these changes aren’t drastic or anything new, but common sense things people should be doing anyway. For example, take this story I saw in my local news this weekend about Innovative New Ways to Manage Money. Here are a few of the “innovative” and “new” ways this woman is saving money:

We used credit cards a lot and just changed some things,” Budzinski said. “We have dogs, and instead of buying high end dog food, we switched to the lower end dog food.

A good start, and how about:

[We're] buying generic stuff, and not going out to eat as much. And when we do, we more or less split a meal or we go out to eat lunch instead of dinner.

Amazing! You can save money just by not using credit cards as much, buying cheaper dog food, and not going out to eat as much. These truly are new and innovative money saving ideas! I’m sorry about the sarcasm and I don’t want to belittle anyone’s attempts at saving money, because it’s fantastic that people are making changes. But what bothers me is how the media treats this as news. I see articles exactly like this every week going on and on about how people are just using common sense and actively trying to save money. That’s not news, it’s just something people should have been doing all along, and it really just illustrates how excessive people’s spending habits were if they feel that eating out less or not using credit cards is some financial revelation. If it takes a recession to make people think harder about what they are spending money on, and to make a conscious effort to save money, that will help a lot of people in the long run.

Back to Basics in Housing

One of the root causes of this recession was a real estate market that got out of control, fueled by speculation and the ability for almost anyone to get a loan. Yes, there were plenty of shady lenders, but it got to a point where anyone could get more house than they could truly afford. A plethora of no-doc or low-doc loans allowed people to fudge numbers in order to afford their dream house, you could easily get 0% down loans, not to mention all of the ARMs and interest only loans. This put people in a position who had no business trying to buy a home suddenly find the bank willing to lend them the money to make their dreams come true.

Owning a home is a privilege, not a right. Prior to the real estate boom, lenders had tighter standards in determining who could afford a home, and how much they were willing to lend. In most cases, a down payment was required, and this meant prospective buyers had to have the discipline to save some money on their own first. In turn, this down payment then provided immediate equity that could help minimize fluctuations in property values. In addition, lenders were typically more conservative in terms of how much they would lend based on credit history and income. With these tighter standards, it helped put people in a home that they could comfortably afford while the bank minimized risk.

Today, we’re moving back to the basics, although we’ve overshot the baseline a bit with the credit crunch. But banks are starting to move back to more traditional fixed-rate loans, requiring a good credit score, and down payments. They are also taking into consideration how much people make, and making sure they aren’t lending too much.  Unfortunately, this move has priced a lot of people out of a home purchase right now, and it’s made it harder to get a loan, but it’s a step in the right direction. It will hurt for a while to be sure, but it should create a more stable situation in the future provided history doesn’t repeat itself.

What Doesn’t Kill Us Makes Us Stronger

Without diminishing the pain and suffering people go through during difficult economic times, a job loss, or home foreclosure, it likely isn’t the end of the world. It may feel like it, and it may lead to years of trying to claw yourself back up, but it can make you stronger. People faced with difficult times learn things about themselves they may have never realized, may explore a new direction in life, or find out there is more to life than money and material things.

But I’m not talking about individuals, as each story and situation may be a heartbreaking tale, but rather I’m talking about the country as a whole. We’re faced with some economic conditions of epic proportions, and we’ll get through it. It may change the face of our country forever, and create a new way for many businesses to operate, but we’ll learn from it and come out the other side even stronger. Of course, once we do, history is bound to repeat itself. Our economy will grow, money will be made, and jobs created, but at some point we’ll find ourselves a victim to the inevitable economic cycle. The best thing you can do is to learn from the mistakes, and take actions to ensure the next time it happens, you limit the impact.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.