Consumerism Essay Revised Laatste Versie

8/2/2019 Consumerism Essay Revised Laatste Versie

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Consumerism: The Killer of The American Economy

Consumerism [kuhn-soo-muh-riz-uhm]

Noun

1. Continual expansion of one's wants and needs for goods and services.

2. Doctrine that ever-increasing consumption of goods and services forms the basis of a sound economy.

Anne Wiersma

H23B

609028

PCONS23


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Table of Contents:

1. Prologue.

2. Chapter 1: The role of the Government and Financial Institutions in the economic crisis of 2008.

1.1 Financial deregulation in the 1980s: a 20-year period.

1.2 Financial Innovations and new products of the 21st century.

1.3 The rise of leverage.

1.4 The Burst of The Bubble: AIG and The Credit Default Swap.

3. Chapter 2: The role of consumerism and consumer effects causes by the economic crisis of

2008.

2.1 Consumer Spending.

2.2 Consumer Debt and Income.

2.3 Negative effects caused by the crisis.

4. Chapter 3: The future of the consumer and consumerism.

3.1 New trends.3.2 New problems.

3.3 Possible Solutions.

5. Main Conclusion.

6. Afterword.

7. List of sources.

8. Appendix.


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1. Prologue

There is an awful lot to read about the causes of the American economic crisis of 2008 and maybe even

more about the solution to it. Solving this crisis from government perspective is said to be rather easy,

just cut government spending and raise taxes. Logically this will solve most of the problems but doesnt,

in any way, attack the nature of a crisis. In every crisis there seems to be a certain pattern, often involving

consumer behavior.

Ive always believed the consumer has a large role in both creating a crisis and eventually in solving it but

I doubt that it is in the consumers power to change anything. We need to create some basic rules and

codes for everyone to apply, in order to rule out future crises. These rules and codes will have to be very

strict and must be introduced in all levels of society. Besides these new rules, we need to protect the

human being from primal behavior by eliminating options, which involve shirt term taking risk. In this

paper I will try to discover and formulate all these necessary changes. In order to do so, the main

question in this paper is:

What mandatory changes are needed for economic recovery of the United States? Where do

consumerism and consumer behavior stand in this process?

Because of the fact that this paper is linked to the Consumentisme chapter in theConsumentengedrag: de basis book, I will focus on subjects regarding the American consumer like

consumer debt, savings, income and outlays. Some cases treated in this paper are highly specific and

complex. From the readers perspective, its very easy to get lost in a jungle of complex financial

terminology.

Because of this, Ive tried to construct the chapters in a logical way. The first chapter is about the

American economy prior to the crisis and will explain how the crisis eventually happened, basically: how

did we end up here. Chapter two describes the consumer point of view and the role of the consumer

during the crisis. In chapter three I will try to describe where the American consumer is heading, think of

this chapter as: where are we going.

The conclusion of this essay consists of two subjects: regulation and incentive structures. For both

subjects I will formulate mandatory changes on three levels: banks, lenders and borrowers. I believe that,

if all the changes and new rules described in this essay are applied on the US economic system, the oddsof a new occurring economic crisis will decrease substantially. In my opinion, it is time to change the

system instead of taking some governmental decisions and start the cycle all over again.


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2. Chapter 1: The role of the Government and Financial Institutions in the economic crisis of 2008.

The government and some financial institutions have played a major role in the economic crisis of 2008

by making some particular decisions. In this chapter, the most important decisions will pass and it will

become clear how the crisis started.

1.1 Financial deregulation in the 1980s: a 20-year period.

In 1981, Donald Reagan, a former CEO of Merrill Lynch, becomes Treasury Secretary. In 1982, he starts

deregulation for Savings & Loans companies, allowing them to make risky investments with their

depositors money.

In 1987, Alan Greenspan becomes Chairman of the Federal Reserve and Greenspan. Greenspan starts

deregulating the financial system, using the belief in consumerism as the main pillar of his vision. The

same year, Citicorp. and Travelers merger. Because Citicorp. is an investment bank and Travelers is an

insurance company, this merger was in violation of the Glass-Stiegel Act of 1933, which prohibited

commercial banks to make risky investments with the money of normal customers.

Instead of taking action against the merger, Greenspan changes the law. In 1999 Greenspan passes the

Gramm-Leach-Bliley Act removing barriers that prohibited any one institution from acting as any

combination of an investment bank, a commercial bank, and an insurance company.

1.2. Financial Innovations and new products of the 21st century.

After the Cold War in 1991, more and more scientists and mathematicians started working on Wall Street.

They started creating complex financial products called derivatives. Because only the scientists and

mathematicians had the brains to understand these products, the traders basically had no idea what they

were trading. Also, nobody at the top could correct mistakes made by these so-called Quants. Because

derivative could provide large profits for the investment banks, they tried to sell as many as possible to

their customers. In 2000, the Congress passed The Commodity Futures Modernization Act, banning all

regulation on the derivatives market. Between 2000 and 2007, the derivatives market exploded and a lot

of new products saw the daylight.

In 2001, George W. Bush was elected as President. An important part of his vision was restoring the

American Dream, giving every American citizen the change to own a house; on May 17, 2002 he gives

his now famous speech about the reform of the housing market1.

In the 2000s, a new loan system was developed, called The Securitization Food chain. This new system

fundamentally changed the distribution of risk in a loan. In the old system, a person who wanted a loan

went to see the account manager of a bank who would provide the loan and then expected the borrower

to pay back this loan over time. The Securitization Food chain, worked very different from this system: a

home buyer would lend the money from a lender (for example a mortgage broker), this lender would sell

the loan to an investment bank and the investment bank would bundle the loans and sell this bundle to

one of their customers2.

These loan bundles were called CDOs: Collateralized Debt Obligations, a bundle of mortgage loans, car

loans, student loans and some other loans. The three biggest rating agencies: Standard & Poors,

Moodys and Fitch were responsible for the rating of this new product. Because the investment banksliked the CDOs and paid the rating agencies for rating new products, CDOs became AAA products.

Because CDOs were rated AAA, they became very popular with retirement funds.

1http://www.youtube.com/watch?v=kNqQx7sjoS8

2Exhibit 5: The Securitization Food chain.


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After the George Bush speech, it became a lot easier to buy a house and home purchases quickly rose.

With the rise of home purchases, housing prices rose quickly as well1. Because of The Securitization

Food chain, mortgage brokers could get a large fee for selling the loan to an investment bank. So they

started pumping out more loans, again lowering the demands to get one. Soon, documentation or a down

payment wasnt necessary anymore (Roubini, N. (2009), The Financial Crisis of 20072009, p. 20).

These new super high-risk mortgages were called: Subprime Mortgages or NINJA Mortgages (No

Income, Job or Asset Mortgages). These mortgages also held so-called teaser rates, these interest

rates were floating rates which remained very low for about two years. After these two years, the rate

would go up, sometimes almost doubling the monthly mortgage costs.

Borrowers accepted these risky loans and teaser rates because they didnt knew any better. Mortgage

(and a lot of other financial) information is asymmetric: the expert on the subject is the same person

selling you the loan. So the information which influences you the most is from a person who wants to

make money and isnt making decisions in your best interest (B., Tufano, P. (2010). Consumer Financial

Protection, p. 8).

The guy on the streets, the borrower, thought: if the banks are willing to lend me this amount of money, I

must be able to afford it. So he reaches out to the American Dream, and buys that house.But the incentives of the lenders arent based on the fact that the borrower must repay the money tothem; its based on the fact of selling off the risk to others and making a short-term profit.

In consequence, the borrower trusted the lender because he only has limited information and financial

knowledge, relying on the lender to make this very important decision, the financial expert. But the lender

isnt concerned about the risk for the borrower anymore, because that risk isnt connected to his risk on

any level. So suggested the lender wanted to make a good decision for the borrower out of its own

interest, that incentive was out the widow as well.

The situation became unrealistic; a person fresh out of jail could get a mortgage in a matter of days. The

number of Subprime mortgage in the system exploded and the ratio of subprime mortgages in the CDOs

became proportionally larger. But still the rating agencies gave the CDOs AAA ratings and because

pension funds liked them, the CDO market boomed. Everybody started buying them.

All the incentives in this system were wrong. Everybody in The Securitization Food chain earned a fee

when selling the loan to someone else and nobody cared about the risk of the loan anymore because

once they had sold it, it wasnt their responsibility if the lender could repay the loan. As for the lender, this

was basically the same story: because no down payment was required, if a homeowner would default on

the mortgage, he would just walk away from it without losing money.

As for California, a hot market back then, the average equity borrowers had in their home was 0.71% and

58% of the loans were non-documentation (Sloan, A. (2007), House of Junk p. 3). This meant that

nobody knew if the owner of the house actually lived in it. Loans became speculative. You could go out

and buy a house with almost none of your own money at stake and if house prices rose, youd make a

profit. If house prices fell and you couldnt make your mortgage payments anymore youd get to walk

away from it without losing money (Sloan, A. (2007), House of Junk, p. 3). As a logical effect to this, home

purchases and housing prices skyrocketed and the investment banks sold more CDOs, making themmillions in profit.

1Exhibit 2: A History of Home Values.


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1.3 The rise of leverage.

To finance the fees investment banks had to pay to lenders for the loans (in order to create CDOs) and to

buy assets (in order to benefit from the rising house prices) the investment banks used leverage.

Leverage is the ratio between the banks own money and borrowed money. To make more money in this

hot market, the investment banks needed more leverage. In 2004, Henry Paulson, the CEO of Goldman

Sachs, lobbys to lift leverage rates and succeeds (Roubini, N. (2009), The Financial Crisis of 20072009,

p. 23).

Between 2004 and 2007 leverage increased to enormous levels. The best example of this borrowing

frenzy were the investment bank Lehman Brothers which had a leverage rate of 33:1 at some point and

the investment bank Bear Sterns, which had a leverage rate of almost 40:1. Meaning, in Lehmans case,

a minor 3% decrease of their asset base would leave them insolvent.

1.4 The Burst of The Bubble: AIG and The Credit Default Swap.

In a response to the CDO, AIG (American International Group, the largest insurance company in the

world) starts creating and selling Credit Default Swaps. This product is an insurance policy against the

default of a CDO. So when a person holds a defaulting CDO but owns a CDS as well, AIG has to come

up with the money. But the derivatives market was unregulated, so speculators could buy CDSs as well.

Normally, when someone who owns a house, he is the only person who can insure that house. With thebirth of the unregulated CDS, people could ensure assets they didnt actually owned.

Now 50 people could ensure one house, so if this house burned down, the losses in the system became

proportionally larger. And because this derivative market was unregulated, AIG didnt need to have the

money to cover potential losses. In the years following, AIG sold 500 billion worth of CDSs (Roubini, N.

(2009), The Financial Crisis of 20072009, p. 10).

Slowly the bubble started bursting. Subprime mortgages started to default at a very large scale, mainly

because of the teaser rates, which started to go up. Foreclosure numbers exploded. Because nobody had

their own money invested in the house, homeowners walked away. The house and the property got

auctioned receiving about 35% of its value, generating huge losses for the holder of the loan. Logically,

foreclosures had a negative effect on the neighborhood (Roubini, N. (2009), The Financial Crisis of 2007

2009, p. 45). House prices fell because of foreclosures in the neighborhood.As a reaction to the high default rate of the Subprime mortgages, CDOs started defaulting as well. The

ratings of CDOs fell sharply (Sloan, A. (2007), House of Junk p. 3) from AAA to BBB in just a couple of

months. The CDO market collapsed and owners of CDOs took huge losses. Investment banks couldnt

sell them anymore and got stuck with large amounts. At the same time and their total asset base value

decreased because of the falling housing prices.

On September 12, 2008 the investment bank Lehman Brothers filed for bankruptcy and on September 16,

2008 AIG runs out of cash and is bailed out by the government. These two events are considered as the

start of the crisis as known to the public.

Conclusion:

The belief in non-regulation by Alan Greenspan and the belief in the American Dream by George W. Bushdid great harm to the US economy. Financial deregulation has proven to be self-destructive over time

because self-regulation clearly is impossible. When the economy is cooperating and there is money to be

made, everybody loses track of Asset Value and becomes obsessed with consuming and making profits.


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3. Chapter 2: The role of consumerism and consumer effects causes by the economic crisis of

2008.

As mentioned in chapter 1, between 1980 and 1990 a significant change in consumer behavior came into

existence. But when people are selling, there must be people who are buying. And consumers did buy;

they bought a lot, actually.

2.1 Consumer Spending.

Over the past quarter century, US consumers have raised consumption norms. More important, theyve

raised consumption norms faster than the growth in income. Personal spending has risen as a share of

disposable income from 88% in 1981 to about a 100% in 20051. That consumption levels should rise in a

growing economy is no surprise, as rising incomes allow individuals to support higher standards of living.

Good economic times raise incomes and allow consumers to spend more, and the increased spending

increases consumption norms. But because people get used to spending a lot, economic downturns do

not cause reductions in consumption norms. This implies that families will try to keep the same level of

consumption when economic times change.

So if households can get the money, allowing them to finance desired consumption, actual consumption

growth will exceed income growth, contributing to the trend as seen in exhibit 6. This was a huge

problem, which made US households addicted to spending without having the cash to back this behavior(Mian & Sufi (2009), House prices p. 45).

And because companies keep creating new consumer needs and wants by innovative products (think of

the Smartphone, a huge multi million dollar market which didnt exist a couple of years ago). Back in

2005, this trend didnt seem to end very soon (Fazzari & Cynamon (2008), Household Debt in the

Consumer Age p. 10).

This is explained by products which are essentially bought by above-median income consumers: because

these consumers are more influential and often serve as role models (for example, celebritys) for lower

incomes, the products they buy will become popular with lower income consumers. Not having the cash

to consume, easy credit access solves this problem immediately (Fazzari & Cynamon (2008), Household

Debt in the Consumer Age p. 12). As stated in paragraph 2.2, when consumers want to buy a new (larger

and more expensive) home and are given the opportunity, they most definitely will consume.

2.2 Consumer Debt and Income.

This behavior led to a sharp increase in customer indebtedness. In 2007, consumer debt was

approximately 2.5 trillion (excluding mortgage and other real estate related loans), roughly $11.000 per

adult (Pressman & Scott (2009) Household debt, p. 2). Data show that during the past 20 years, total

consumer debt has been increasing at an annual rate of 4.1%, this is indeed much faster than the

average 0.6% increase in median income (Pressman & Scott (2009) Household debt, p. 2).

As stated in the previous chapter, this increase was due to income inequality and easier access to credit.

This rising debt and increase in spending has important consequences.

For example, the US savings rate went negative2. But the most important consequence was the change

in living standard. When an increased share of household income must be used to pay interest and otherdebt related payments, there is less income available to buy goods

3. When taking the outcome of the

previous chapter into account, households did continue to consume at the same level.

1Exhibit 6: Personal Outlays as a % of disposable income.

2Exhibit 2.

3Exhibit 7: Debt Service as a % of disposable income.


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The immensely dangerous consequence of this was: US households were paying off debt by using debt,

obviously creating more and more debt.

2.3 Negative effects caused by the crisis.

As stated in paragraph 2.4, the default of Subprime mortgages and the losses of the financial institutions

with the consequence of decreasing housing prices started the economic crisis. Logically, this crisis has

negative effects on the consumer.

First, the losses highly leveraged financial institutions led caused a decrease in consumer trust and

consumer spending. Large companys like AIG were untouchable in the public eye. When they suddenly

appeared very fragile, the consumer immediately reacted and consumer trust started decreasing,

immediately triggering a decrease in consumer spending (Roubini, N. The financial crisis of 2007-2009, p.

11).

Second, as a result of the defaults, housing prices fell. Foreclosures have a negative effect on a

neighborhood, making it seem less attractive. The drop in housing prices from the peak in the first quarter

of 2006 until now is 23%.

Given this current price drop, the estimate is that 30% of all owner-occupied homes with a mortgage havenegative equity, and that this figure may become as high as 40% if home prices drop another 15%. Since

homes are the primary assets for most households, this means:

a significant number of households are essentially broke, leading the way for more defaults, especially at

the Subprime levels1.

Finally, about 47% of all the assets of major banks are real estate related; the figure for smaller banks is

closer to 67%(Roubini, N. The financial crisis of 2007-2009, p. 21). Because most of these banks have

led losses and need to recapitalize, theyre likely to sell some of those real estate assets. Logically this

wont be positive for real estate prices making the quoted statement above seem more realistic.

Conclusion:

Because of a period of ongoing consumerism in combination with the economic crisis, the US consumer

is facing huge problems. They were addicted to consumer norms that werent realistic and were using

debt to keep these norms alive. Because of this behavior, these debt costs as a percentage of disposable

income kept rising, again forcing the consumer to take on more debt.

The economic crisis has caused even more trouble. Although it slowed down consumer spending2

and

the borrowing frenzy3, it revealed the underlying problems of American consumer behavior of the past 10

years. Also, it became clear how consumerism had taken over consumer behavior. Because of

decreasing house prices, the most valuable asset most US households have is decreasing in value

making some households theoretically broke.

1Roubini, N. The financial crisis of 2007-2009, p. 15

2Exhibit 12.

3Exhibit 11.


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4. Chapter 3: The future of the consumer and consumerism.

As for the future of the consumer, a new trend is developing. People are starting to realize something has

to change in consumer behavior.

3.1 The new trend.

Consumer spending is still decreasing at the moment because of further decreasing consumer trust and

the ongoing increase in job uncertainty (Carroll, D. (2009), The American Consumer p. 4). But with this

trend developing, a whole new set of problems is facing the US economy. Because if people stop

spending and start paying off their debt (deleveraging), the effect on the economy cant be neglected.

Logically, as a result of this huge drop in personal spending, the US GDP is showing a major contraction:

US household spending is the main engine for the US GDP and between 2000 and 2007 it represented

77.3% of the total GDP1.

The key problem the US is facing is nailed on the head in Martin Bailys article:

How can US households dig out of debt without further cutting consumption and crippling a US and

global recovery?2

3.2 The new problems.Unfortunately, theres one major factor which makes it less likely that consumer spending will go up or

even remain at the same level in the next couple of years. This has everything to do with the location of

the consumer debt. Between 2000 and 2007, the consumer debt exploded, but this growth wasnt

proportionally divided between all consumer groups. The groups, which were hugely responsible for the

growth, were: Young Homeowners and Low Credit Quality Homeowners3. The consequences of their

actions are rather logical.

First, young people are the future of consumer spending and arent likely to increase spending because of

high debt payments that have to be made (decrease of disposable income). Second, low credit quality

homeowners arent likely to increase spending or even stay at the same level because they dont have

the money and must use everything they do have to make debt payments. Because they were consuming

with money that never belonged to them, their increased contribution to consumer spending has always

been fake.

Another minor factor is the increase in the US savings rate, which is a consequence of the low level of

consumer trust and growing job uncertainty (Baily, M. (2009), Will US consumer debt reduction cripple the

recovery? p. 6). Assumingly, this rate will remain the same for the near future.

3.3 A possible solution.

The most common solution for this problem is the rise of income. With rising incomes, households can

reduce their debt burden without having to cut consumption by as much.

For example, if incomes grow by 2% per year, households could reduce their debt-to-income ratio by five

% with a personal saving rate of just 2.3%. This would require a spending reduction of $254 billion per

year, all else being equal. If incomes do not grow, the same reduction in household leverage would

require more than twice as much saving, translating into $535 billion less consumption4

.

1Exhibit 8: Consumer spending contributions to real GDP growth.

2Baily, M. (2009), Will US consumer debt reduction cripple the recovery? p. 2.

3Exhibit 9: Cross-Sectional Heterogeneity in Leverage Patterns for 1997 Homeowners By Housing Supply Elasticity.

4Exhibit 10: Saving required to reduce the household debt-to-income ratio by 5% over 1 year.


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Conclusion:

The future of the American consumer doesnt look so bright. Although theyve collectively woken up and

are trying to pay off their debt, this behavior has a major effect on the US GDP. The solution to the

problem is to remain spending at the same level, but taking in account which groups of the US population

are holding the most debt, this doesnt seem realistic. The solution for this problem would be increase in

income, but with more and more jobs on the line because of the decreasing consumer spending,

accomplishing this wont be easy. Keeping all this in mind, the US GDP and the US economy isnt likely to

recover in the following years.

5. Main conclusion:

By now it has become clear how the economic crisis of 2008 came into existence and what could happen

in the future if nothing changes. In this conclusion I will present my solutions in order to rule out future

crises. As stated in the prologue, I will focus on two subjects described on three different levels.

The two subjects are: regulation and incentive structures. The three levels of implementation are: banks,

lenders and borrowers.

1. Banks:

Regulation:

It has become clear that self-regulation doesnt work and is destructive over time. The financial market

needs to stay healthy and become more transparent.

First, the derivatives market must become regulated. For example, buying Credit Default swaps without

owning the assets (naked buying) must become illegal. The financial system cannot cope with large

losses generated from the default of a single asset. In the normal world, only a person who owns a house

can insure that very same house, in the financial system, this principle should be the same.

Second, the balance sheets of large banks should be more transparent and open to the public. Banks

need to fulfill their sole purpose: providing financial services. Once the people know what banks do with

their money, its far easier to spot a bank heading for trouble. It also becomes a lot easier for the rating

agencies to rate specific products created by banks, which decreases misjudged ratings.

Incentive structures:

Incentive structures at the banks must change. CEOs are compensated in large part based on how well

the stock performs. So there is an incentive to maximize shareholder profits. This often results in taking

excessive risk because greater risk can lead to greater profits, which leads to greater compensation. So

the reward for maximizing risk can be high. Of course, if the firm blows up then the CEO gets to leave

with their golden parachute and they go play golf somewhere for the rest of their life. Its almost a no-

brainer. Maximize risk and its a win win for the executive.

So the CEOs compensation cant be linked to stock performance, it must be linked to a number that

implies good management, for example: the solvency ratio or the Credit Default Swap spread. When the

companys profit increases by taking on more risk, this means nothing. When a companys profit

increases with the same solvency ratio, this means theyve done a good job: attracting more customers,leading more M&A deals or IPOs and providing better service levels. Also, when the bonuses are linked

to the solvency ratio or the Credit Default Swap spread, leverage rates wont need to become regulated.

Employees and management will not encourage each other to take on more risk, because if the solvency

ratio decreases, their bonuses will decrease. So the incentives change from taking on more risk to

generate short-term profit into improving the long-term company value and products. Banks will do their

jobs, providing financial services, instead of speculating with customer and government money.


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2. Lenders:

Regulation:

Trying to deceive borrows with complex lending products must become illegal; regulation has to ban

some of the many complex mortgage products. For example, Negative Amortization (NegAm) mortgages

and adjustable rate mortgages. NegAm mortgages reduce monthly payments by adding the non-paid

difference to the overall debt. This mortgage type basically encourages consumers to buy a house they

cant afford. Adjustable rate mortgages work with a very low teaser rate for a short period of time (3 to 5

years), after this period the monthly payment go up a lot, sometimes up to 50%, logically this type of

mortgages leads to default and foreclosures when people cant come up with the money anymore.

For other types of loans, regulation must define a maximum interest rate. Of course this is also happening

right now but lenders can easily bent these rules by using all sorts of tricks, charging high administrative

fees for example. Rules and regulation on this subject will have to become stricter.

In my opinion, the government should provide default mortgages. Because of the asymmetry in

information, its better for the consumer to have limited mortgage options. By narrowing the options and

promoting safer mortgages types, it becomes easier for the consumer to get a solid mortgage deal.

Incentive structures:Incentives for companies involved in the lending business must change. Because of the Securitization

Food Chain, by selling off all the loans, these companies could generate huge profits without holding the

responsibility of the loans. The incentives focused on generating more and more loans in order to sell

them and generate short-term profits. Risky loans were in fact better because they hold a larger interest

rate. Looking at historical numbers, we know what the normal default rates on mortgages, student loans,

car loans and consumer loans are. When a company generates loans, which have a significant larger

default rate (maybe 10 to 20%), theyve clearly provided risky loans and should be fined.

A second option is to link bonuses to default rates. If employees generate loans that have a lower than

average default rate, they make more money. By doing so, the incentives change from generating risky

loans in order to make short-term profits to making solid loans and expecting the borrower to pay back

the money. The lender wants to provide a solid loan for the borrower, out of its own interest.

3. Borrowers:

Regulation:

Regulation on consumer loans and credit should become stricter. We now know young homeowners and

low credit quality homeowners took on the most debt in the past 10 years.1

Having 10 different credit

cards shouldnt be allowed and credit scores like the FICO2

score should be of more importance when

applying for a loan. Documentation when applying for a loan should be mandatory as well. We now know

these types of non-documentation loans became very popular before the crisis3. Everyone can claim a

certain level of wealth but without having evidence, people who appear to be rich could be poor and the

other way around as well.

Im not saying poor or less fortunate people cant get a mortgage; they just shouldnt be able to get amortgage they cant afford.

1Exhibit 8.

2Fair Isaac Corporation, the best known credit score system in the US.

3Exhibit 13.


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Incentive structures:

The incentives of borrowers before and during the crisis were all wrong. Because of the different popular

mortgage types with limited documentation and very little down payment the perception of owning a home

became different.

Owning a home should provide security and stability, not a tool to make money and speculate with.

Because of these loan types borrowers had the incentives to speculate on housing prices and buying a

much bigger than needed house1. In order to change these incentives and ban speculation, the first thing

to do should be creating rules on minimum down payment as a ratio of the overall price. By doing so, the

borrower sees the newly purchased house as his retirement savings and is willing to pay back the loan.

6. Afterword

During the creation of this essay Ive learned a lot and had deeper and better insights of the US economic

crisis. Im very content with my decision to re-write the most important part: the main conclusion. The

conclusions made in the first version were rather obvious and not thoughtful at all. With this version, Ive

completed my mission: to formulate solutions other than governmental economic interference. It feels like

Ive succeeded. Im very curious to see whats about to happen next. In my opinion, the next two

economic years arent going to be any better. But as always, we can only find out afterwards.

1A. Sloan, House of Junk.


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7. List of sources.

1. Pressman, S., & Scott, R. (2009). Consumer Debt and The Measurement of Poverty and Inequality in

the US. Review of Social Economy, Vol. LXVII, No. 2.2. Guttmann, R., & Plihon, D. (2008). Consumer Debt at the Center Finance-Led Capitalism. New York

School of Research.3. Campbell, J., Howell, E., Jackson, B.,Tufano, P. (2010). Consumer Financial Protection. Harvard

Business Review.4. Chari, v., Christiano, l., Kehoe, P. (2008). Facts and Myths about the Financial Crisis of 2008. Federal

Reserve Bank of Minneapolis Research Department.5. Mian, A., Sufi, A. (2009). House Prices, Home Equity-Based Borrowing, and the U.S. Household

Leverage Crisis. University of Chicago Booth School of Business.

6. Cynamon, B., Fazzari, S. (2008). Household Debt in the Consumer Age: Sourceof Growth/Risk of Collapse. Capitalism and Society, Volume 3, Issue 2.7. Goodman, P. (2009). Lucrative Fees May Deter Efforts to Alter Troubled Loans. The New York Times.8. Gorton, G., (2010). Questions and Answers About The Financial Crisis. National Bureau Of Economic

Research.9. Gerardi, K., Foote, C., Willen, P. (2010). Reasonable People Did Disagree: Optimism and Pessimism

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8. Appendix.

Exhibit 1: A History of Home Values.

Exhibit 2: Personal Savings rate as a % of disposable income.


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Exhibit 3: US household liabilities as a % of disposable income.

Exhibit 4: The Securitization Food chain.


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Exhibit 5: Personal Outlays as a % of disposable income.

Exhibit 6: Debt Service as a % of disposable income.


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Exhibit 7: Consumer spending contributions to real GDP growth.


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Exhibit 8: Cross-Sectional Heterogeneity in Leverage Patterns for 1997 Homeowners By Housing Supply

Elasticity.


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Exhibit 9: Saving required to reduce the household debt-to-income ratio by 5% over 1 year.

Exhibit 10: Outstanding Household Debt as a % of GDP


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Exhibit 11: Household-borrowing reduction.

Exhibit 12: Household-spending reduction.


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Exhibit 13: US loan types.


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Consumerism Essay Revised Laatste Versie

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