Who Would Lose Under Obama

Who Would Lose Under Obama’s Financial Reforms President Obama’s ambitious overhaul of the financial regulatory system would create a new layer of consumer protections, expand the Washington regulatory establishment and change the way America’s banks do business. The goal is to provide more stability to the financial system, which would benefit most Americans. But such abrupt change would also cause some casualties. Here’s who stands to lose under Obama’s reforms: Big Money. The nation’s biggest financial firms—those deemed “too big to fail,” like Citigroup, AIG and Bank of America—would get enhanced treatment under the Obama plan. Since the failure of just one such institution could trigger a global meltdown—the way AIG’s collapse nearly did last September—they’d have to keep more capital on reserve than smaller firms, disclose more information, endure more supervision from regulators and submit to quick corrective action if a crisis occurred. The danger is that government handcuffs could turn TBTF firms into quasinationalized monoliths that can’t keep up with more nimble competitors. Of course, that’s what AIG, Citigroup, and some other big bailout recipients have already become. The real aim could be a set of rules so stringent that the biggest firms decide it’s better to break themselves up than submit to superregulation. Overpaid CEOs. The glory days seem to be over for chief executives getting multimillion-dollar bonuses based on a couple quarters’ worth of good numbers. Or even a couple quarters’ worth of lousy numbers. Proposed “say on pay” rules would require public companies to hold shareholder votes on the pay packages top executives get. Other proposed rules would require bonuses to be held in escrow for a few years, so the CEO’s pay can be better linked to the company’s performance. We’ll miss hearing about those golden commodes. Fannie Mae and Freddie Mac. The two mortgage giants were taken over by the government last year, as they approached insolvency. They now back most of the mortgages issued in the United States, but the future of these lightning-rod agencies seems cloudy at best. The Obama administration has begun a review process to figure out what to do with them. One option is to nurse them back to health, then spin them off as public companies. But given their tattered history, that seems unlikely. Other options Obama has put on the table: slowly winding them down and liquidating them; incorporating their activities into some other federal agency; running them like public utilities, with regulated fees and profit margins; and dissolving them into a bunch of smaller companies. S&Ls. The local savings and loan might be a nostalgic throwback to the days of George Bailey, but this breed of bank —also known as “thrifts”—may lose its niche. S&Ls, which typically offer limited services like savings accounts and mortgages, had an unwitting role in the financial meltdown: Some huge conglomerates, like AIG, bought a thrift or two, because it meant they could be overseen by soft-shelled regulators like the Office of Thrift Supervision, which has more lenient rules than the FDIC or the Federal Reserve. That’s one reason Obama wants to abolish the OTS, and turn thrifts into ordinary banks. The only change their customers may notice is that interest rates become a bit less generous, since the banks would have to meet stricter standards that would cost them a bit more. Standard & Poor’s and Moody’s. These private-sector credit rating agencies played an insidious role in the housing bust, giving top ratings to mortgage-backed securities that contained lots of subprime mortgages destined to blow up. Their stamp of approval made “toxic assets” seem much safer than they were, drawing investors who never would have put their money into mortgages if they knew the true risk. S&P and Moody’s, the top two rating agencies, have revised their rating procedures, but Obama’s proposal dinged them anyway, stating that “regulators should reduce their use of credit ratings in regulations and supervisory practices, wherever possible.” The official rebuke indicates that these once venerable firms may need to make sweeping changes to get back in the government’s good graces. Shadow banks. The housing boom was fueled by thousands of mortgage brokers that weren’t banks, and therefore evaded regulation by federal or state overlords. Those lenders were often the ones that issued the most egregious mortgages to borrowers who shouldn’t have qualified, couldn’t afford the payments and didn’t understand the risks. Obama’s plan would bring just about any kind of lender under the feds’ purview. And the proposed Consumer Financial Protection Agency would have the authority to issue new rules for debt counselors, mortgage advisors, and anybody else aiming to make a buck off unsuspecting borrowers. Fresh hucksters will no doubt materialize, but when they do, newly energized financial sheriffs may form a posse instead of looking the other way.

Consumers. Sure, there will be a lot of new rules designed to protect you and me, but if the government’s got our back, why bother looking out for ourselves? Financial illiteracy has been a major contributor to the economic meltdown, and for some people, more government responsibility will lead to less personal responsibility. Buyer beware, whether the government’s on the case or not.

Who Would Win Under Obama’s Financial Reforms The man doesn’t think small. If President Barack Obama’s proposed overhaul of the financial regulatory system gets through Congress, it will be a virtual reboot of some of the most engrained government agencies. The plan would rearrange the duties of Federal Reserve, the Treausury Dept., and many other Washington fiefdoms. It would extend federal oversight to hedge funds and a whole new basket of financial products, and change the way Americans use mortgages and credit cards. Here’s who some of the biggest winners will be if the plan goes into effect: Tim Geithner. The Treasury Secretary is already Obama’s point man on the bank bailout and economic recovery effort, and the big man on campus is about to get bigger. The Treasury Secretary would chair the new Financial Services Oversight Council, an agency similar to the National Security Council whose role would be to knock heads and achieve harmony among all the agencies overseeing some part of the financial system. The head of the FSOC would also be a kind of inverse kingmaker, helping identify which firms should be on the government’s new superregulated “too-big-to-fail” list. Treasury would also get two powerful new agencies: the Office of National Insurance and the National Bank Supervisor. And the Federal Reserve would have to get a sign-off from the Treasury Secretary before doing any emergency lending, like it did with AIG, on its own initiative, last fall. Go Tim, go. Ben Bernanke. The Federal Reserve chairman would have a bit less autonomy when it comes to emergencies, but the Fed would have broad new powers to step in and take control of big firms that are failing. The FDIC already has that kind of authority over traditional banks, but no agency is in charge of other types of failing firms that could threaten the whole financial system—a major handicap during the collapse of Lehman Brothers and AIG last September. Consumers. Also known as voters, and thus recipients of lavish government indulgence. A new federal watchdog, the Consumer Financial Protection Agency, would protect consumers from ... their own greed and foolishness, as well as the many unscrupulous firms eager to take advantage of it. The CFPA would be similar to the Food and Drug Administration, overseeing a long list of products and practices involving bank accounts, credit-cards, and mortgages. The agency could require simplified explanations of the rules for mortgages and credit cards. It might require lenders to offer online calculators allowing their customers to compare a variety of loan types and payment plans. There could be new rules requiring merchants to warn you of an overdraft if you pay with a debit card that draws your balance below zero. Some fees could be banned altogether. Expect the banking lobby to fight hard against the CFPA. Tri-state residents. Anybody who does their banking in more than one state has probably bumped into archaic rules that make interstate banking more complicated than necessary. An account opened in one state, for instance, can be hard to access in another. The Obama reforms would scrap those “interstate branching” laws, making banking a seamless experience no matter where you do it. Hooray. Gary Gensler. He’s chairman of the Commodity Futures Trading Commission, which would gain responsibility for regulating derivatives, like credit-default swaps and collateralized debt obligations, that have been lightly regulated up till now. Expect more arcane Congressional hearings in which few of the questioners know what the heck the chairman is talking about. Whistleblowers. The Securities and Exchange Commission already has a fund for paying rewards to people who report significant insider-trading abuses. The Obama plan would extend such payouts to people who blow the whistle on other kinds of financial or corporate crimes. Clever financiers. Hedge funds and other private investing pools, currently unfettered by federal oversight, would be subject to regulation under the new plan. The hedgehogs will whine, since the feds might rein in their legendary freedom to invest as creatively—or aggressively—as they see fit. But the smartest moneymakers will quietly find the seams in the new regulated environment, and profit accordingly. They always do. Securities lawyers. The Sarbanes-Oxley reforms that followed the Enron debacle earlier this decade produced marginal investor protections—but generated tons of work for lawyers advising firms how to comply with the new

requirements. With even more new rules, new agencies, and an aggressive new focus on Wall Street, the Obama reforms could be an even bigger windfall for lawyers. Maybe he’ll regulate them next.

How To Find Gold In a Recession Economy The recession has hammered New York, yet the mood is upbeat in a midtown Manhattan classroom where struggling business owners have gathered to sip wine and swap business cards. "I'm going to bring my business to a whole new level," vows Valerie Bennis, whose company, Essence of Vali, sells natural health and beauty products. Orders from spas and hotels have dried up, but that's forced Bennis to seek lucrative new customers, like drug companies looking to expand their product lines. Matthew Frank, laid off from Goldman Sachs last year, is starting a consulting firm targeting local utilities—with hopes to land a couple clients by summer. Lauren Levy works at a big Wall Street firm that announces layoffs every week, so in her spare time she's helping a college pal start an infant-wear business. "The only way to go in a recession like this is up," she grins. Millions of American may feel like they're going in the opposite direction, yet for all the distress, recessions can also be a time of fantastic opportunity. Without a doubt, the Great Recession has triggered widespread pain, as companies from Wall Street to Detroit shrink (or die), jobs disappear, incomes decline and anxiety spreads. But in American history, virtually every period of economic upheaval has sundered bloated conglomerates, carved openings for hungry new competitors, rewarded aggressive innovation, and produced Adversity Millionaires. "There's always been a yin and yang," says Professor William Sahlman of Harvard Business School. "One person's crisis is another's opportunity." Famed economist Joesph Schumpeter first articulated the concept of "creative destruction" in the aftermath of the Great Depression. It's a pleasing theory that justifies the death of obsolete companies and industries, since in capitalism they're replaced by newer, better ones. The trick is making sure you're part of the creation, which is usually scarce at the beginning of an economic purge, and not the destruction, which tends to be everywhere. During the depression, for instance, thousands of businesses failed, and most that survived slashed spending and payrolls. Yet even amid the carnage of the 1930s, some determined entrepreneurs found the resources to start or build companies that later became powerhouses. HewlettPackard, Polaroid and Revlon were founded during the depression. IBM and RCA, formed earlier, expanded in ways that made them dominant in their industries. Chemical company DuPont faced a conundrum in 1930, when its scientists invented neoprene, a form of artificial rubber. The material's real-world potential was promising. But DuPont's revenues were falling, and with banks going bust or hoarding their cash and the future looking scary, it was tempting to simply put off investments. Yet DuPont increased R&D spending, and by the late 1930s brought neoprene and its cousin, nylon, to market. Within a couple of years the two materials were used in every car and airplane made in America, and DuPont was one of the most successful companies in the world. While competitors were hunkering down, says economic historian Tom Nicholas of Harvard, DuPont was hiring scientists and thinking ahead: "When the uptick came, they were ready to take advantage of it." One common attribute of those who succeed during difficult times is a shrewd grasp of the changes going on around them. And that requires unconventional wisdom. Today's headlines, for example, herald every arcane indicator suggesting the economy may be on the verge of a rebound. The prevailing cliché involves "green shoots" bursting forth from a fallow economic landscape. Many Americans, worn out from job insecurity and plunging household wealth, are eager to believe things will get back to normal before too long. That probably won't happen, even though the recession has already lasted a year and a half, which is much longer than usual. A recent Wall Street Journal survey of economists found that most believe the recession, technically speaking, will end later this year. But they also expect another 2 million jobs to disappear over the next 12 months, and they predict it will take years—not months—for the economy to fully recover. You don't need to be an economist to understand some of the fundamental changes transforming the U.S. economy. It starts with consumers like you and me, whose spending in recent years accounted for as much as 70 percent of all economic activity in the United States. That percentage is going down, and not because we're all suddenly as thrifty

as Ozzie and Harriet. When the housing bubble was inflating, people "saved" by investing in real estate and everything associated with it: Appliances, furniture, and home improvements, along with cars, boats and vacations financed with home equity loans. That wasn't entirely foolish. If you could earn 10 percent on your money by investing in your home, why accept 2 percent on a bank CD? As a bonus, we also got cool stuff while "investing" in our homes, and that spending kept the economy humming. Obviously real estate turned out to be a lot riskier than a bank account, and now consumers are saving for real. Economist Gary Shilling predicts that the savings rate, which bottomed out close to 0, will rise by 1 percentage point a year for the next 10 years or so. With more money going into banks and less into stores, economic growth will be stunted. "We'll have slow growth for the foreseeable future," Shilling says, "and housing will be dead for years." That should worry anybody counting on a return to the status quo. But it could be good news for people poised to benefit from a shakeup. Glenn Grossman, for example, seems to be cultivating an inverse relationship to the state of the overall economy. Grossman left a job with bond-trading firm Cantor Fitzgerald in 1999, shortly before the Internet bubble burst. With the stock markets deflating, no decent jobs surfaced, so Grossman started his own investment banking firm, the Dinosaur Group, in 2001. His goal was to create a modest, 1950s-style brokerage firm that took few risks and catered to small and mid-sized firms looking to raise cash. The boom years nearly killed his 50-person firm, which he runs with his brother and son. "The go-go years were terrible for us," says Grossman. Potential clients all wanted to trade in collateralized debt obligations and other flashy derivatives, which Grossman's firm shunned. Then the housing bust triggered a financial chain reaction, as trillions of dollars worth of CDOs and their ilk blew up, nearly bringing down the global financial system. In the aftermath, Dinosaur has been hiring talented bankers fleeing bigger Wall Street firms, and gaining clients who never would have bothered to return the firm's calls a few years ago. "If I can survive this crisis, it will be the best thing that ever happened to my firm," says Grossman. Other boutique firms are beginning to sprout from the rubble on Wall Street, perhaps one of the true green shoots to emerge from the financial meltdown. Small enterprises and individuals can benefit too, if they focus on where the economy is headed and not where it's been. Matthew Frank, the former Goldman Sachs employee, is targeting his startup, Aqueous Advisors, at water utilities because he figures there will be a lot of business there. "The pipes underneath the cities are rotting," he says. "There are $300 billion in needed fixes." Plus, the Obama stimulus spending could trickle down to such projects. Tearing up roads to fix old pipes may not be the most popular way to spend taxpayer money, which is where Frank hopes to help—his firm will help devise strategies for generating community support. And if the idea doesn't fly, Frank learned an important lesson in that Manhattan classroom, through a four-week seminar sponsored by New York City and the Kauffman Foundation, which promotes entrepreneurship: "If you're going to fail, fail quickly." If he does, there are plenty of other fields likely to welcome industrious workers with new ideas—recession or not. Sahlman of Harvard ticks off several. "There are enormous opportunities related to energy," he says, including solar heating, insulation, biofuels, and improving the electrical grid—all Obama priorities. Sahlman is optimistic about the prospect for science and technology to help solve problems like poverty and global warming. In retail industries, luxuries and extravagances are obviously out, but time-tested business strategies still hold. "The opportunity to compete on price with an acceptable level of quality will make you very competitive," Sahlman insists. Trying something new might even feel liberating. Lawrence Scheer, another participant in the Kaufmann program, was a Wall Street lawyer who hated his job, but loved the pay. Then the work dried up and he decided to start Magnificent Baby with his college friend Lauren Levy. Their merchandise, a line of innovative clothing meant to ease the contrivances of changing a baby, won't be ready until 2010. But forming a startup has given Scheer a new sense of purpose. "It's awesome," he says. "I feel useful." Scheer is realistic about his firm's prospects, acknowledging that even if it succeeds, it could take three years before there's enough revenue to pay two employees a decent salary. Meanwhile, he's living on his savings and thinking about teaching standardized-test prep courses to bring in some extra income. And his partner, Levy, is holding on to her day job as long as she can. That highlights another enduring lesson for people who want to thrive in good times and bad: Have a backup plan. Or two.

Why the Banks Still Aren’t Fixed

The stress tests are done. The results are better than feared. Bank stocks are up. A few large lenders, such as Capital One, US Bancorp, and BB&T, are even preparing to repay billions in federal bailout money. Sounds like the bank crisis is solved! Except for everything that could still go wrong. "Yes, everyone passed the stress test, but it was a questionable test to begin with," writes Charles Rotblut of Zacks Investment Research. "Foreclosures are still rising, credit card defaults will get worse, and, despite all of the analysis, nobody still knows how to value the toxic assets." The Federal Reserve, in fact, thinks the loss rate on loans at the 19 biggest banks could end up even worse than during the Great Depression. That doesn't sound like we're out of the woods. That sounds like we're trudging deeper in. Here are the biggest challenges the banks still face. Huge losses. The Fed estimates that the 19 biggest banks could lose up to $600 billion over the next two years. There are so many billions flooding out of Washington these days that perhaps that number doesn't seem all that large. It is. To put it in perspective, the 19 banks have lost a mere $400 billion over the past 18 months, yet that's been enough to drive Citigroup and Bank of America to the brink of insolvency, severely disrupt the credit markets, and trigger a deep recession that would be a depression in the absence of vast amounts of government aid. With the economy as fragile as it is, additional bank losses that are 50 percent worse than what the banks have already endured will continue to threaten the solvency of some banks. And the Fed's loss estimates are lower than others. There's a lot of pain still to come. Massive defaults. For most of the past 50 years, the loss rate on all bank loans has stayed well under 2 percent. The Fed estimates that over the next two years the loss rate could reach 9.1 percent. You know all those historical comparisons that end with "the worst since the Great Depression"? Well, 9.1 percent would be EVEN WORSE than during the 1930s. Still looking forward to a soft landing or a quick recovery? The Fed projects that the median loss rate could hit 8 percent on mortgages, 10.6 percent on commercial real estate loans, and 22.3 percent on credit card loans. A number of banks that made riskier loans face loss rates that are much higher. Banks can't just absorb losses of that magnitude and briskly bounce back. To survive, they'll have to sell assets, hoard cash, curtail lending, and simply wait it out. None of that generates economic growth. Wounded giants. The stress tests accomplished some important things, and one of them was giving healthy banks a pathway to repaying their government loans and getting back to business as usual. Unfortunately, some of the biggest banks are still in intensive care. Here are the four banks to watch: Citigroup, Bank of America, Wells Fargo, and GMAC. They account for half of all the assets of the 19 banks tested and 86 percent of the capital that the combined banks need to raise. And they've received about $133 billion in government aid, more than 60 percent of all the bailout money injected into banks. In other words, the nation's biggest financial companies are still in precarious shape, which will impede their ability to lend for months or years and soak up capital that would otherwise go to healthy firms. In the best case, that will continue to be a major drag on the economy. Those stubborn toxic assets. By pronouncing the banks healthy enough to muddle along, the Fed has in effect given a reprieve to banks that might have been on the verge of more dramatic action. That could affect the government's public-private investment partnership, or PPIP, Treasury Secretary Tim Geithner's plan to create a market for moneylosing mortgage-backed securities and other troubled assets that have become cement shoes threatening to submerge many banks. With home values plunging and foreclosures skyrocketing, the value of securities linked to mortgages has been in free fall. Banks could sell such securities for perhaps 30 cents on the dollar, but booking the huge losses that would ensue could trigger insolvency. So the banks are just sitting on their troubled assets, hoping that at some point their value will go back up. To many investors, regulators, and customers, that's the equivalent of deciding to set off a bomb tomorrow instead of today. The PPIP was designed to create a market for troubled assets at prices the banks could live with. But banks may be even less inclined to sell those assets now, since the stress tests have effectively bought time for the sickest banks. "The PPIP will probably be slowed, if not stopped," says Peter Wallison of the American Enterprise Institute, who's also a former top Treasury Dept. official. "Banks are much less likely to sell assets than before." If so, the thorniest problem in the whole banking crisis will continue to go unresolved.

More stress ahead. The Fed's stress tests aren't sacrosanct, and they could turn out to have been far too lenient. In the worst-case scenario, for instance, the unemployment rate for 2009 was pegged at 8.9 percent—which happens to be where it is now. With unemployment forecast to rise for the rest of the year, the average for all of 2009 is likely to be higher than 8.9 percent, which in turn would lead to higher default rates and even deeper bank losses than the Fed predicted. The Fed also scaled back initial capital levels for several stress-test banks, according to an enterprising Wall Street Journal story. The Fed reduced its requirement for Bank of America by $16 billion, for example, and its requirement for Wells Fargo by $3.6 billion. There may be valid reasons for the reductions. But wishful thinking has been a hallmark of the entire financial crisis. We may be guilty of it again.

4 Ways to Tell When a Real Recovery Has Begun You could conclude just about anything from the daily cavalcade of economic statistics. Some suggest an imminent recovery. Others seem to foretell years of gloom. The bent of the expert interpreting the latest news—bull, bear, Obama-basher, Wall Street-hater—has as much to do with the outlook as the numbers themselves. For the foreseeable future, there will be an aggressive hunt for two economic recoveries. One is the technical improvement in economic indicators that signals the economy is growing again. That's the one economists care about, which is why they scour the numbers on retail sales, business inventories, purchasing manager sentiment, subatomic inflation, the mood in Shanghai, and anything else that could help pinpoint the exact inflection point for a turnaround. The other recovery, the one that most consumers are waiting for, is the one in which companies stop firing and start hiring, banks return to normal lending, and families stop worrying about jobs and income. And that turnaround—the consumer recovery—is likely to take much longer to materialize than the technical recovery. The danger of hyping a technical recovery is that it will arrive, with much fanfare—but fail to make ordinary consumers feel better off. Many economists, for example, are predicting that the recession will officially end by this summer or fall. The only problem is that when a technical recovery begins, a lot of companies fail to get the memo. They don't play along; they keep payrolls lean and maybe even continuing to lay off workers. So to guard against false optimism, here's how to tell when a real recovery is finally kicking into gear: Unemployment improves. The single best indicator of the health of the economy is the job market. People who have lost their job, or worry that they might, obviously hoard their money and don't spend. That spells doom for an economy driven by consumer spending, as ours is. But once it's clear that jobs are coming back, consumers are more likely to relax and open their wallets. Projections about unemployment should make anybody queasy about the prospects for a recovery this year. The unemployment rate is currently 9.4 percent, a steep rise from one year ago, when it was an unremarkable 5.5 percent. And by most accounts, it's going to get worse. The International Monetary Fund expects the U.S. unemployment rate to be 10.1 percent in 2010. Economist Gary Shilling thinks unemployment will hit 11.4 percent and not peak until late next year. It's hard to imagine a "recovery" in which jobs are even more scarce than they are now. When the unemployment rate finally starts to go in the other direction, we can start to think about putting the umbrellas away. Until then, no number of upticks or volume of optimistic talk will persuade Americans worried about their jobs that they should part with precious cash. Housing prices stabilize. This has become a mantra by now: For the economy to get healthy, housing prices must stop falling. Problem is, the houses haven't been listening. Housing matters for two reasons: It represents a big chunk of the economy, and it's the largest single repository of Americans' household wealth. With prices falling, buyers are scarce, since nobody wants to buy an expensive good today if it's going to be worth less tomorrow. With few buyers, all the other economic activity that swirls around real estate—remodeling, appliance and furniture sales, relocation services—is depressed. Homeowners are worse off, too, because the value of one of their vital assets is eroding.

House prices have already fallen by 32 percent nationwide from the 2006 peak. And they have further to go. The latest readings on the S&P/Case-Schiller home price index, one prominent measure, showed another record decline in May. At some point, the declines will moderate and stop being records. But prices need to stop falling altogether, and probably rise, for a real recovery to happen. The Federal Reserve thinks home prices could stop falling in 2010, after a total decline of 41 to 48 percent. Other metrics, like housing starts and new-home sales, might point upward before then. Those will be signs of signs of a turnaround, not the real thing. Household wealth increases. The housing bust and the volatile stock market have hammered the traditional investment tools that most Americans use, causing epic declines in the wealth of Americans. Since 2006, household net worth has declined by about $12 trillion, which equates to about $107,000 of lost wealth for each of America's 112 million households. That's partly because of the 40 percent plunge in the stock market since October 2007 and partly because of the steep declines in real estate values. Americans simply own less, too. Home equity for the typical homeowner is just 41.1 percent, a record low. In 2002, it was 58.4 percent. Owning less means we owe more and will have to rebuild savings before we can spend like we used to. "This will be a drag on all discretionary purchases," says Dirk van Dijk, an analyst at Zacks Investment Research who thinks the tightfistedness will cut into the earnings of firms ranging from hotel chains to furniture makers to motorcycle manufacturers. Those are the same kinds of companies that need to start hiring again for a real recovery to develop. But they won't if sales stay sluggish. A turnaround will require sustained stock market gains and an end to the housing bust. President Obama stops fudging on the economy. There's still a lot that could go wrong, and Obama knows it. Yet part of the president's job is to reassure skittish Americans, even as his economic lieutenants are fighting battles in the war room. That's why Obama has been making half-hearted pronouncements, like saying that the economy shows "some return to normalcy" and that "we expect there'll be some stabilization of the economy." Virtually all of Obama's remarks on the economy contain modifiers and future tense and a not-quite-there-yet quality, since he'll blow his own credibility if he tries to convince Americans that they're better off than they actually are. When Obama starts hedging less, be happy. That will signal better days. Finally.

Why You’re Going to Save More, Like It Or Not Congratulations, America: You’re learning how to be thrifty after all. Now, for the sake of the economy, would you please cut it out? By now, we’re all getting familiar with the “paradox of thrift,” as famed economist John Maynard Keynes put it: Saving money is a good thing in general. It helps stave off unneeded debt and makes money available for investment. But the modern economy is driven by consumer spending, so people need to buy stuff if the economy’s going to grow. It’s especially destabilizing if everybody switches their habits all at once, and we flip from a nation of spenders to a nation of savers. Yet that’s what is happening. The personal saving rate—the amount of disposable income left after consumers are done spending—has surged over the last few months, hitting 5.7 percent in April. A year ago, it was almost 0. Since the early 1980s, when it peaked at about 12 percent, the saving rate has drifted down steadily, barely interrupted by recessions or other events. It even dipped below 0 in 2005, meaning that Americans, collectively, were spending more than they earned. Too much spending and debt is one of the reasons we’re in an economic pickle now, but Americans weren’t quite as profligate as the low saving numbers suggest. And the mismatch between saving and spending earlier this decade helps explain why spending will be crimped in the future, no matter how determined we are to splurge. It doesn’t show up in the savings data, but many Americans thought they were saving over the last few years—mainly because they were spending money on their homes. Under the prevailing wisdom at the time, home values always rose, so any money you socked into your home was an “investment” likely to produce a positive return. Just like savings. As home equity skyrocketed, the “wealth effect” led people to believe they were sitting on found money they could use for retirement, their kids’ college tuition, and everything else we typically save for. As a fringe benefit, they

bought countertops and appliances and stone for that new pool in the backyard, juicing spending and economic growth. People had similar attitudes toward the stock market, which rose handsomely from 2002 to 2007—at the same time interest rates on CDs and savings accounts were falling. It was logical to put less money in the bank, earning 2 percent, and more into investments likely to offer a much higher return. “What drove the savings rate down was stock price appreciation and housing appreciation,” Bruce Kasman, chief U.S. economist for J.P.Morgan Chase, said at a recent conference. “People spent on those because they thought it was like saving.” It helped that jobs were plentiful for most of that time, with the unemployment rate well below 5 percent. So if you lost your job you’d probably be able to find another one quickly, which made it less important to build a supersafe rainy-day fund. Obviously the prevailing wisdom was wrong. Spending money on real estate and stocks wasn’t the same as saving. The housing bust and stock-market rout slashed Americans’ household net worth by $11 trillion in 2008—almost $100,000 per U.S. household. We feel less wealthy, and in fact we are less wealthy. We’re also redefining what it means to save whatever money is left after paying the bills. Putting it into your house is out. The stock market has bounced back a bit in 2009, but it’s still down 40 percent from its 2007 peak—and far too risky for people with savings they actually want to keep. So we’re rediscovering old, boring ways to save, like putting money into CDs and insured bank accounts. And that includes new stimulus money the government is hoping will pump up the economy. Instead of spending the extra cash showing up from tax rebates and higher incomes (for those lucky enough to get a raise), Americans are saving most of it. For the next several years there are likely to be few alternatives. House prices are likely to be stagnant at best, and volatility will define the stock markets. With jobs scarce and likely to stay that way, building that rainy-day fund suddenly seems a lot more important. Interest rates are creeping up, meanwhile, making plain old bank accounts look like a reasonable place to stash your cash. A bit better than the mattress, anyway. Better savings habits will make consumers more secure. But they could also keep the economy in the dumps. Economist Gary Shilling predicts that the savings rate will increase one percentage point per year for about 10 years. Consumer spending, as a result, seems likely to fall from 70 percent of economic activity to 65 percent or less, which means slower economic growth, fewer jobs and even more conservative spending and saving habits. We used to envy our neighbors’ new acquisitions. Now we wish they’d make a few more.