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Why It's So Difficult to Recover

It's hard to downplay how bad things were 10 years ago. The dot-com bubble burst, erasing $5 trillion of wealth faster than it was created. Decades of slowly eroding U.S. manufacturing jobs turned into a devastating burn. Enron and WorldCom collapsed amid fraud. And then 9/11 hit -- how does it get worse than that? What saps an economy is fear, and 9/11 produced lots of it. Not surprisingly, 2001, 2002, and 2003 saw far slower job growth than we've experienced over the past two years.

And yet! In the three years after 9/11, real consumer spending rose by 3% a year -- faster than the previous 20. Real GDP growth averaged 2.6% after 9/11, not far below the long-term average.

How did this happen?

The answer is straightforward: leverage.

One of the most incredible charts I've seen comes from the finance blog Calculated Risk. It shows what GDP growth would have been in the early 2000s without mortgage equity withdrawal, or the extra boost the economy got from homeowners using their homes as ATMs. From 2001 to 2006, as-reported GDP increased at an average rate of around 3%. Without mortgage equity withdrawal, however, that growth would have averaged less than 0%. Put another way, deprived of leveraging mortgages, the economy would have been in or near recession for most of the last decade -- just what one might expect when considering the hell left behind from the dot-com bust and 9/11.

All of this is coming back to haunt us today.

Easy come, easy go
The chorus over whom to blame for today's slow economy is mostly aimed at public policy, with a little hate left over for big banks like Bank of America (NYSE: BAC  ) and Citigroup (NYSE: C  ) . "[President Barack Obama's] policies are not creating the necessary jobs, and he has no plan to do anything about it," said presidential contender Tim Pawlenty last week. For his part, Obama has reckoned that Republicans "drove the car into the ditch."

Neither is entirely fair. Public policies often have lower impacts than some think. The correlation between tax rates and jobs growth, for example, might seem straightforward at first thought -- higher taxes equal lower job growth -- but such a relationship is elusive when looking at the data. "Government gets blamed too much," Warren Buffett said last week, "and it may get too much credit when things do improve."

Policies can and do make things worse -- the Great Depression is the best example. But by far the biggest driver of economic success over time is productivity growth and population growth. The good news is that both tend to be fairly consistent over time and, for the United States, rising rapidly. Economies, like stocks, have intrinsic drivers, or the real worth once all the noise is stripped away. For stocks, that value is earnings. For economies, it's productivity and population.

Intrinsic drivers guide long-term results, but what happens in between is erratic. The reason stocks went nowhere over the last decade was not because earnings -- or intrinsic value -- stagnated. Indeed, earnings grew quite nicely throughout the decade. But returns that should have been spread out between 2000 and 2010 were experienced all at once between 1995 and 2000. From 1995 to 2010, investors achieved a very nice average annual return driven by fairly stable earnings growth. Those 15-year returns just happened to be frontloaded into a five-year period in the late '90s. It's as if we had average rainfall for the year, but got there by a one-day flood followed by 364 days of sun.

Economies go through the same phenomenon. The reason our economy is stagnant today is not because its intrinsic drivers are crumbling -- productivity and population growth are fairly strong. It's stagnant because what should have been a slow economy last decade frontloaded a boom by robbing growth from today. GDP growth should have been flat last decade; instead it was 3%, driven almost entirely by leveraging real estate. Growth should be decent today, but it's not because we're paying for last decade's frontloaded boom by paying off debt.

This is simple stuff, but gets ignored too often. Growth isn't slow because of public policies; it's slow because we're deleveraging. Growth won't return when someone else is elected into office; it will return when we're done deleveraging. That won't be this month, next month, or even next year. At current rates, it'll be several years at least. That's why it's so hard to recover today. Don't blame current policies. Blame past choices.

Fool contributor Morgan Housel owns B of A preferred. Follow him on Twitter @TMFHousel. Try any of our The Fool owns shares of and has opened a short position on Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (13) | Recommend This Article (45)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 15, 2011, at 4:33 PM, mracz425 wrote:

    Good article!

  • Report this Comment On July 15, 2011, at 5:08 PM, CMFStan8331 wrote:

    Succinct, articulate and very well-reasoned, as we've come to expect. Unfortunately, neither our politicians or the public they represent will want to hear it.

  • Report this Comment On July 15, 2011, at 5:13 PM, medicalquack wrote:

    Come on folks let's get with it beyond past year comparisons and talk about those "algos" and our love for them as a nation. I used to write the darn things and they are powerful as some give accurate results and others are created for "desired" results and it's hard to tell the difference today, especially when you come along and build another level on top of one "desired" set of formulas, it's gets distorted and the first algos are hidden to a degree.

    We need balance and the algos are not all bad but they are not all good either:) I wrote about one set of bogus algos created y FICO that is being sold to help insurers and pharma determine who's going to take their medications...bunk...we have a mismatch here and another case of "everyone selling their ass off" if you will, but there's plenty more where this came from sadly.

    People get confused and distracted and shoot it's easier to create the next level to show studies on these mismatches and then boom we have "it must be so I read it in a study" and the over dependence on what we "think" are the experts. There's enough in the news today with "experts" and there are some real ones, but the bogus folks are starting to show up as we track back.

    We need a better balance of "algos" and tangibles and people still create tangibles last I looked or have a big part in it, but the algos build on each other and don't require many humans, so think is why gold is so popular, it's tangible we can hold in our hand, unlike an "algo".

    There's a place for both but we are just not balanced right now and if we had our senses about us and look at what banks are putting out as far as values on intangible social network values, we can see it this time, but during the mortgage era we were not that advanced to be able to see behind the scenes.

    We have some smart technology that can help the processes but don't have lawmakers that will use it, so thus the unintended consequences are not measured nor is a decision simulated with biz intelligence software and they throw darts the board I think.

    That poor gang of six can't get any satisfaction and the financial sector is exploding way past where healthcare and science is today with technology so it's dull knives trying battle machine guns if you will. The job won't be there until we have more manufacturing come back and grated they will be different jobs but we can learn if we want to.

  • Report this Comment On July 16, 2011, at 12:24 PM, rgperrin wrote:

    This analysis, which is reasonably well argued, represents one point of view among many others, some already existing, some possible. As such, it is not a definitive account of the events and circumstances in question, but a plausible interpretation of them and, consequently, a basis for cautious extrapolation. Certainty in such matters in never achievable.

  • Report this Comment On July 17, 2011, at 7:16 AM, xetn wrote:

    "Policies can and do make things worse -- the Great Depression is the best example. But by far the biggest driver of economic success over time is productivity growth and population growth."

    I would argue that the biggest driver of economic success is saving and investment; both of which contribute to capital formation. Government consumption removes much of that capital.

    You also fail to include the Federal Reserve in your theory of what contributed to the "boom".

    Perhaps you would do well to understand the "Austrian Theory of The Trade Cycle" which substantially predicts boom/bust cycles and explains their causes. It was first proposed by Ludwig von Mises and later expanded by Nobel winner FA Hayek.

    You can read all about it for free:

  • Report this Comment On July 17, 2011, at 4:12 PM, Wood1024 wrote:

    We should blame past choices of an easy and loose FED led by Greenspan and Bernanke, Greenspan’s old lieutenant. It didn’t hurt that public policy was extremely favorable too. The Community Reinvestment Act suggested that banks and mortgage companies should give mortgages to people who used to not qualify for loans and now these debtors look like they cannot ever pay them back. It was also helpful that Fannie and Freddie backstopped the crazy mortgage market even though underwriting standards (or lack thereof) overall were the most lax in the history of mankind. If these weren't purposeful public policy choices I don't know what public policy is!

  • Report this Comment On July 17, 2011, at 10:01 PM, hawkise wrote:

    We shaved off this peak to fill in the last canyon. Simple as that. (along with the reducing of personal debt and the uncertainty of the cost of hiring)

    It is not one party's fault or one party is the salvation but Prichard, Al whom has defaulted on their pension payments can show an example in micro of what will happen.

  • Report this Comment On July 17, 2011, at 11:46 PM, jekoslosky wrote:

    Interesting piece, Morgan. Always nice to see put things into context and explained simply like this. (Even though there may be no single, simple explanation.)

    Getting back to saving and spending within our means seems to be a healthy thing in the long run. But in the short term, it's going to contribute to the pain.

  • Report this Comment On July 18, 2011, at 9:35 AM, jpdal09 wrote:

    Excellent point xetn, The FED was created to elimitnate the Boom/Bust cycle but all it really did was make each cycle longer and more severe.

  • Report this Comment On July 18, 2011, at 9:52 AM, ETFsRule wrote:

    "jpdal09 wrote:

    The FED was created to elimitnate the Boom/Bust cycle but all it really did was make each cycle longer and more severe."

    This is factually incorrect. Before the FED was created, boom/bust cycles were much more severe. If you study economic growth during the 1800's you will see this for yourself.

    Since the Fed was created, we have only had 1 "depression" (or maybe 1.5 if you want to count our current malaise).

    In the 1800's we had several depressions and many very severe recessions. For example the railroad industry had a lot of bubbles, and each time they popped, it completely ruined the economy. You can learn about this here:

  • Report this Comment On July 20, 2011, at 10:43 PM, ynotc wrote:


    Your right public policies like spending more than we have by a factor of 50% have little effect on the economy. I am sure once individuals pay thier debts down everything will be fine

  • Report this Comment On July 23, 2011, at 3:04 PM, Classof1964 wrote:

    Public policies have to play a bigger role than suggested. We had tax policies and constraint of Congress' propensity spend borrowed money that in the 1990s led to huge surpluses. Then we had the Bush multiple tax cuts that effectively bankrupted the federal government over the last decade, given the two unfunded wars and the unfunded drug benefit passed to take an issue from the Democrats in 2004. So here we are today, the Federal Government receiving the historically low rate of 15% of GDP and spending about 25% of GDP. Furthermore, after the reckless libertarian policies of the Bush Administration, SEC, and the Fed, we got a near Depression, that significantly reduced Federal revenue and significantly raised Federal outlays for unemployment insurance, stimulus, and TARP. So what did we have after the dotcom bubble, a phoney expansion based on reckless borrowing at all levels from consumer to Congress. Now what do we have, $7 trillion lost in 2007-2008 and probably a decade before the country deleverages and realizes the Tea Party extremists will only be hollowing out the middle class and trying to deconstruct government, which can and does much to bring some equality and a more level playing field to what is emerging as a new plutocracy of Robber Barons.

  • Report this Comment On September 24, 2011, at 6:21 PM, walt373 wrote:

    I think you hit the nail on the head. Great article.

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