Why the Economy Could... Pop!

Housing is coming back. Banks are lending again. Energy is booming. A prominent Democrat argues that the U.S. economy is finally coming back to life

  • Illustration by R. Kikuo Johnson for TIME

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    FACTOR NO. 3


    About 70% of U.S. Economic activity comes the old-fashioned way: from consumer spending, on everything from autos to apparel to food. The consumer's mood and pocketbook have big impact on the whole country's growth and jobs. And that pocketbook took a tremendous hit in 2008, so much so that it has taken five long years for American households, in aggregate, to recover from the financial damage. Americans conserved cash to pay down debt, and this process pushed down their spending even further.

    It's hard to exaggerate the financial damage inflicted on consumers during the recession. Total net worth fell by $13 trillion, or 20%, from its level in 2007--a staggering loss. That hit came at a vulnerable moment when U.S. households were highly leveraged. When the bottom fell out, consumer debt had reached a remarkable 138% of income, a 35-year peak. Within a few months in 2008, household finances were crushed as asset values fell, millions of jobs were lost, countless credit cards were canceled and thousands of homes were foreclosed on. As the financial pressure on families reached acute levels, they had no choice but to cut spending and pay off debt.

    Five years on, households have finally repaired their balance sheets. According to the International Monetary Fund, household debt has now fallen back to 105% of household income, a ratio near historical averages. Further, Federal Reserve data shows that U.S. households spent only 10.5% of their after-tax income on debt payments in the early part of this year, the smallest portion since the Fed began keeping track in 1980. This reflects both lower levels of debt itself, given pay-downs, and lower interest rates on remaining debt, especially mortgages. The rise of the stock market has also helped, as has the turnaround in home prices. Other Federal Reserve data shows that household net worth recently topped $70 trillion, a record high, which means that the financial losses of 2008, as a whole, have been recovered. (Achieving this recovery in household asset values has been a primary goal of the Federal Reserve's hyperaggressive monetary policy for the simple reason that families need to feel financially healed before they will spend normally.)

    Americans are starting to open their wallets. Retail sales grew 5.7% in June compared with the same period last year. The consumer price index also strengthened in June, which suggests that demand is growing as Americans feel more optimistic about the economy. And consumer confidence is near a five-and-a-half-year high.

    FACTOR NO. 4


    In September 2008 the overleveraged and undermanaged U.S. banking system suffered a terrifying collapse. And that, in turn, nearly took the whole country down. Short-term, wholesale lending came to a stop, including from one bank to another. (Keep in mind that the core business of banking is to borrow at one rate, including through deposits, and lend at a higher rate. If banks can't borrow, they can't function.) So when banks got into trouble, lending to businesses and consumers essentially stopped and the whole economy cratered.

    Federal authorities mounted a huge and heroic intervention. The Federal Reserve's support for the credit markets reached $13 trillion at its peak, according to Bloomberg. The FDIC provided billions of dollars in federal guarantees on new, long-term borrowings by banks and finance companies. Congress rushed through legislation that established TARP, which invested another $475 billion in new stock issued by these financial institutions.

    The rescue worked. Slowly and, at first, unsteadily, banks began to borrow again on their own. Then the regulators initiated a sweeping restructuring of the industry. Capital and liquidity levels were raised through wide-scale divestitures of assets and sales of new stock at low prices. Balance sheets were further cleansed through aggressive write-downs of poor-quality loans and other assets. Improved disclosure practices were also imposed. Old leaders lost their jobs, and new management teams were put in place. It was probably the most successful rescue of private enterprise ever conducted.

    Today, most large U.S. banks have the kind of clean balance sheets we last saw 10 years ago. They are again generating large profits, and almost all have resumed paying dividends. Overall, this is now the healthiest banking system in the world, and it is lending strongly again. Total outstanding bank loans to business, according to the Federal Reserve, have reached $1.54 trillion, up 30% from their post-2008 low and just below their historical peak. Consumer loans already have surpassed their previous high and are growing at a robust 8% rate so far in 2013. A continuing soft spot is loans to small businesses, which is still $40 billion below the prior high. But overall, the lending recovery is boosting growth.

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