The following excerpts came from an article I wrote for The Daily Campus in September of 2006; though it’s really just thinly veiled self-aggrandizement, I’d like to revisit a few comments and evaluate them in light of today’s economic situation.

“America is heading for an abrupt and rather unpleasant crash into a financial brick wall; in fact, it is already feeling the crunch. The housing bubble has been pricked and everyone is running for cover from the hissing sound. … But why is this of any concern to anyone other than those who invest in real estate? If a homeowner is not considering selling their house in the near future, why should they be concerned about falling house prices?”

We were headed for a crash, all right, but it turns out falling house prices were only the beginning of the problem. Financial firms’ vulnerability to these toxic securities was exposed once a few (thousand) went bad, counter-party risk went through the roof, Bear Stearns and Lehman tanked and here we are today. The worst part is that this won’t be the last time the complexity of modern finance will be underestimated.

“A tight financial spot is exactly where many of these homeowners now find themselves, but the homes that many thought would be their saviors are now the culprits. Rising house prices and subsequent spending cushioned the blow from the 2000 recession; in fact, American spending kept the world economy fairly buoyant after the economic downturn. According to The Economist, ‘The boom has lifted the economy in three ways: it has boosted residential construction; it has made people feel wealthier and so encouraged them to spend more and it has allowed homeowners to use their property as a gigantic cash machine, taking out money by borrowing against their capital gains. Merrill Lynch estimates that the three together accounted for more than half of America’s total GDP growth last year . . . The housing boom has also been responsible for one-third of all jobs created since 2001.”

These are sobering numbers when you think that American GDP growth could be cut in half just by the absence of this source of growth. Add in the negative effects occurring in the economy, the loss of job growth and the jobs that will be cut, and it becomes a bleak picture indeed.

“Being the world’s largest economy, the United States causes more than a ripple with any change in its economic situation. As aforementioned, spending in America padded the world economy when the rest of the world’s consumers were saving. This helped fuel the fantastic GDP growth of China and India, which in turn boosted oil and raw material prices. It also spared the international economy from a harsher recession.”

The biggest question now is whether those in Asia and Europe who have been saving will spend some of it, boosting demand in key places like China and India. If they do, it could significantly lessen the severity and duration of the downturn.

“America’s economic imbalances do need correction. Consumers need to spend less of their income and save more; the long-term health of the economy depends on it. If house prices slow dramatically, the Fed might be pressured to slash interest rates to support spending; this is what happened earlier this decade when share prices plummeted. To do so now would be a mistake. An economic jolt brought about by a decline in house prices is exactly what the economy needs to regain an even keel of spending and savings.”

Yes, Americans need to save more and spend less, and yes, it would be beneficial to future generations if we saved more now, but in the middle of a crisis the view tends to change. It took everyone by surprise how fast things went south. We’ve received a bit more than a jolt, and to not cut rates now would be the real mistake. With inflationary pressures such as commodity prices significantly reduced, the Federal Reserve and especially European governments have quite a bit of room to boost demand.

“The American consumer will feel a bit of a sting from the slowdown. Much like the initial shot of a vaccine hurts a bit, the economy will take a short term hit. But this is much preferable to a long-term terminal illness that poisons the system and is much harder to cure. A housing shock is a necessary evil that homeowners should reconcile themselves to and start preparing for immediately.”

It may be necessary but those who’ve been laid off or lost their savings will readily agree it is damn evil.

John is a junior finance and economics double major. He can be reached for comment at [email protected].