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Paul Krugman’s blog post Bailout for Bunglers was instructive. I particularly liked the end:

“There’s more at stake here than fairness, although that matters too. Saving the economy is going to be very expensive: that $800 billion stimulus plan is probably just a down payment, and rescuing the financial system, even if it’s done right, is going to cost hundreds of billions more. We can’t afford to squander money giving huge windfalls to banks and their executives, merely to preserve the illusion of private ownership.”

Though I agree with Paul Krugman, I think somethink is missing. We need to identify the cause of the recession before we can put forward a recovery package.

From the perspective of business and economic processes, two processes collided in 2005-2008 time frame that resulted in our current recession. The first was the bursting of the house price bubble, and the second was the oil price spike.

The figure below depicts US Home prices up to 2005. House prices peaked in 2006 and started to decline.

shiller_ie2_fig_2-1

Source: Robert Schiller’s United States Housing Bubble (Wikipedia)

The two figures below show average monthly oil prices (Dec 07 to Jan 09) and average yearly oil prices (1967 to 2009).

yearlyavgoilprice

monthlyavgoilprice

Source: OPEC


Conference Board tells us that the average per capita discretionary income in 2006 was $9,148 or gasoline cost was went up from 11.5% (2005) of discretionary income to 26.9% ( 2008 ) (using 2006 discretionary data for all years). A sizeable increase. But this does not tell the whole story.

For households with incomes of $50,000 or less, i.e. small business employees, the 2006 discretionary income was $1,900 for the whole family of 2.7 people. That is, gasoline costs went from 55% (early 2005) to 90% (mid 2006) to 130% (mid 2008). Definitely not sustainable.

Given that the initial toxic mortgages were Alt-A/Subprime loans, and my guess, is that most of these borrowers were small business employees, the gasoline price spike would have killed off these borrowers’ ability to service the loans. No payments resulted in deliquencies, defaults, suffocated demand and finally home price depreciation, and further time-lagged domino effects that scuttled the banks and the rest of the economy.

House prices only started to fall in 2006 when gasoline prices had become unsustainable.

Looking at the graphical data, we can now infer that gas prices at the pump must remain below $2.00/gallon, if the US economy is to come out of this recession any time soon. This is a very important lesson, gasoline prices wiped out a substantial portion of the discretionary income of about half of the US working population.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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