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The U.S. Economic Crisis: Root Causes and the Road to Recovery

Return to prosperity requires reversal of excessive consumption, low savings trends.

October 5 , 2009
by Gregory Brown and Christian Lundblad/Journal of Accountancy

Many attribute the beginning of the financial crisis to the collapse of the housing market. While the housing bust indeed plays an important role, particularly in the health and stability of the banking sector, the real problem is deeper. The fluctuations observed across real estate markets over the last decade or so simply reflect sizable macroeconomic imbalances. It is the nature of these imbalances that we must fully appreciate to better understand the crisis and to potentially forecast plausible scenarios going forward. At the broadest level, we have witnessed a consumption boom over the last two decades, where U.S. aggregate household consumption grew to represent more than 70 percent of gross domestic product (GDP), a historically and unsustainably high level.

Excessive consumption was fueled by a loosening of lending standards prompted by government policy to increase homeownership rates and accompanied by record low savings rates. Cheap credit from both home and abroad and a substantial increase in financial intermediation including new structured derivative products also contributed. In line with the private sector, the U.S. government also ran sizable budget deficits and a huge current account deficit.

Collectively, the expansion of credit yielded levels of U.S. household indebtedness and corresponding decreases in household savings, as a percentage of disposable income, that were also unprecedented. In other words, U.S. consumers and policymakers have been financed to a significant degree by borrowing from abroad (and, by default, from future generations). Simply put, the U.S. economy, financed by excess credit, spent more than it earned.

Structural Changes Are Required

The long-term implications of these factors are significant. Perhaps more importantly, a thawing of credit markets will not on its own portend a rapid economic recovery in output growth and employment. It is likely that the economy will not enjoy a healthy recovery until these long-run imbalances are rectified. In fact, given these long-run challenges, a swift recovery could be undesirable. If a rapid recovery merely reflects a temporary return to the levels of excess consumption and debt, we would only have delayed adjustments with a potentially larger economic cost down the road.

This article has been excerpted from the Journal of Accountancy. View the full article here.