The number of bankrupted families reached 2,000,000 in 2005. The number increased to 5,000,000 during the second term of President Bush. Loan crisis is not limited to the US; it is a global issue.

One of the basic rules of finance is the distribution of risk. In classical terms, the investor should not put all his or her eggs in one basket. This golden finance rule advises investing in different sectors in a given economy, operating in different regions of a given country and conducting business in different countries in the contemporary “flattened” world.    

The principle of risk distribution is based on the assumption that not everything turns bad at the same time. At a time when one sector is in a dire situation, the other may be in good shape; or a country can make progress while another one is on the decline. For instance, in 1997, when the Southeast Asian countries were suffering from a severe economic crisis, the American economy enjoyed an economic boost. The strong American economy was the saver of these suffering countries. However, the rapid globalization made the economies all alike and interdependent. The homogenization of the world economies means the weakening of the principle of risk distribution. The problem of a particular country is not limited to its boundaries anymore. If this country is the US, the situation will most likely affect the entire world. American economy is the motor of the world. If this huge economy does not operate well, then other regions will have to suffer from severe tsunamis and tornadoes. Today, the correlation between the American economy and the other world economies is 80 percent. (Shapiro, 2005). This indicates that the US holds the economic fate of the world.

In 2006, one-fourth of the foreign trade deficit of the US originated from trade with China. Now think about a probable stagnation in the US economy and its impact on China. For this reason, China (and even Japan) does not want to take any risk and follow policies to keep the purchasing power of the American consumers alive. The Chinese production requires constant spending by the American consumers. For this reason, China artificially keeps the value of its currency at low levels despite severe condemnation by the US which described it as “currency manipulator.” To achieve low currency rate, China invests its export revenues on American assets. This increases the demand for the US dollar and decreases its value. A substantial part of the monies coming from China and Japan finance the American real estate sector. The remaining part is spent to finance the federal budget and private consumer loans. The monies coming from outside ensures the continuation of the American consumers’ dreams by keeping the US interest rates under pressure. The sweet dream of the US is the reason for happiness in the other countries. However, no matter how sweet it is; the dream will eventually end. The negative situation in connection with the risky mortgage loans market in the US has affected the other loan markets. Eventually the local crisis showed its impact on the world stock markets.        

In an effort to calm down the markets, the US Federal Reserve Bank decreased the interest rates by 0.5 percent. I think that the problem’s solution should be sought somewhere else, though the said measure worked out in the short run. The recent small crisis points to a deeper global problem: consumerism and loan madness. The US is the country that witnesses these two diseases in the deepest form. Today, the ratio between the savings and the incomes has decreased to minus levels in two decades. Such a situation was witnessed only during the Great Depression in 1930s. The inability to save was connected with deprivation in the 1930s; however, today the major reason behind the reluctance to save is consumerism and the tendency to finance this madness.    

To better understand the root of the problem...

In today’s world, the number of the states with budget deficit has so increased that the sector that emerged to finance the deficit turned into a huge service sector. Recently, banks broke profitability records in the US. The finance profits that increased the appetite of the entrepreneurs also appealed to the industrial companies and dragged them to this market. The incomes on the industrial companies in the areas that do not fall within their areas of activities in late 1990s exceeded the revenues from regular activities. Today, there is almost no reel company which does not finance the purchasing and renting activities of their customers and offer credit card services. In a sense, all are engaged in banking today. It is interesting to note that experts point to the finance company of the world automotive giant General Motors as the most valuable unit of the company. Competition became severe in finance market when the number of players proliferated. Because they have the power to negotiate and easy access to the fiscal markets, the companies are no longer profitable for the banks which now target the individuals. Today, people in America find a few credit card application forms in their mailbox every day. More than 20,000 companies marketing credit cards send out over 5 billion credit applications every year. It has never been so easy to get loans and profit from their benefits. Interestingly, the modern economies encourage consumption. Individual consumption constitutes 70 percent of the national income in the US. For this reason, the “take now-pay later” approach is the backbone of the consumption economy. The motive for George W. Bush’s remarks in his address immediately after the Sept. 11 events that the best response to the terrorists would be to continue their regular lives was the fear that the consumerist American people would give up on consumption, resulting in a huge economic crisis. Maybe the modern age terrorists who hit the twin towers considered it would be easy to destroy the US that way because they sensed the dynamics of the consumption economy. However, the initial response to this move came not from the armed forces, but from the financial circles. The cost of receiving loans and spending them was reduced to virtually zero; large sums of monies were injected into economy and checks were sent to people from the treasury (tax return). The policies to reduce the taxes and promote spending coincided with the growing need for additional funds to be used in the operations in Iraq and Afghanistan. It seems that the economic shock following Sept. 11 was considered more dangerous and the threat was confronted by promotion of consumption.

Such an easy loan environment inevitably led to some serious problems. If you consume extra energy every day, obesity is inevitable. Similarly, if you spend more than your actual income, bankruptcy becomes inevitable. In 2003, the average household credit debt was $10,000, consumer credit except mortgage loans $19,000 and federal government debt $66,000. The total debt per household except mortgage credits was $85,000. In 2005, credit card debt per head reached $5,000.

American economy in trouble

Of course, there is a price to be paid for the excessive use of “plastic.” About half of the credit card holders are able to make the minimum payments only; two-thirds have outstanding balances and pay monthly interests in high amounts. According to the famous finance website bankrate.com, the late payments penalties and the overlimit charges constitute 40 percent of the profits of the credit card companies. This indicates that the majority of the users are at the edge of an upcoming collapse and their financial situation will be ruined even in a small crisis. The number of families that sought federal protection against the creditors has exploded in the last decade. The number of bankrupted families reached 2,000,000 in 2005. The number increased to 5,000,000 during the second term of President Bush. Loan crisis is not limited to the US; it is a global issue. In many parts of the world, savings in the family budgets are very insignificant, triggering the consumption. This situation is simply alarming. Today, only one-third of the dollars in use can be found in the US; two-thirds is at the service of international trade. The other countries sell goods to the US in return for the US dollar; this way, the US exports its currency. The majority of these dollars do not return back. So, it will be fair to say that the US dollar is the most important export item of the US.  

The US, which issued monies in huge amounts following the Sept. 11 events, increased the level of liquidity in the world. The lowest cost of money instigated the tendency to spend. Because of the recent stock exchange crisis in 2000, the additional monies were spent in real estate market increasing the house prices. This time investors talk about an artificial price increase in real estate sector. The overvalued houses and the revived economy artificially made people confident and kept their tendencies to spend and receive loans alive. The families that exhausted their credit card limits started using their houses as ATM machines. They began purchasing the cars they had been dreaming of by mortgaging the overvalued house. The value of average home equity loans for the Americans is $30,000 whereas they are able to receive a loan amounting up to $200,000 takes only two weeks.  It could be said that the American economy has survived up until recently based on the consumer loans granted in consideration of the overvalued houses of the individual consumers. The banks, the most crucial institutions in the process, virtually found gold mines. The bank granting the house loan does not hold these loans on its balance sheets; it sells them to the investors. Of course it receives its own commission in the transaction. For banks, commission revenues are more important than interest incomes. Because it does not bear the last risk, the bank became increasingly ambitious.

As a consequence, they introduced more lenient criteria for loan review. Even those with no regular income are able to receive loans in high amounts. The high interest rate policy that the American federal reserve bank implemented to take the economy under control and combat inflation deeply affected the marginal owners of house loans. Americans with low income preferred house loans with varying interest rates because of the initial low rate. These kinds of loans start with low rates in the first years; but then they follow the average market rates. Because the interest rates have grown recently, the interest rates of the house loans also increased. Besides, the houses are not valued anymore. Today, the market price of the houses does not suffice to pay the house loans. Under these circumstances, people are unable to pay the loans and left with no choice but handing over the house to the bank. The banks, which put the house on sale, further reduce the prices of the houses making the crisis even deeper. One of the most important problems is that the majority of the home owners who had to hand over the house to the banks are black people. This indicates that the US will have to confront an important social problem in the near future.  The loan crisis in the US may have indirect impact on Turkey. Considering the low interest rates, a lot of Turks bought houses and upgraded their cars. A number of Turkish companies received loans in the US dollar because of the low interest rate. The international loans of this kind are generally based on fluctuating interest rate. If the crisis in the US rockets the US dollar interest rates, the interest rates in Turkey will respond to this with even a sharper increase. This will cause serious trouble for the consumers and the corporations. The debt burden of the state will further increase because of the increased interest rates; even more, the state investments may be seriously affected. However, because the impact of the American loan crisis on global markets will be huge, the central banks across the world will exert a coordinated effort. For this reason, reactionary attitudes in connection with panic should be avoided in the short run. The world money authorities increased the amounts of liquidity to deal with the crisis. Even though the monetary policies will offer short term solutions, the real solution will be offered by people, states and companies which will have to make reasonable spending in the long term. Naturally, the budget deficit cannot be permanent; it has to stop at some point.     

PROF.IHSAN ISIK*
Board Member of World Turkish Council Americas Committee
Rowan University Faculty & Founding Chairman and CEO of the American Turkish Chamber of Commerce (ATCOM)