SDSU financial experts offer tips to ease financial strain in an economic downturn

We sold the cow for beans and the wolf blew down the house when we couldn’t afford the mortgage.

What fairy tales failed to teach us about economics, recession will.

The National Bureau of Economic Research determines when a recession occurs – or has occurred. Usually it is not declared until after the fact. However, the folk definition of recession is two consecutive quarters of declining gross domestic product (GDP).

SDSU finance professor Dan Seiver integrates the current
economic situation in classroom discussions every day.
Photo by Tom Farrington

We’re not there yet, but with a mortgage crisis and a credit crunch on our hands and inevitable decline in consumer spending looming, many economists say this is going to be one bumpy ride to grandmother’s house.

“Whether they call it a recession or not, if GDP falls in the first two quarters of 2008, and I believe it could, that’s bad,” said SDSU finance professor Dan Seiver, who authored the book “Outsmarting Wall Street” and publishes The PAD System Report. “Unemployment will go up, incomes will go down and some people will lose their jobs.”

Real problems

Fueled by historically low interest rates, housing prices tripled between 1996 and 2006.

Banking on increasingly valuable collateral, lenders lent money to people who might not ordinarily qualify for loans. Buyers took advantage of the new, cleverly packaged financial instruments (interest-only, pay-option and adjustable rate mortgages with low teaser rates among them) that allowed them to buy more than they really could afford.

“People were stretched; they had very little discretionary income left,” said SDSU finance department chair Nikhil Varaiya (pictured in banner). “They thought they could refinance later, but values plummeted and one thing after another went wrong. A perfect storm descended.”

According to SDSU finance professor Xudong An, real estate generates 70 percent of local government revenues, creates nine million jobs nationally and comprises 27 percent of GDP. Consumer spending, the largest component of GDP, is strongly influenced by the health of the real estate sector. Where it goes, so goes the economy.

Last year, as more people defaulted on their mortgages, foreclosures rose 75 percent. This drove prices down further by increasing supply and dragging down neighborhood “comparables.”

“Things are going to be soft, for sure, at least through the end of 2008,” Varaiya said.

Down the rabbit hole

In hopes of averting recession, the Federal Reserve has cut interest rates significantly and several major lenders are offering delinquent borrowers a 30-day grace period to work out foreclosure alternatives.

Additionally, a stimulus package proposed by President George W. Bush is making its way back to his desk after winning approval in the House and the Senate. The main component of the package is a tax rebate of $600 for individuals and $1200 for couples.

If approved, the checks won’t arrive until late spring, and economists are cautious about their potential to reinvigorate the economy.

“It’s not clear whether these government stimuli tend to mitigate the problems,” Varaiya said. “In order to answer that question, you would have to go back to a time when the economy was in a recession and the government provided no stimulus. Fiscal stimulus requires additional spending that increases budgetary deficits and that can adversely affect the economy in the long term.”

The largest component of GDP, consumer
spending, is heavily impacted by real estate.

While it’s more psychological than scientific, “bottoming out” has proved an important catalyst for economic improvement. When people feel the situation can’t get any worse, consumers re-enter the housing market and businesses resume hiring.

This process happened relatively quickly in recent downturns – in 1991-1992 and 2000-2002 – but economists say this time we don’t know exactly what’s down the rabbit hole.

The new financial instruments many people used to fund their home purchases – and subsequently defaulted – on were bundled into complicated, collateralized debt obligations and sold to banks. It is still unclear how much of this “junk” financial institutions are holding on to. As a result, banks are having greater difficulty obtaining loans.

“This recession would be different because we haven’t had this kind of major credit problem before,” Seiver said. “It’s not just the danger that consumers won’t spend, but also banks not being able to lend, and that’s a serious concern.”

SDSU experts share advice

When the foreclosure rate jumps and big bank losses make the news, you can be sure SDSU finance professors are discussing it in their classes.

“I tell my students that it is a bad time for the real estate market but it is a very good time for them to learn from others’ mistakes and get prepared for their future career,” said An, who teaches real estate finance. “Second, I teach them business ethics so maybe in the future we can avoid another mortgage market nightmare, like this one caused partially by shady lending.”

Even if none of Varaiya’s students turns out to be the next Federal Reserve chair, he says they can positively impact the economy by applying their financial education to make wise choices as consumers.

“I hope that we are teaching our students – as consumers and as people who may some day work in the finance industry – to be fiscally responsible,” Varaiya said. “I hope it would not be an SDSU finance graduate who sees these teaser loans and throws caution to the wind.”

With this advice from SDSU economists and alumni, you too can safeguard your money, relieve the financial strain and get back on track if you find yourself unemployed or about to be.

• Get back to basics. “Be prudent in your expenditure patterns. With respect to assets and the stock market, don’t rush into any decisions about getting in or out. It’s impossible to predict the markets on a short-term basis, and most investments pan out over the long term.” – Nikhil Varaiya, SDSU finance professor
• Ease your tax burden. “If your property value has significantly decreased from your purchase price, apply to have your property taxes reduced under Proposition 8. There are firms that will do it for you for a few hundred bucks, but it took me about 30 minutes to do it online myself.” – Dan Seiver, SDSU finance professor
• Monitor your spending. “Use the services that you are paying for or cancel them. For example, if you're not using your gym membership, cancel it. If you're not using most of the minutes on your cell phone calling plan, downgrade to a less expensive plan. Remember that you're spending after-tax dollars for personal expenses. Mid-range taxpayers need to earn about $1.50 for every dollar they spend on personal expenses. So to buy that $3 latte at Starbucks you might need to earn $4.50. – Jean Sinclair, College of Business Administration alumna and managing member of Avenue Advisors, LLC
• Take advantage of public programs. “San Diego has a wonderful career center network. They offer job search assistance, resume writing, interview skills and access to computers. They have connections with employers so they can find jobs that aren’t listed and get you back to work quickly.” – Cheryl Mason, College of Arts and Letters alumna and SANDAG senior project manager (formerly with the California Employment Development Department)
• Get credit while you can. “Establish a home equity line of credit as an emergency cash source while you are still employed; you probably won't qualify for one if you don't have a job, which might be when you really need access to cash.” – Jean Sinclair
• Get creative. “Remember, even the Depression ended eventually, and we're hardly in that bad shape yet. One of the most important skills workers need today is flexibility. Figure out how you can apply that degree in 14th century French philosophy to the business world to pay your rent. Learn how to translate the skills you do have to fit the job opportunities that are available. Creativity and optimism can help you turn even the worst setback to your advantage.” – Rick Brooks, College of Business Administration alumnus and a vice president of Blankinship & Foster, LLC

Related information

• National Bureau of Economic Research
• SDSU Finance Department
• Gross Domestic Product (GDP)
• Federal Reserve
• Property tax reduction

Credits

• Story by Lauren Coartney
• Story edited by Coleen L. Geraghty
• Graphics by John Signer and Jeff Ernst
• Photos by Tom Farrington