Great Recession Archive

The Storms on the Economy’s Horizon

By
Rob Shapiro
Published: November 19, 2009

The high economic anxieties that most Americans felt six months ago may have faded, but count me among economists who are still very concerned.  Sure, the last GDP report came in at 3.5 percent, and the next one should show comparable gains.  Virtually all of those gains, however, come from the temporary stimulus and unusual inventory corrections.  Once those factors run their course – mid-2010 for the stimulus and maybe earlier for inventories – a second dip down becomes very possible, and it could be even worse than the first.  And the main reason we remain so vulnerable is the series of political stumbles which have left largely unchanged many of the forces that drove us off the cliff.

Just today we learned that new residential construction fell again last month, while home foreclosures continue to rise.  It could hardly be otherwise: Washington has still done little to address the pressures from falling home prices colliding with rising mortgage payments, even though they were the largest single factor in the financial meltdown. We did warn that the government’s housing plan wouldn’t work:  A small government benefit to encourage banks to offer better terms to strapped homeowners couldn’t overcome the basic rule that anymore facing foreclosure becomes a poor credit risk, and banks don’t refinance mortgages for poor credit risks.  So, as jobs have continued to disappear and incomes fall, foreclosures continue to rise.  We could still declare a brief moratorium on foreclosures while putting in place some measures that might actually work – for example, directing Fannie Mae, which we taxpayers now own, to provide better terms to strapped homeowners whose mortgages are held there.

Washington also gave financial institutions hundreds of billions of tax dollars without ever requiring them to get rid of their toxic assets and reboot credit to businesses – and so, they largely didn’t.  Now, as foreclosures continue to rise, they face more losses from the mortgage-backed securities and their derivatives they still hold.  Those losses will continue to limit the credit flows needed to keep the economy going once the stimulus fades.  And that doesn’t factor in the increasing pressures on financial institutions from growing problems with commercial real estate.

And by the way, oil prices are up to $80 per-barrel again and headed higher if the dollar continues to weaken.  You may have forgotten, but it was the run-up in oil price in 2007 that actually triggered the recent recession, with the financial crisis coming a little later and making it so much worse.  If oil prices keep on rising now, on top of weak credit flows and anemic consumer spending, and the economy heads down again, its trajectory could well be even worse this time, since it will come in the context of already weak demand and high unemployment.

This possibility brings us to Washington’s largest failure of all – okay, the second largest after its astonishing incompetence dealing with the financial bubble and bust.  Throughout the last expansion, Washington sat on its hands as jobs continued to disappear for two years after the 2001 recession ended, and then finally began to grow but at less than half the rates seen in the 1990s and 1980s.  This political failure means that we now face double-digit unemployment for a long time, even if we manage to avoid returning to recession.

At least the administration and Congress finally are noticing the jobs problem.  What we don’t know is whether they’ll do anything effective to address it.  They have real options here.  For example, for the short-term, they can provide more money to states squeezed by falling revenues and balanced-budget requirements, so the states can keep their teachers, police and other employees working.  An even better idea would be to jumpstart new job creation by exempting the first few thousand dollars of wages from payroll taxes.  And they could pay for it with a small, Tobin-type tax on financial transactions.

What really scares me and some other economists, however, is the possibility of another large shock to the financial system.  For example, while it’s not likely, we could see a sudden collapse in the markets for securities backed by commercial mortgages.  The real nightmare on Wall Street, however, is an international crisis that suddenly drives up the dollar’s value.  That would present terrible problems, since much of the near-record profits being reported by Goldman “We’re doing God’s work” Sachs and others come from nearly a trillion dollars in complicated financial plays that depend on a weak dollar.

If this somehow should come to pass, Washington’s incapacity to deal effectively with the recent crisis will create very scary scenarios.  At a minimum, even President Obama’s legendary skills of persuasion won’t be enough to convince the public to bail out Wall Street a second time. It’s may not be too late, however, for the administration and the Fed to privately jawbone Wall Street to reduce this new risk exposure – and ours. Whether they’re willing to accept smaller bonuses, which usually come with less risk, could be a good test of whether they deserve to ever be rescued again.

A New Economic Strategy for Hard Times and Good Times

By
Rob Shapiro
Published: November 4, 2009

You might not know it from what passes for economic commentary on cable TV, but the U.S. economy remains pretty sick.   Last week’s report of 3.5 percent GDP growth in the third quarter seemed like cause to celebrate – until you looked more carefully at the data and saw that virtually all of the upside came from temporary government stimulus.  As the head of a revered British firm told a crowd of fellow CEOs in Washington the same day, “if we gave that many drugs to a dead man, he’d dance too.”    The next day, the report on personal incomes showed consumption continuing to slump, along with incomes.  In coming months, the media and the administration will trumpet more reports of “good news” which actually will provide little comfort to most American businesses and households.   GDP may grow even faster in the fourth quarter as the stimulus continues to run its course and businesses stop cutting inventories that already are down to the bone.   After that, we could yet face a second dip down, a possibility raised last week by Harvard economist Martin Feldstein.

We could even face more upheaval in financial markets already growing giddy again.  In fact, Nouriel Roubini, the NYU economist who warned us in 2006 and 2007 that the end of the housing bubble could wreck the financial markets, now sees a new bubble forming from trillions in new investments by financial institutions playing the declining dollar off of other currencies.  Moreover, he also sees an inevitable bust coming, with devastating new costs.  He’s certainly correct that currency plays are very risky, since exchange rates can turn unexpectedly on a dime.   That’s actually a variant of what happened to the Long Term Credit Management fund in the late-1990s.  The big bets placed by that single fund, and the liabilities of its Wall Street investors, nearly brought down the financial system.  What’s happening now is on a much bigger scale, and the underlying system is a lot more vulnerable.

If we do dodge Roubini’s latest bullet, the bad news eventually will run its course – though it probably will take at least another year, and longer than that for employment to recover.  By that time, it will be more obvious that we don’t have a national strategy to avoid another boom-and-bust cycle and produce sustained gains for most people.   It’s hard to face, but the Treasury and Congress have to give up their comforting assumption that the handful of financial institutions which dominate our capital markets are driven to behave in ways that ultimately produce good times for everyone.  In some periods, markets do work nearly as well as that – from the latter 1950s and through the 1960s, for example, and again in the latter 1980s and through the 1990s.  At other times, distorting new conditions bound the system, and markets go a little haywire.  That’s what unfolded in the latter 1920s and through the 1930s, again in the 1970s, and now it’s happening again.  So it’s time to retire the economic strategies of the last 25 years or so, which relied on efficient markets to drive those who run its largest institutions to work their will for everyone else’s benefit.

What we need now is a new debate over the terms of a new economic strategy.  One place to begin is by limiting some of the risks taken by institutions that dominate critical markets, which the rest of us also depend on.  It’s hard to do, because it’s very difficult to even measure and monitor those risks.  It also means effectively limiting the profits available to the society’s richest companies, and how often does that happen?

A greater challenge will involve facing up to the way that the fast-evolving global economy has undermined our capacity to create jobs and deliver rising incomes for most people.   It’s not about sending jobs to China.  Rather, it’s about how hard it’s become for many companies, facing intense competition from tens of thousands of new foreign and domestic businesses created in globalization, to raise their prices when their cost go up.  So as their health care and energy costs have marched up, they’ve cut other costs – starting with jobs and wages.  And whenever this crisis and downturn truly end, the intense competitive pressures that indirectly eat into the American incomes will be as strong as ever.

The debate has to begin with the recognition that in this period at least, markets won’t cure these problems.  If we truly want to restore steady wage gains, there will be no way to avoid serious government steps to slow future cost increases in health care and energy. A new strategy also has to acknowledge our only certain competitive edge in a global economy.  In the country where the idea-based economy took hold first, our companies and workers still do better than most of their counterparts elsewhere in developing powerful new innovations, adopting them across the economy, and adapting them to their own particular circumstances.   We have to generously fund both the seeds and the infrastructure of innovation.  And we should help everyone develop the flexibility demanded to operate effectively in innovation-dense workplaces, by funding universal opportunities for people to upgrade their skills and education every year.

Dr. Jagdish Bhagwati Kicks off New Econ Speaker Series

By
Dan Boscov-Ellen
Published: October 8, 2009

On September 8, 2009, Council on Foreign Relations Senior Fellow for International Economics and Columbia University Economics Professor Jagdish Bhagwati and Globalization Initiative Chair Dr. Robert Shapiro kicked off a new series on the challenges facing the American and global economies. Experts in international economics, Bhagwati and Shapiro discussed the impact of the economic and financial crises on international trade, the changing shape of the global economy, and the future outlook for the trade liberalization agenda. Watch the full video below:

Message to World at the G-20 Summit: Don’t Depend on a Strong U.S. Recovery to Bail You Out

By
Rob Shapiro
Published: September 23, 2009

This week’s U.N. General Assembly and the countless, private discussions between presidents, premiers and prime ministers will range from climate change to terrorism, but most of the leaders are more preoccupied with the outlook for their economies.  In this sense, the UN meeting is an opening act for the main attraction, the G-20 summit in Pittsburgh at the end of the week.  There, the leaders will focus on new regulation for global capital flows and the institutions behind them, with some good doses of finger-pointing at the United States.  (Christina Kirchner of Argentina, the world’s largest debt defaulter, couldn’t wait: She led yesterday with America-bashing at the UN.)   But the blame game is really a plea that the United States help pull the rest of the world out of its ditch.

America, with 23.5 percent of worldwide GDP – Japan is second at 8.1 percent, followed by China with 7.3 percent – is the only country with the economic heft to move other nations.   Much of our impact comes from our annual imports of $2.5 trillion, which help keep employment up in most other large economies.  If we could get our imports growing strongly again, the world’s finger-pointing would turn into high-fives.  But that depends on reviving American consumption and investment, and the outlook for that is mixed at best.

Washington’s optimists point to recent gains in a number of important indicators – but look closely, and they’re less encouraging.  Retail sales in August were up 2.7 percent over July, for example.  But that’s 5.3 percent below levels a year earlier, when things already were pretty grim.  It’s the same story with other measures.  Housing starts were up 1.5 percent in August, but down 29.6 percent from a year earlier; and industrial production was up 0.8 percent, to a level still nearly 11 percent below August 2008.  These are the numbers that led Ben Bernanke and Janet Yellen to caution that while the recession may be technically over, hard times could be with us for another year or longer.

The bottom line for most Americans is that the steep decline in the value of their investments and homes is driving them to cut back their spending and restore some savings.  Mostly, they’re paring down the record credit card debt they ran up during both the first stage of the recession and an expansion before it which didn’t produce income gains.  This spending slowdown is unlikely to change soon.   And as we have argued here for more than a year, jobs will probably continue to contract for two or three years after this recession ends, just as they did after the 1990-1991 and 2001 downturns.  It’s hardly a recipe for a recovery strong enough to lift U.S. incomes or the prospects of other economies.

Nor can we expect help from other countries boosting our exports.  Of our five largest foreign markets, U.S. imports are still falling in three of them (Canada, China, and the UK); and American imports in all five (Mexico and Japan, plus the other three) are still running 17 percent to 27 percent below their levels a year earlier.

What if the modest pick-up we’re seeing now only reflects the President’s stimulus package finally kicking in?  Republicans had some cynical fun a few months ago charging that the stimulus had failed, since everything was still headed down.  Now, it’s the Democrats’ turn, as its effects increase over the next several months.  The hard question is whether the economy will keep growing once the stimulus runs out.  The administration’s economic strategy depends on the stimulus triggering self-sustaining growth – by creating jobs, which boost spending and then, in turn, lead to more jobs, more demand, and finally more investment.   That’s also the basis of their financial strategy, hoping that expanding growth will bring down foreclosures and bankruptcies, easing the pressures on banks so they can lend more.

Their economic logic is perfectly reasonable; but it may be a long shot in the world where we now find ourselves.  And it certainly doesn’t take account of the possibility of yet another nasty shock to the economy.  The most likely candidate is an implosion of securities based on commercial real estate.  Price movements in commercial estate have been running 12 to 16 months behind those in residential housing.  So, they remained strong for more than a year after the housing bubble began to deflate – and then began to fall sharply in the last six months.  Now, more and more commercial developers can’t keep their properties sufficiently occupied to service the loans they took out to build them.  As they default, the securities and derivatives based on those loans also go bad.   It could be another very nasty hit, with most of the impact falling on the regional and local banks across the country that made the loans.  That’s why we’re already seeing a sharp rise in bank failures.

The good news is that the Fed and the Treasury have more advance notice this time, and they have a better idea of what works and what doesn’t.  The bad news is that at after what we’ve already been through, Washington couldn’t borrow the money required to manage the failures of large numbers of big commercial banks, with all of the fallout, without risking the credit of the United States.

There’s a good chance we’ll dodge that particular bullet.  But even if we do, the prospects for a strong U.S. recovery are slim, especially one strong enough to help the rest of the world.  And that will be the biggest, unspoken disappointment at this week’s G-20 meetings.