The Coming Economic Crisis
This morning I posted a lengthy piece on BigGovernment.com entitled Economic Storm Clouds on the Horizon. I wrote it, to be frank, to sort out for my own understanding what I took to be happening economically. The starting point for my reflections was this chart depicting the trajectory of unemployment in each of the recessions since World War II, which first appeared on Business Insider and on Calculated Risk.
As you can see at a glance, what we are experiencing now clearly differs from the norm. The cause, if I am right, is that the current recession is less a consequence of the ordinary oscillations in the business cycle than of a growth over the last couple of decades in indebtedness on the part of home-buyers, consumers, investors, states, and municipalities so dramatic that, when the initial downturn took place, millions of Americans were caught short.
In some measure, of course, this happens in every recession. But rarely does it happen on this scale. The last such occurrence took place in 1929 after an extended period in which the Federal Reserve Board kept interest rates artificially low, and the prime cause of our current difficulties is arguably the easy-money policy followed by Alan Greenspan in the late 1990s and the early years of the current century.
In the circumstances, I argue, everything that the Obama administration has done – the “stimulus” bill, subsequent bills of the same sort, Obamacare – has made matters worse by aggravating federal indebtedness and reinforcing the desire of Americans to pay down debt and hoard money. In the process, if I am right, all that the government has done is to delay the day of reckoning and deepen the crisis.
As I point out, there are still something like 2.1 million houses in foreclosure. When the foreclosures go through and these houses come onto the market – and they will at some point in the next year or two – housing prices will drop further (especially, in California, Arizona, Nevada, Florida, and the like), and banks will have to stop pretending that all is well and recognize their losses. Then, even more Americans will discover that they owe more on their houses than these are worth, and they will be tempted to stop paying their mortgages and to abandon their houses – which will have further consequences for the banks.
At about the same time, Illinois, New York, and California will have to declare bankruptcy, restructure debt, cut salaries, restrict pensions, and lay off public-sector workers. Interest rates on government debt will then go up, and the federal government, which is overextended, will suddenly find itself in a fiscal trap. If I am right, we are by no means now out of the woods.
If you have the time and the inclination, take a look at the long version; and, if and where I am wrong, set me straight.
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Jun '10
Re: The Coming Economic Crisis
What's unique about America is our social (or class) mobility, but that mobility goes both ways. When the trend is upward, it creates lots of new service jobs, but that mobility can go just as fast the other way. That's what happened over the last two years. The only way to get back on top is to increase our productivity, and the only way to do that is with better education and lots of hard work. The formula hasn't changed. India and China are thriving today, because, for the last few decades they've been concentrating on education.
Oct '10
Re: The Coming Economic Crisis
I agree professor. We are in a negative feedback loop with every intervention resulting in an ever downward spiral. What is your perspective as a historian: Has a society with an economy on such a scale as ours ever pulled back from the abyss without experiencing war or a "dark age". What is our hope?
Edited on Dec 10, 2010 at 2:09pmNov '10
Re: The Coming Economic Crisis
"...more Americans will discover that they owe more on their houses than these are worth, and they will be tempted to stop paying their mortgages and to abandon their houses..."
This is a moral problem that should not be perpetuated. The existing laws that make it easy to walk away from an obligation are silly.
I maintain that two synthetic options have played into the current housing bubble which, had they been either not been available or properly priced, would have dampened the bubble substantially and perhaps prevented it altogether. They are the "put" option given by regulatory support to walk away from your obligations and the "call" option to refi at a whim without either notice or cancellation penalty. In other words, there are really no 30-year mortgages and there is really no obligation. This lead to asset price inflation as buyers entered the market who had no economic strength to be there.
Edited on Dec 10, 2010 at 2:19pmRe: The Coming Economic Crisis
Good Berean: I agree professor. We are in a negative feedback loop with every intervention resulting in an ever downward spiral. What is your perspective as a historian: Has a society with an economy on such a scale as ours ever pulled back from the abyss without experiencing war or a "dark age". What is our hope? · Dec 10 at 2:06pm
Edited on Dec 10 at 02:09 pm
I am a bit at sea historically on this one. We have weathered other fiscal recessions, and my suspicion is that we will do so this time. It will require facing the music, letting bankruptcies happen, selling off foreclosed houses at fire-sale prices, and severe cuts in public expenditures. If done right, all of this will be good for us . . . in the long run. Along the way it will be painful, and a lot of innocent people will suffer..
Jul '10
Re: The Coming Economic Crisis
You know, we talk all the time about government spending.
But to be candid, as you point out, a lot of the blame for our woes should go to irresponsible homeowners and consumers.
And I'm not just talking about the sub-prime crowd. It was very widespread.
I was in the mortgage business from 2002 to 2005. Every day, I dealt with solidly middle-class homeowners who wanted to do their third, fourth or fifth cash-out refinance in the space of a couple of years. As the illusory value of their homes grew, they rushed back out to milk their equity.
Though it was none of my business, I often inquired what they wanted to do with that cash. Rarely was the answer anything responsible like financing a child's education or paying down consumer debt. They wanted to buy new cars, go on vacations or build a new deck. And they were blithe about borrowing 105% loan-to-value.
I occasionally suggested that housing prices were probably going to fall, but it never made an impression.
Jul '10
Re: The Coming Economic Crisis
Nov '10
Re: The Coming Economic Crisis
Paul A. Rahe
along the way it will be painful, and a lot of innocent people will suffer.. · Dec 10 at 2:16pm
Are there any true innocents?
Oct '10
Re: The Coming Economic Crisis
Paul A. Rahe
I am a bit at sea historically on this one. We have weathered other fiscal recessions, and my suspicion is that we will do so this time. It will require facing the music, letting bankruptcies happen, selling off foreclosed houses at fire-sale prices, and severe cuts in public expenditures. If done right, all of this will be good for us . . . in the long run. Along the way it will be painful, and a lot of innocent people will suffer.. · Dec 10 at 2:16pm
I agree here also. We all need to grow up and take our licks. My fear is that our government will continue to forestall the inevitable and so prolong the suffering. I see similar impulses in society in dealing with the sick elderly. We just can't seem to let gramma and grampa die with peace and dignity. We must "rescue" them again and again to return to their torment in a stinking nursing home.
Jul '10
Re: The Coming Economic Crisis
"We just can't seem to let gramma and grampa die with peace and dignity. We must "rescue" them again and again to return to their torment in a stinking nursing home."
Talk them into a living will. And do one yourself.
May '10
Re: The Coming Economic Crisis
I quarrel with one aspect of this. One school of thought follows the Taylor Rule up one side of the hill and down the other, in blaming all of the troubles on easy money in the half decade after 9-11.
I join with many people, including a lot of solid conservative economists (Russ Roberts, Greg Mankiw, Gary Stern, many) in believing that it is not as simple as just "easy money". Somewhat too-easy money for somewhat too long a period certainly joined with many other factors in creating a perfect storm- but I really see the fact, still not corrected, that the large financial institutions are not subject to market discipline as thew primary problem. As Kenneth points out, easy money offered opportunity for profligate and irresponsible American Epicureans to behave more irresponsibly than usual, but these people overspend in general on current gratification, even when the conditions are less ripe.
Our bailout nation syndrome, to me, is the primary symptom and cause. And the public is actually rapidly reducing consumer debt, even as the biggest spenders - mostly governments- continue to pour charcoal lighter fluid on the tissue paper.
May '10
Re: The Coming Economic Crisis
I couple of my undergraduate friends were asking me how the job market was for engineers when I got out of college; these are people who are smarter than me and would probably be better engineers than most that I've known. I told them it was incredible, which it was: over 95% of my class had $55K+ jobs on graduation. Five years later and half can't find jobs anywhere. They'll be alright, they're creative enough to get something eventually, but none of them have any confidence in the establishment that's come before them. I know the Ricochet chorus will respond that they should quit crying and hang up a shingle because, you know, it's so feasible to start your own business in a recession. But I don't think every generation should be expected to hedge their bets or plan to put off their futures just in case the preceding generations send their country into an unprecedented spiral. You're right on, Paul, a lot of innocents will suffer, even after making the right choices.
Jun '10
Re: The Coming Economic Crisis
Watch California. It could be the point of singularity that sucks in the rest of the nation. It's doubtful that the Democrat-controlled legislature and Jerry Brown, who admitted during the campaign that he didn't have a plan to get the state's fiscal house in order, will be able to resurrect the state. I believe the state is already having difficulty enticing investors to buy bonds because of the state's risk of insolvency and credit rating collapse. I'm anticipating more foreclosures, more flight out of the state and possible unrest when austerity measures have to be imposed. And I don't think Congress (or should I say the Chinese) will have the inclination to bail the state out.
I am typically optimistic but until there's a concerted effort by everyone in power to face reality, stop the profligate spending, shut down agencies and bureaucracies that run programs that federal and state governments shouldn't be involved in in the first place then it's only going to get uglier.
I need to get my hands on Paul Ryan's plan and pore through it. It sounded promising when he sketched the outline of it.
May '10
Re: The Coming Economic Crisis
Same here, Brian, Christmas reading. Here's the pdf of his Roadmap, not sure if it's changed since January, and here's the CBO analysis, whatever that's worth.
Dec '10
Re: The Coming Economic Crisis
I wanted to upbraid you yesterday when you talked about a possible double dip recession. In fact, I was going to link to the same chart to prove this is no recession. We are in a full blown Depression.
Re: The Coming Economic Crisis
Duane Oyen: I quarrel with one aspect of this. One school of thought follows the Taylor Rule up one side of the hill and down the other, in blaming all of the troubles on easy money in the half decade after 9-11.
I join with many people, including a lot of solid conservative economists (Russ Roberts, Greg Mankiw, Gary Stern, many) in believing that it is not as simple as just "easy money". Somewhat too-easy money for somewhat too long a period certainly joined with many other factors in creating a perfect storm- but I really see the fact, still not corrected, that the large financial institutions are not subject to market discipline as thew primary problem. As Kenneth points out, easy money offered opportunity for profligate and irresponsible American Epicureans to behave more irresponsibly than usual, but these people overspend in general on current gratification, even when the conditions are less ripe.
Our bailout nation syndrome, to me, is the primary symptom and cause. And the public is actually rapidly reducing consumer debt, even as the biggest spenders - mostly governments- continue to pour charcoal lighter fluid on the tissue paper. · Dec 10 at 3:14pm
Thanks, Paul
Jun '10
Re: The Coming Economic Crisis
Thanks for the links Joe. Love your comment "...whatever that's worth." about the CBO analysis. They haven't exactly had a great track record with their prognostications.
May '10
Re: The Coming Economic Crisis
That's only half the picture, too.
At the same time that government is repeating all the mistakes that led into this mess, it's also making new mistakes. It has propped up unions around the country with money and political favors. Card Check might be on the way.
The Justice Department has demonstrated a willingness to ignore offenses by particular groups. Might the Black Panthers case have sent a signal to Obama supporters?
Meanwhile, Obama and his fellow tyrants threaten businesses with ever more regulations. It's not enough that they want to interfere in our lives, but they often don't clarify how they'll do so. Businesses don't want to hire while aspects of the new healthcare regulations have yet to be clearly defined.
The upcoming Republican House will help, but it won't protect businesses and investors from executive orders and agency-initiated regulations. We're pretty much guaranteed a dismal job market for the next two years.
I'm far from an economic expert, so I could easily be mistaken. But I see a slumped economy for many years to come. We'll be lucky if it doesn't get much worse.
May '10
Re: The Coming Economic Crisis
I wrote an essay recently on QE2 and the role of the Federal Reserve in the recession here if anyone is interested.
May '10
Re: The Coming Economic Crisis
The government is behind the profligate spending in the private sector. It does everything it can to reduce interest rates and credit exchange requirements, from using the Fed to purchase Treasury debt and lower the fed funds rate to prohibiting institutional lenders from discriminating against uncreditworthy borrowers. Consumers can only spend when someone is willing to give them money. The Fed is the single biggest perpetrator of out-of-control spending; without it, there would be no business cycle and no recessions.
Edited on Dec 10, 2010 at 5:27pmJul '10
Re: The Coming Economic Crisis
Looking at that chart, I would say we are in an Eames Chair depression.
Relax and enjoy.