Another Dip in the Road?

Since the economy torpedoed in 2007, the U.S., along with much of the world, has been suffering under the worst recession since 1930’s.  Unemployment is hovering around 10% and “real” unemployment exceeds 15%.  The recovery has been limited and the future is uncertain.

While predicting the future is a risky endeavor (I typically fare better when I make predictions after the fact), following is a marginally informed guess on our economic future for the next few years.


Part 1. Things we should have learned in school but weren’t paying attention.


The 2008 stimulus package helped avert a new Great Depression.  When, in 2007, the credit markets froze, business activity slowed to a crawl.  Without capital to fund business cash flow, purchases of inventory and business investment; financial activity around the world started grinding to a halt, causing a cascade of lay-offs and bankruptcies, which in turn, led to less credit, more lay-offs, more bankruptcies, in an downward spiral that wouldn’t have stopped for a long time.  We would likely have had 20% or 30% unemployment.  In fact, the only thing stopping a complete economic collapse was the steady infusion of money from government to pay for safety net programs, health care, public workers, etc.


So, the government’s actions – such as flooding banks with cash, taking over GM, creating stimulus programs – while unpopular, kept things from getting much, much worse.  And it’s clear that, if we want to return to full employment, further government stimulus will be necessary.  While, reducing the deficit at this point in time would send the economy further down.

And, no, the government is NOT like a family sitting around the table at night balancing the budget.  That’s a nice sound bite; maybe it’s a good vote getter; but it’s not true.

In the mid 1930’s, after President Roosevelt implemented stimulus programs, the economy started to grow again.  However, just as now, deficit hawks urged government cutbacks and . . . the economy quickly went downhill.

We did emerge from the Depression finally when the government pulled out all the stops and embarked on the biggest stimulus program in our history.  In the late 1930's, government stopped relying on the private sector to fix the economy and, instead, fully embraced . . . Socialism!   Government hired millions of unemployed people and spent billions buying lots of new clothing, food, vehicles, ships, etc.  We went hog-wild with the biggest deficit spending spree in history.  Our current deficit is 60% of the gross domestic product; but in the 1940’s, it soared to 150% of our GDP!  Even worse, our "robber" government increased taxes on the middle class and rich to unheard of levels.  Marginal tax rates for the very wealthy soared over 90%.

And, of course, the pundits' dire predictions came true.  The profligate spending of the 1940’s saddled the next generation and their children with crushing debt, from which they never recovered.  Government domination of the economy and high taxes completely destroyed private initiative and wrecked the economy.  By 1950, the country lay in utter ruin, people barely had clothes, lived in hovels and scoured the countryside for food.  It was the end of the great American experiment.

Well, not exactly.

Not even remotely.

Government went on its spending spree, increased taxes on the wealthy and we went from 17% to 5% unemployed in twelve months!  The Great Depression?  Fixed, solved and banished for two entire generations.  And after 1945, there was no collapse; in fact, the economy took flight for the longest period of continuous growth in our country’s history.

And the crushing deficit debt?  It faded away under a rapidly expanding economy – an economy, by the way, where the highest tax rates remained above 90%.

That profligate stimulus spending was, of course, World War II.  It appears that we can’t act in our own best economic interest unless it involves a really big war.  It’s politically just fine to deficit spend and increase taxes on the wealthy if we’re fighting a war.  But, otherwise, we can’t bring ourselves to do the things that would help us.

Oddly, an enormous, ongoing increase in stimulus funding could not only get the economy back on its feet; but could actually prepare us for a new round of growth and expansion.  Deficit spending used to improve our transportation system, advance our educational programs, and wean us off oil, could create a higher functioning, more efficient economy – a good thing, by all accounts.


Still not convinced?  Well, don’t tell China because that’s exactly what they are doing.  When the world economy took a dive in 2007-2008, China took a hit too.  But China learned from our experience in the Great Depression and embarked on an enormous, Keynesian, stimulus-spending program by building transportation, improving schools and migrating to alternative energy.  Guess who is going to come out ahead in this debate?


Part 2.  When the music’s over  . . .
~ Jim Morrison

Unfortunately, we don’t seem to be heeding the lessons of the Great Depression and, instead, are going down a very different path. Here’s what’s coming up in the near future and the impact it will have on us:

First, stimulus funding is OVER.  The old Congress had a difficult time passing bills.  The next Congress will do even less.  And incoming Congress members are clear that they will not support any new stimulus spending.

The 2008 stimulus funding, which kept local government and the economy alive, is winding down.  State budgets are in sharp decline and Legislatures are cutting billions in spending.  Some argue that’s a good thing; after all, what could be better than getting rid of bureaucrats?   Bureaucrats do not make up the bulk of state and local government workers.  These are mostly teachers, college employees, fireman, law enforcement, etc.  So states will be eliminating lots of those jobs, which will affect classroom sizes, the number of police on the beat, etc.  Cuts to Medicaid will affect hospitals, doctors, nursing homes and other medical providers.

Sick of all those road construction projects that are going on right now?  Well, not to worry, as federal stimulus funds dry up, we can say goodbye to those as well.  And while we’re at it, say goodbye to all those jobs that kept the construction industry on life support after the housing market collapsed.
Well, maybe we can live without a few teachers or construction workers.  But keep in mind, those newly unemployed people will stop spending as much money at the local Safeway and other stores.  As their numbers climb, business activity will decline.  If the cuts are severe, it could throttle the weak recovery.

Contrary to what the pundits say, we do not live in a “we’re all on our own, pull yourselves up by your bootstraps” world.  We are profoundly and intimately connected to and interconnected with each other.  When many of us suffer, we all suffer.  When most of us thrive, we all thrive.  This is not socialism; this is our reality.  And nothing demonstrates this interconnectedness more than the housing market.


Part 3. And I’ll huff and I’ll puff and I’ll blow your house down.
~ B.B. Wolf

It was the popping of the housing bubble in 2007 that led to the great financial collapse.  After being driven sky high by Wall Street’s funny money derivatives, the whole edifice collapsed in 2007 and millions lost their homes, millions more lost decades of savings and, of course, the world economy nearly collapsed.
Well, at least that part is behind us, right?

Right?

Well, not exactly.  In fact, not at all.

You see, there is a cloud on the horizon. It’s not exactly a secret; in fact, you can find mention of it inside the WSJ and NY Times.


Remember all of those toxic, subprime loans?  These were the loans given to borrowers who would never be able to pay them off.  These bad loans have mostly worked their way through the financial system.  People lost their homes, a lucky few were able to refinance, and most of these loans have been accounted for.

Unfortunately, the innovators on Wall Street didn’t stop with subprime loans.  In the mid-2000’s, they started promoting “Alt-A” and “Option ARM” loans.  These loans often had “teaser” rates.  Borrowers would pay low amounts – for example, interest payments only – for the first few years of their mortgage.  After 3-5 years, they would start paying interest and principle and their payments would increase . . . a lot.  Say, 30%, 50% or more.  Lenders assured borrowers that perhaps they would earn more income in a few years; or perhaps they could refinance in a few years.

A good plan, except that incomes have not gone up and you can’t refinance your home if you owe more than your house is worth.  And that’s what is happening now in a big way.  In fact, there is over $1 trillion in such loans that are coming due in 2011 and 2012.  As these loans “recast”, a few million people will be unable to pay their mortgages and many will foreclose.  More foreclosures means more banks need to sell more homes, and the glut of housing should drive overall housing prices down.  This will create a downward spiral where more and more people will find themselves “under water” – owing more on their houses than they are worth.  And, once again, as people lose their homes and their accumulated wealth, the effects will percolate through the economy dragging it down further.

This is an awful scenario, but there’s more to come.

It was not enough for Wall Street to sink the housing market and torpedo the economy; there was still more mischief to be done.  After making enormous profits on home mortgage loans and derivatives, they moved on to the commercial real estate market, introducing similar “innovations” there.  As a result, there is about $1 Trillion in commercial real estate loans that are at risk of defaulting in 2013 and 2014.

So, we appear to have a triple whammy:

1. The one thing to revive the economy would be stimulus funding; but this appears unlikely to happen. The existing stimulus funds are winding down.  As they peter out, state and local governments will make dramatic cuts to education, health and construction programs, further depressing the economy.
   
2. More toxic mortgage loans are about to come due, which will increase foreclosures, drive down home prices and roil the credit markets and economy.
   
3. Commercial real estate loans will go through similar turbulence in 2013 and 2014.  This will further disrupt the financial markets and lending will diminish, subjecting the credit markets to a slow freeze.

We can therefore expect a possible second dip to the recession with unemployment rising again.  If Congress cuts domestic spending as some predict, this will further weaken the economy.

It’s a sorry picture – one that implies long-term unemployment for millions, job insecurity for many, and considerable (and unnecessary) suffering.


However, it won’t be bad news for everyone.  Over the last 40 years, the very wealthy have gotten . . . well . . . very, very wealthy.  More wealth is concentrated in fewer people’s hands than ever before.  And those few people sitting on enormous amounts of cash will be able to clean up.

As housing prices plummet, you’d think that ordinary people would be able to buy those homes at really low prices.  However, this would not be the case.  Because, at the same time, the instability in the financial markets will make lenders scared or unable to lend.  The only people able to take full advantage of rock bottom prices will be those sitting on mounds of cash.  As they sweep up cheap homes and commercial real estate, two things will happen: 1) a growing percentage of Americans will become renters and 2) the accumulated wealth of much of the middle class will have been captured by the wealthiest sliver of society.


In other words, the rich will get richer.

The lights are dimming . . .

Another wonderful column from Frank Rich.  The last 4 decades have resulted in a steady hollowing out of the middle class. And lest anyone think this trend has abated, all signs point to it getting much, much worse in the coming years.  Here's why:
1)  The only real solution to the recession is for more stimulus funding.  Yes, I know that the pundits shriek about the dangers of the deficit; but they are flat out wrong - at least for the short term.  As we should have learned from the Great Depression, a national budget is NOT like a household budget.  Shrinking the deficit in the short-term will simply cause the economy to contract - a real disaster.  The only thing that ended the Great Depression was the largest deficit spending stimulus program in U.S. history - namely World War 2.  There's no technical reason we couldn't do another stimulus that strengthens our infrastructure instead of going to war.  But, sadly, the new elected Congress plans to cut funding.

2) The current ARRA stimulus spending is winding down; and states are starting to lay off workers, teachers, police, etc.  This will increase unemployment and have a further dampening effect on the economy.

3) Last, the media has barely mentioned this . . . but we are on the verge of a new foreclosure tsunami.  There is about $1.5 TRILLION in toxic loans (so-called Option ARMS and Alt-A loans) that will reset in 2011 and 2012.  As people's monthly payment suddenly increase, more homes will foreclose.  And, as banks try to sell off these properties at the same time, housing prices will drop again.  This will feed a vicious cycle where more people go underwater and walk from their mortgages.

Even worse, a 3rd sucker punch will occur when toxic Commercial property loans come due in 2013 and 2014. This will further roil the real estate industry and the economy at large.

The above factors will further destabilize the economy, leading to a second dip in the recession.  Unemployment will increase and this time, there will be fewer safety net programs (thanks to the new Congress) than in 2008-2009.  For example, workers will not be able to receive extended unemployment benefits.

But there will be a few winners.  Hedge funds and the top .1% superrich will sweep in and buy property at bargain prices - primarily because they will be the only ones with available cash.  (With so many people underwater, getting a mortgage will be even more difficult than it is today.)  In other words, those who destroyed the economy in 2008 will be the beneficiaries of the next economic dip and, in the process, will transfer what remains of middle class wealth directly to their own pockets.

In addition to the toll in human suffering, this situation will challenge the survival of this country's democratic institutions.  A citizenry with no hope for help from a non-responsive government will turn to more authoritarian figures to "fix" their problems.

There is a slight, but ever-dimming, chance that President Obama and Congress would take action to avert this situation.  It would require 1) enabling homeowners to refinance their mortgages to lower fixed rate loans to stabilize housing; and 2) passing a new stimulus package focused on strengthening our infrastructure and educational systems.  In other words, real investments in our future.  We already have the example of China which successfully avoided the recession by taking this second step.

Not likely to happen . . . but consider the alternative.

Nearer my God to Thee

Earlier this week, President Obama was asked about the huge bonuses for the heads of Goldman Sachs and CitiGroup.  His response was astounding and revealing:  "Well, look, first of all, I know both those guys. They're very savvy businessmen. And I, like most of the American people, don't begrudge people success or wealth. That's part of the free market system."  The President went on to compare the Wall Street bonuses to the extraordinary salaries of baseball players don't perform well.

His solution?  Give shareholders a chance to ". . . scrutinize what CEOs are getting paid. And I think that serves as a restraint and helps align performance with pay."

Hello?  Did Goldman Sachs earn its wealth and success?  Is torpedoing the economy no more serious than a ballplayer who had a bad season?  And last, does anyone really believe that "scrutinizing" CEO pay will somehow stop Wall Street bankers from awarding themselves obscene bonuses?

I wish this were only a matter of tone deafness, as Frank Rich suggested in this week's column.  Would it were so.  Sadly, after one year of this administration, there is no escaping the conclusion that, despite the soaring rhetoric, President Obama is continuing many of the practices of the previous administration:

• The election was barely over when he hired several of the architects of the global economic meltdown, from Larry Summers, who dismantled Glass-Steagall protections, to Tim Geithner who presided over the meltdown from his perch at the NY Federal Reserve.  Mr. Geithner's instincts are always to protect the interests of the monied elite.  He cleared every obstacle that might have stopped Goldman Sachs from receiving $20 billion in taxpayers' funds from a bankrupt AIG.  Goldman then had the astonishing chutzpah to grant those same billions as bonuses while claiming to be doing "God's work", as Lloyd Blankfein put it.

• This administration's affinity to Wall Street  is reflected in its foreclosure policies.  "Protect the bankers at any cost (to the taxpayer)" seems to be White House policy.  The administration's efforts to avert foreclosures have been a sad failure.  Banks have lowered payments for a few months for a few customers.  And, only 7% of that select group have had their mortgages permanently lowered.  Meanwhile the pace of foreclosures is quickening - nearly $1.5 trillion in mortgage loans are scheduled to recast in the next two years.  Soon the wave will become a tsunami unless aggressive action is taken.  The Fed must require banks to re-value their real estate portfolios to current prices and then require them to adjust the principal owed to reflect the new, lower value.   This would reduce the volume of foreclosures and investors would have greater confidence in valuations.

Regardless of intent, policy has tended to support powerful, corporate elites, while the rest of America continues to struggle.

After the Massachusetts Massacre

As always, Frank Rich's enlightened commentary is right on the mark.  President Obama has been handed a very full and difficult plate; but there have been some serious missteps.


Merely days after the 2008 election, he hired an economic team comprised of people who played a key role in wrecking the economy.  In 1999, Chief Economic Advisor Larry Summers teamed up with Sen. Phil "Americans-are-whiners" Gramm to repeal the Glass-Steagall Act.  And under Tim Geithner, Treasury became a principle employer of former Goldman-Sachs executives.  This team blocked any kind of real help for people struggling to avoid foreclosures and successfully funneled billions to the unrepentant bankers who now use the taxpayers' billions to lobby Congress and the Administration to make sure they never get regulated.


Most Americans recognize the blatant injustice of it all.  We see that Wall Street is populated by pirates whose rash actions hurt us all and who control our government and write the rules with impunity.


What would an alternative course of action look like?  A few ideas:

1. Remove the Wall Street insiders - they are too enmeshed with the power-brokers to get it.  Left to their own devices, they will tend to favor their brethren . . . at the expense of the rest of us.
    
2. Replace them with credible, skilled people like Simon Johnson, Volker, Reich, Stiglitz and Krugman.
   
   
3. Tax the Wall Street pirates.  Their reckless risk-taking won't stop until their wings are clipped.  And the simplest way to stop them would be to impose confiscatory taxes - say 75% tax rate after the first $50,000 in bonuses.  This single action would remove some of the incentive to over-leverage, would reduce the deficit and would let Americans know whose side the administration is on.  And, if they threaten to run away to work elsewhere . . . well, is that really a bad thing?  Again, their actions endanger all of us.  (Incidentally, the administration's proposal to tax the banks which pay excessive bonuses would be worse than doing nothing - the bankers will simply increase the fees they charge customers to pay the tax.  No, they have to tax the bankers' bonuses.)
   
   
4. The media is only now beginning to shed light on the new foreclosure tsunami.  A new round of foreclosures is ramping up as a new wave of toxic loans come due.  The Obama Administration - or a revitalized economic team - can simply stop homes from entering foreclosure unless there has been good-faith mediation between borrower and lender.  The administration can also simply stop loans from resetting so families that can afford their current monthly payments would remain in their homes.
   

These are the kinds of steps that would match meaningful action to the soaring rhetoric.  We are all waiting . . .