US Recession Takes Root as Job-loss, Housing, Banking, Energy Crises Converge to Slow Growth

Crisis Policy Forum, Quipu Economic Forum ::

CafeSentido.com :: The United States is firmly in the thrall of a banking meltdown, in which the normal structures, the means of measuring performance, and the meaning of debt-holdings, are all out of balance. More than one Wall Street firm or investment bank has written of tens of billions of dollars in uncollectable debt. Financier George Soros has published a book on the Great Credit Crisis. Economic growth figures have been worrying, with some seeing federal figures as “nudged” upward to avoid playing into a downward spiral of apprehension.

We have spent a year now debating if the nation is in a recession, closing in on recession or if recession were unavoidable at any given point, and throughout, we have heard that “two consecutive quarters of negative growth” equals recession. In fact, recession officially hits when the National Bureau of Economic Research finds “a significant decline in economic activity, spread across the economy, lasting more than a few months”. A recurring decline in growth, though still growth, can coincide with the conditions of a broad economic recession.

We can ask, for instance, when is a real estate market “unhealthy”, and thereby at risk for a sudden or ongoing decline in values? It is commonly argued that not until prices are in decline and foreclosures on the rise is the market in poor shape. But the symptoms of approaching collapse can be seen in the boom time, when values are dramatically inflated and the “bubble” effect becomes apparent: values are too high to continue rising, given the wealth available to finance that desired expansion.

In January 2005, Café Sentido (then Sentido.tv) reported on the apparent real estate bubble inflating over the UK economy. The Economist magazine had predicted an imminent fall the summer before. The lesson should be that signs of ill health were visible, and treatment did not come in time. In November 2007, The Hot Spring examined in its Quipu Economic Forum the mounting economic troubles related to real estate inflation and ‘predatory lending’.

The US, over this period, has been relying on three phenomena to sustain the appearance of consistent economic expansion: unsustainable levels of outstanding credit debt, a housing price bubble and massive new military expenditures for the war in Iraq. Huge profits to oil firms, coming from a crisis-driving, stratospheric and ongoing price-rise, helped cover up serious weaknesses in industry and trade, and costs to other businesses reliant on low oil prices, undermined the sustainability of what growth there was.

Then, the steep decline of the dollar, worth today just 42.8% of its best value against the euro (in 2001), spurred tourism and US exports, helping to obscure the mounting crisis. But the decline in American wealth resulting from the dollar’s slide means less spending power for acquiring foreign goods. It also means the low cost of goods manufactured overseas is not as dramatically low for the American consumer, undermining the cost-benefit of manufacturing arrangements that have moved millions of jobs overseas.

According to The New York Times, house prices must fall another 10% to 15% before the market will recover, if we consider the trends seen in past economic crises. That continued fall is projected to last 3 years, before we see prices start to rise again, adjusting for inflation and for the real value of the dollar. The diminishing dollar value has been able to allow for prices and spending increases that appear to signal economic expansion, as spending increases, even as expansion had come to mean escalating consumer debt, and stagnant wages meant the economy was building itself into a trend of stagflation, in which wages cannot keep pace with rising prices.

Between 1985 and 2002, the average home sold for roughly 14 times the annual rent one could charge for that same property in that market. By 2006, that figure was 25 times rental, meaning that renting a property would pay it off only after 25 years, if one had zero interest over the life of a mortgage. So owning to rent was only 56% as sustainable as was the norm from 1985 to 2002.

With the average now at 20 times annual rent, there is still room for correction, and it is worth considering that reduced availability of wealth, mounting foreclosures and bank failures and overall job losses mean recession will likely bring over-correction. As the Times puts it:

With mortgages now hard to obtain and speculation no longer attractive, arithmetic has replaced momentum as the guiding force for housing prices. The fundamental equation points down: Even as construction grinds down, there are still many more houses on the market than there are people to buy them, and more on the way as more homeowners slip into foreclosure.

The government has had to rush a bailout plan for the two institutions that hold over half of all American mortgage debt, the government-chartered Fannie Mae and Freddie Mac, costing as much as $300 billion. That sum is intended to protect the solvency of institutions holding over $5 trillion in outstanding debt, and the plan comes immediately after the federal government seized Indymac Bancorp of California, potentially the largest single bank failure in US history.

Alan Blinder, a Princeton economist, has said “We haven’t seen this kind of travail in the financial markets since the 1930s”. Nouriel Roubini, an NYU economist, who 2 years ago predicted the housing bubble would lead to financial crisis and recession, predicts the financial fallout could reach $2 trillion in losses, more than 3 times the current dolor.

1930s stakes mean the need for 1930s action, and it may require a broad spectrum of new financial regulations before the worst is over. Already the free-marketeering Bush administration has imposed some of the most sweeping new regulations ever seen —giving the Federal Reserve leverage over Wall Street investment banks, via new loans, for instance—, in an effort to guarantee the solvency of major financial institutions considered “too big to fail” but which taken all together are also too big to be funded entirely by government money, were they to approach collapse.

The Times predicts 2 million jobs may be lost before the recession is over, but this is a survivable amount compared to the 20% of all jobs lost during the Great Depression. The labor market has been disturbingly slow for some time, however, with only 5 million new jobs created since 2000. The population of US citizens has expanded by 20 million since 2000, meaning job creation has lagged seriously behind economic necessity. And from 1992 to 2000, 22 million jobs were created by the information technology boom.

Another sign of trouble is the coming shortfall in consumer spending: the mortgage crisis is linked to the amount of cash-on-hand the average homeowner has because the rapid expansion of the mortgage markets over recent years has allowed spending well above real income levels. Average household debt reached 120% of income by 2006, having stood at 60% in 1984.

If the flow of new credit remains tight, and job losses and foreclosures continue mounting, there is no conceivable way the average consumer can continue spending at pre-recession rates. This will further strain banks, industry and the retail sector, as the well of consumer spending —70% of US GDP— goes dry.

The economic crisis we now face is a recession, at least. Recovery will be slower than we hope and we will likely see spasms of painful correction before we get close to a stable crouse toward reliable expansion across the whole economy. The question is not whether recession has hit, but which levers to pull to steer through it.

Joseph Eugene Robertson @ July 21, 2008