East Coast Economics

When Will Things Get Better?

with 5 comments

Two days ago President Obama signed the 2009 stimulus package into law, committing an additional $787 billion to supporting the American economy.  A number of banks – JPMorgan, Citigroup, Bank of America and Wells Fargo among them – have agreed on temporary moratoriums on foreclosures. Weekly mortgage applications jumped 46% last week, and (as noted in my last post) a variety of indexes seem to be slowing their decline.  Credit Suisse recently suggested that the  much-bemoaned US debt to GDP ratio might not be in as bad a shape as commonly assumed. Yet the S&P500 lost -4.6% the day President Obama signed the American Recovery and Reinvestment Act, and the Dow Jones gave up -3.8%.  As of February 18, the Dow Jones has lost roughly 14% for the year.  I have no idea when equities are going to see a bottom or when the economy is going to reach a turning point.  I do believe, though, that there are certain prerequisites to be met before a lasting recovery can begin:

1) We need some signs that the stimulus package is working.

In their January meeting, the minutes of which were published yesterday, the Federal Open Market Committee once again reduced their 2009 growth projections.  The consumer confidence index stood at 37.7 in January, its all-time low since inception of the index in 1967.  I think that consumer and investor confidence will only tick up again as the tax cuts and spending programs of the $787 billion stimulus package (hopefully) prove their effectiveness over time – per the Congressional Budget Office’s estimates the stimulus will add somewhere between 1.1 and 3.8 percentage points to real GDP in 2009, and have an effect of similar magnitude in 2010.

Take a look at the charts below for a breakdown of the stimulus package, and an estimate from JPMorgan showing the sizing of tax breaks and spending quarter by quarter.  Please note that the JPMorgan graph dates to the first week of February and is thus not a fully accurate reflection of the stimulus package that was passed on February 13.

stimulus-package

gdp3

2) Systemic threats on both the national and international level need to be resolved.

Temporary calm returned to the US markets in December of 2008 after the government committed to “doing all that it takes” to thaw credit markets, stabilize the financial system and revive the economy.  Talk of an impending collapse of the US financial system subsided as it became clear that the government would do everything possible to prevent another Lehman disaster.  I believe that we need a similar commitment from the EU regarding the escalating situation in Eastern Europe, and from the US government and banks regarding the prevention of potential systemic shocks such as a large-scale municipal default (think California which just managed to corral the last vote needed to resolve the budget impasse) or a spike in mortgage defaults triggered by a wave of simultaneous interest rate resets.

cs-rate-resets

3) We need to recalibrate our expectations regarding homeownership, leverage and GDP growth.

It seems that by now both Wall Street and Washington and have understood that we can’t go back to “business as usual” – i.e. our pre-crisis reality.  For a while to come, banks and hedge funds won’t be as leveraged as they were over the last decade.  American automakers need to revamp their business models.  I personally don’t believe that almost 70% of households in the US can afford owning a home (stay tuned for a post outlining why).  I don’t think that a personal savings rate in the zero to three percent range is sustainable.  And I don’t see how increasing reliance on debt – both private and public – can continue to drive GDP growth going forward.

The charts below show the US debt to GDP ratio (the revised version from Credit Suisse) over the last 100 years, the growth of GDP compared to the increase of productivity in the US since 1965, and the development of homeownership over the same period.   Looking at these long-term trends, I believe that we’re in for a prolonged period of pain – after all, the stimulus package addresses the symptoms of the crisis and not its causes: leverage is shifted from private to public, instead of being reduced; homeowners who can’t afford their homes are receiving support to avoid foreclosure.

householddebttogdp

gdp-productivity

homeownership1

What do you think needs to happen in order for things to get better?

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Written by eastcoasteconomics

February 19, 2009 at 12:16 pm

5 Responses

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  1. the stimulus is a bad idea

    John Kim

    February 19, 2009 at 3:17 pm

  2. Politically, the relief program makes sense for the government. Who wants to see teary stories of families on the street because of the mean old lenders (regardless of the fact that these people are a miniscule pepcentage of foreclosed homeowners) But what’s wrong with foreclosures? It’s a risk clearly acknowledged by the borrower that uses leverage to seek future gains. If the goal is to relieve the lenders from the burden of going through expensive foreclosures – then concentrate on reducing these costs! Make lending profitable again. Eventually, someone will have to step in and change the whole system of incenting speculative residential home owners.. for example, they could stop the subsidies stemming from mortgage interest tax deductions.

    Dennis Kogan

    February 19, 2009 at 9:06 pm

  3. In general, any spending is going to stimulate the economy to some degree. The real question is what the multiplier effect is. If it is less than 1 then we don’t really get any bang for the buck. Estimating a multiplier on a trillion dollar bill is a pretty hard thing to do, and I suspect the variety of forecasts would fall along political party lines. [Personally, I would have advocated for a variety of smaller bills, each targeting a specific cause].

    As was mentioned in the post, the real issue here is one of leverage. It seems to be all the rage these days to say we’re ‘deleveraging’, and that may very well be true in the equity markets (in fact, I’m 99% sure it is true). This leverage employed by all financial institutions (public, private equity, ‘hedge funds’) I think is now simply being shifted over to the government debt and being expanded over time (7, 10, 30 year bonds).

    If everyone agrees that the underlying problem is that of excessive debt (and not everyone does), then at some point we need to address the issue or else the issue will again address us. There are two obvious ways to address the leverage issue:
    1) Government spending in the hopes of stimulating the economy. If the multiplier is correct, this could boost growth while simultaneously driving down the cost of debt. Government would then need to be smart in the future and buy back the debt at a cheaper price.
    2) Write down the current debt losses and accept the short-term, but very severe, widespread pain.

    I’m not sure one is preferable to the other. I don’t necessarily trust government to do #1 correctly, and #2 really is painful for many, many, people.

    To finish up a long rambling comment and address the main question of the post, I personally see the stock market “recovering” ~Q3 2009 for a year or two only to enter another decline. As of right now, I’m pessimistic as to the long-term growth prospects of the US economy, but of course that view could change as more information and policies come to light and are enacted, respectively.

    capitalkid

    February 20, 2009 at 9:57 pm

  4. I’d be curious to hear comments about the devaluation of the dollar. It ought to have a tremendous impact on the global economy.

    It is obvious that the motivation of U.S. debt holders is going to be to convert dollar denominated debt into something else?

    Dennis Kogan

    February 22, 2009 at 2:08 pm

  5. Oenoeconomist – I am by no means an economist especially macroeconomist, but as far as I understand the immediate goal is to get the banking system restored. No credit crunch, no overzealous cost cutting – no lay-offs , no unemployment? Unemployment is merely an effect to be reversed at some point. Please, correct me if I just said something plain stupid.

    As to sin taxes – it definitely isn’t any kind of a solution – if anything a stopgap made by those who can’t force a macrolevel solution. Can’t imagine it being effective. Budget deficit is way beyond small corrections and will require political decisions of significantly greater magnitude. As capitalkid mentioned, bailouts shifted leverage to government debt, deepening deficits. It will be interesting to see how this process is going to be reversed

    Dennis Kogan

    February 23, 2009 at 3:05 pm


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