A recession? How severe, and at what cost?
The U.S. economy is screeching to a halt, slammed by collapsing consumer confidence and house prices. Spending has been hit by problems on both Main Street and Wall Street. House foreclosures skyrocket to record levels, while the stock market and credit markets stumble.
GDP growth was 4.9 percent in the third quarter of 2007 but a stagnant 0.6 percent in the fourth quarter; preliminary indications for the first year’s first quarter indicate zero growth in retail sales and industrial production.
How did we get here, and what does it mean for St. Louis?
Easy money, easy credit and a false optimism led to our crisis. Low interest rates during the last few years were engineered by the Federal Reserve and designed to reignite the economy after the last recession.
However, most observers believe that the Fed left interest rates too low for too long. Increased securitization — the selling of house loans by Wall Street with little regulation — coupled with unregulated mortgage brokers who willingly lent to homeowners with little documentation or income, led to too much bad credit.
Lastly, homeowners too often and too willingly borrowed money at teaser rates to buy houses 10 to 12 times their income with the expectation that housing prices always go up. The median new house buyer only put 2 percent down, and 30 percent of house buyers had zero initial equity. Others used their houses as ATMs, refinancing in lieu of savings.
All three factors lead to excesses of too much borrowing and buying. As a consequence, personal savings in the last two years plummeted to zero, the lowest since the Great Depression.
As house prices have plummeted, in many areas by double digits, the engine of increased wealth and borrowing to finance consumer purchases has stalled.
The bad news has led to even greater declines in consumer confidence. We are facing a nation of weary, savings-poor consumers, burdened by higher prices for food, oil and health care.
The policies put forth by the Federal Reserve so far have included decreasing the federal funds and discount rates and making liquidity available to banks via borrowing on lower-quality collateral. The new tool in the Fed’s kit is lending to banks using lower quality mortgage-backed securities as collateral.
Again, this provides short-term liquidity to banks, but the lower-quality collateral could result in losses to the Fed and ultimately the taxpayer as well as higher inflation faxless online payday advances. The inability to assess the risk imbedded in some of these instruments is precisely what began the credit crisis the Fed is trying to address.
The Economic Stimulus Act of 2008 has been signed into law and the rebate checks should be mailed in May. By providing checks to joint-filers with an adjustable gross income of $175,000 or less, this policy is targeting the benefit to lower- and middle-income households, which are more likely to spend the additional income.
This is important because the efficacy of this stimulus package is predicated on the rebate check being spent. This one-time rebate will increase the fiscal 2008 deficit, which ultimately will increase the debt.
Where is this money coming from? The government is borrowing it, and because our savings is near zero, we are selling the debt to foreigners. The Chinese and OPEC nations have been financing large portions of our government deficit for years, and in return we have large trade deficits.
The stimulus package implies more borrowing, debt and trade deficits, adding to the $3 trillion that we owe to foreigners.
If the economy continues to sour, credit card troubles and automobile sales may severely dampen retail sales. For now, however, the crisis is primarily a housing and financial one, implying that St. Louis is less likely to be hit as hard as other regions.
We missed the housing boom, and therefore will avoid most of the bust. Housing prices in this region so far, according to the government’s statistics, have been positive. Further, our economy is more based on stable services such as health and education, and less on residential construction than other regions. Our decline, therefore, will be less abrupt.
How long economic growth in the U.S. and St. Louis will remain weak is an open question. The excessive past borrowing implies that recovery will be slow, but, again because our region borrowed less, the balance sheets of households are healthier, and the region is likely to rebound earlier.
Jack Strauss is the Simon Professor of Economics at St. Louis University. Lisa Gladson is an instructor in the economics department at St. Louis University.
strausjk@slu.edu
Filed under: money by Fred