Do you remember that iconic banner? Yes, we had 3.5% real GDP growth last quarter. However, it is premature to declare “Mission Accomplished”. We are facing the specter of double digit unemployment lingering throughout 2010.
Short-term versus Long-term
The growth that we have seen is largely a result of government moving economic activity from the future to the present. The most visible example of this was the cash for clunkers program. Consumers could get up to $4,500 for trading their car in before the deadline. This attracted a lot of people that probably would have bought new cars anyways in the future (and now they won’t).
Indeed, 1.7% of the 3.5% GDP growth was vehicle related. Would we see the headlines, “Economic Growth in Third Quarter Heralds End of Recession“, if the GDP print was 1.8% [actual 3.5% minus auto contribution 1.7%=1.8%]?
This is but one example of the short-term stimulus spending. Another example which has been in the press recently is the phase out of the homebuyer tax credit which has likely accounted for some of the action in the housing market. “Existing home sales have largest percentage jump since 1983“. Again, we are just shifting consumption from the future to the present. Oh, by the way, even though was saw one piece of good news, 8.3% increase in existing sales, let me remind you that new and existing sales are still way below their peak. More seriously if you track housing starts, permits and mortgage applications, they all spell even worse news.
I have mentioned this before. There appears to be a bias in the news to report good news and sweep the less favorable news under the carpet. Let’s look at “New Privately Owned Housing Units Authorized by Building Permits” seasonally adjusted. In September 2009, the number was 575,000. The peak was September 2005 with 2,263,000 units. So we have dropped a staggering 75%!
Some more perspective. The last time we were below one million units was the 1991 recession where we hit a low of 786,000 units in January 1991. The low in the double dip recession of the early 1980s was 731,000 units. In the oil recession of 1975, we dropped to 726,000 in January 1975. Remember, the population has grown. Note that the data begins in 1960. The numbers we are experiencing are historic lows.
If we population adjust these numbers, today’s permits look even worse. The graph below shows “population-scaled” building permits. This is an apples to apples comparison. Essentially, it allows us to look at the permit activity in 1960 and ask, what would permits be in January 1960 if we had the population of September 2009?
There are three points here.
1. The government programs may be able to shift some activity from the longer term to the shorter term. However, this will not necessary “jump start” the housing market. This market has a long way to go before recovering.
2. The housing market will provide a continued drag on economic growth both directly (less construction and associated activity) and indirectly (negative wealth effect, i.e. people will not spend as much if their wealth decreases).
3. The depth of the housing crisis will likely cause a second wave of financial crisis as more an more people default on their “prime” mortgages. I have mentioned this before. If there is a significant housing recovery, this could mitigate the second wave. However, I just don’t see the data to make the case for a strong recovery in the housing market.
The Wrong Strategy
Let me summarize:
- We bailed out directly and indirectly institutions that should have failed (in an orderly way) because their risk bets did not succeed.
- Much of the bailout is below the radar. The nationalization of AIG was a massive indirect bailout of Wall Street as the nationalization effectively eliminated all counterparty risk (a risk that should have been borne by Wall Street not the tax payer). In addition, there are so many programs that provide current profits, such as: (1) implicit government guarantee (too big to fail) reduces cost of borrowing for banks and allows them to make more bets; (2) a zero percent short-term interest rates (negative real rate of interest) allows banks to borrow ultra cheap. All they need to do is to invest in Treasury bonds and they have almost a “risk free” return provided by the U.S. taxpayer.
- There is no government enforced transparency. I feel that banks are sitting on a huge stash of unrecognized non-performing loans. Banks are waiting for Federal programs to kick in or for the recovery rather than writing these loans to market value. I am talking about loans today — not next year.
- We have focused the attention on large financial institutions and large corporations at the expense of small and medium sized businesses. A great example of this was the collapse of the Commercial Paper market which was used by only large corporations. When that market collapsed, these institutions went to their banks for working capital. The banks extended the capital but effectively cut off loan creation to small and medium sized businesses. 75% of job creation comes from small and medium sized businesses. We have exactly the wrong strategy. It is the strategy that sunk Japan – support large business at the expense of small and medium sized businesses.
- We continue to make mistakes on almost a daily basis. GMAC should be allowed to fail.
- We should come clean with our banks. To me, it is a joke that only 106 banks have failed (of the over 7,000 banks). It simply means we are fooling ourselves. There are hundreds of other banks that need to be shut down. If we come clean, people will have well-founded confidence in the survivors.
- Why can’t we take bold action on regulation? Think about it. Why do we have 7,000 banks? It is purely a result of state-specific banking regulations. Other countries have national regulations because a banking crisis is not just a state issue — but a national issue. It is obvious that we don’t need 7,000 banks.
- While there are some good ideas in some of the regulatory initiatives, it seems to me to be a patchwork of ideas rather than sweeping changes that arise from a clearly articulated national financial strategy.
- We need to think of the long-term not just the short-term. Our total debt (personal, corporate, government) is 350% of GDP. Whatever deleveraging that has occured on corporate and personal balance sheets has been offset by the swelling of government debt. Our level of debt like this is not sustainable. Yet, our politicians continue to spend — without thinking of the long-term consequences of the spending. Frankly, this is expected given the election cycle induces short-termism. However, the overwhelming question is this: For a year of 3% growth are we willing to have a “lost decade” of our own?