All of us have suffered through the recent severe recession that followed the bursting of the housing bubble and the financial crisis that resulted from it. Since the peak of every financial index in the 4th Quarter of 2007, U.S. and world markets, along with jobs, tumbled downward in unprecedented fashion (at least since the 1930's) with employers shedding millions of jobs in 2008-09. We hear sound bites from every source blaming various people and institutions, from the present and prior two presidents, to the Federal Reserve, to mysterious "new world order" villains. The 2010 U.S. elections as well as the current presidential and congressional campaigns are chocked full of accusations and counter claims, all the way from the usual Rush Limbaugh polemic that President Obama spends every waking minute trying as best he can to destroy the county, hardly something that any president of any party would do, to general sound bites, supported by no data at all, that say the opposing parties and leading candidates are virtually idiotic ogres leading the country down the path to destruction and disaster. Is anyone taking a position based on data, on facts?
Having been schooled in engineering, and having spent a career dealing with both fact and perceptions, let me offer some economic information. This is not necessarily my personal view, it's all based on actual factual data compiled by two of the country's foremost economists in the 2009 book published by the Princeton Press, This Time It's Different. In this book of 292 pages, along with another 138 pages of notes and references, the data-mining authors have compiled economic facts from every economic crisis that has taken place in the past 700 years. They lay out their findings clearly, without political bent or bias.
The title is a sarcastic play on words, since the authors, Carmen Reinhardt of Maryland and Kenneth Rogoff of Harvard, are acknowledged world-class economic professors who conclude that over and over, the basics of financial crises are rooted in the same fundamental causes, with predictable outcomes. The actions needed to come out of these crises are not universally agreed, and that forms the current political debate concerning public policy, both in the United States as well as the European Economic Community. But first, let's examine their information, well documented:
1. Real estate price bubbles leading to banking crises are similar in key aspects, duration and amplitude, for both "rich" and "poor" countries. The resulting price declines in real estate valuations produce sharp increases in bank failures due to mortgage failures and related factors.
2. Consumer and business confidence falls sharply, with job losses, unemployment, and decreased overall economic levels.
3. Banking crises along with consumer fear and job losses almost invariably result in very sharp decreases in tax revenues. A banking crisis is very serious and produces deep and lengthy financial recessions.
4. On average, during the modern era, government debt (expressed in real, not inflated terms) increased 86% in the three years following a banking crisis. This is a broad average over many countries.
5. In the U.S, the financial crisis of the late 2000's was caused by massive price increases in housing real estate, along with a huge influx of cheap foreign money that resulted from record trade balance deficits, and an increasingly permissive regulatory policy. Housing valuations expressed in non-inflated terms nearly doubled between the late 90's and the corresponding late 00's. That is unprecedented in the U.S.
6. Financial crises take a long time to unwind. They are complex. Broadly, there are three characteristics:
* Valuations in asset markets drop sharply and are prolonged. These include equities (stocks) as well as real estate.
* Banking crises produce deep declines in output and employment. Unemployment rises seven percentage points during the down phase of the cycle, which usually lasts four years. Industrial and economic output decreases at least nine percent on average, over the first two years.
* The amount of government debt increases substantially, on average in real terms (not counting inflation) 86%. Thus a nation dealing with a financial crisis will, on average, have a substantial increase in national debt. It is an unpleasant fact, regardless of the political party. The biggest drivers of increases in national debt are lower tax revenues, due to reduced levels of business and personal tax revenues. "Bailout costs," although visible and controversial, are difficult to quantify, but pale in comparison to decreases in economic activity.
7. Data comparisons between the present recession, more and more widely described as the "Great Contraction," and the Great Depression of the 1920's and 30's indicate the current financial crisis is extremely serious, and could very well have spiraled out of control into an international contagion. The general public seems not to fully grasp just how serious the problem was as 2008 came into focus. Although we appear to have weathered the initial financial crisis, by no means are we, the U.S. or the world, out of danger.
8. The book is not cookbook specific about the formula for "what now to do," but it's clear that the banking gridlock had to be released, and that the economy had to be stimulated. The corrective "medicine" is more complex since the national debt levels had risen to peacetime levels not seen before. Thus any administration had/has to walk a line between unlocking lending and stimulating the economy, in order to spur business growth and tax revenue increases, while keeping an eye on the inevitable increase in sovereign debt.
At this point, please allow me to depart from the information in This Time It's Different, and move to my own assessment. Clearly, the long term solution must include means to grow the economy. In this sense, "It's the economy, stupid," to paraphrase recent slogans. People must get back to work, business levels must grow, and tax revenues must increase. Short term and medium term stimulus coupled with national spending prioritization in the medium and long term must take place in order to get the economy moving yet reduce the growth of the national debt such that is is a manageable fraction of the GDP. I don't believe we can "cut our way" to prosperity, and that is being demonstrated before our eyes in Europe. The economy must grow. Period.
Senator Coburn of Oklahoma, one of the Republicans who candidly speaks, said in an interview that the overall outline of the agreement, or grand bargain that must be struck, is clear to both parties, yet neither party will outline it since they feel it would prevent their election. I hope this is not the case, since it speaks badly about the American electorate. The basic framework involves stimulating the economy, cutting the growth rate of social security (roughly 22% or the budget), reforming health care (currently 22% of the budget), limiting the growth of the defense budget (currently 24% of the budget), and scrutinizing the Welfare portion (12% of the budget). These four, along with interest payments (6%), make up 86% of the national budget. The other 14% of the budget operates everything else that takes place, and if you believe some politicians, the solution is to "cut waste and unneeded programs" in this remaining area. Clearly, that ain't gonna play.
So forget all about the nice sound bits that "Obama doubled the national debt." That was going to happen no matter who was president. The real question is who can get the economy growing again, and make the necessary hard choices to reduce the cost of government, which for the most part, boils down to paring back on programs and employment that exists today, and which has plenty of backers and lobbyists who will resist any changes. It's hard to justify why the U.S. provides $2 Billion subsidies to the oil companies, the top five of which earned profits of nearly $140 Billion last year alone. It just doesn't make sense, but somehow that folds into the lack of a factual national debate on public policy. Let's hope that we get some straight talk, as the nation needs to make some hard decisions, and soon.