Are We in a Recession? What Will It Look Like If We Have One?

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Slides for the "current macro situation" talk...

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The Fed Has Started Cutting Interest Rates:

• From the 1960s through the 1990s, we had recessions when the Federal Reserve said "uh-oh; inflation"
• The recession of 2001 was the first in a long, long time not brought on by a steep upward push of the interest rates it controls by the Federal Reserve to curb spending and inflation
• The potential unpleasantness of 2008 may be the second such

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The Construction Sector Is Collapsing:

• When the dot-com boom collapsed at the start of this decade, the Federal Reserve lowered the interest rates it controls far and fast
• The hope was to keep employment and production from falling much: if we can't put people to work in high-tech and spend money investing in the internet and allied industries, perhaps low interest rates can spark a construction boom * It worked--really well (perhaps too well)
  • Construction joined as a leading sector of spending and employment by
    • Defense
    • Commerce--side effect of "selling" "political risk insurance" to rich foreigners and to foreign governments
• Now the construction boom has collapsed--without the Fed hitting the construction sector on the head with a brick
  • Construction not coming back soon: 2 million extra houses...
  • Financial uproar
• What could take up the slack this time?
  • Exports? And import-competing manufacturing?
  • Medicine?

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What Is Happening Right Now?

• We do not know
• Standard payroll-employment series tends to go awry when economy changes its phase from employment expansion to employment contraction
• And the economy does change its phase
• Household employment survey a better guide at turning points
  • But a lot of noise in household employment survey
• The problem of the anemic employment recovery of the 2000s
• The labor market has not changed its phase--yet--as far as we know

• The fact that we undergo a half-sized business cycle every year what with Christmas, etc., makes reading the tea leaves on these particular months especially... complex...

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The Federal Reserve: Stuck Between a Rock and a Hard Place:

• The Federal Reserve
  • Doesn't want to lose its price-stability credibility by cutting interest rates too far too fast and igniting inflation--both by misjudging domestic demand and because cutting interest rates means a cheaper dollar hence import price inflation
  • Wants, in fact, to raise interest rates--to make feckless over-leveraged financial institutions pay rather than to bail them out
  • But doesn't want to hold the entire economy and the jobs of millions of Americans hostage in order to make sure a few mortgage loan originators and packagers get their just deserts
  • Good luck to Bernanke and company...

Comments

[bakho]

Lowering interest rates now will help the U.S. economy ``a little bit, not very much,'' Stiglitz said, adding that easing terms on mortgage loans would be like ``kicking the problem further down the road.''

``That game is over,'' Stiglitz said. ``As house prices are going down, people are not going to be able to take more money. We are looking at a major slowdown. The impact of that is going to be a very major slowdown, maybe recession.''

http://www.bloomberg.com/apps/news?pid=20601103&sid=abh8h7M3uKBA&refer=us

[Craig Nelson]

Should the Fed be reluctant to prevent import-price inflation? Isn't a cheaper dollar a good thing to slow the flight of manufacturing, engineering, back-office jobs? And a good thing to combat a worrisome trade imbalance that is still looking for a soft landing? I'm puzzled. If the Fed is concerned with financial morality, shouldn't they be acquiring and using regulatory actions with legal teeth?

[Lee]

Wouldn't inflation be a good thing right now? It would help cushion the collapse in housing prices and other assets, improve our exports, while eroding the value of all the cash piled up by the wealthy and highly profitable corporations (or at least give them an incentive to spend it) who have benefited from the Bush regime of tax cuts, deficit spending and corruption.

[save_the_rustbelt]

What Will It Look Like If We Have One?

Spend a couple of days in Detroit - you can see for yourself.

[save_the_rustbelt]

OR PERHAPS IT WILL LOOK LIKE THIS.....

Thursday, January 17, 2008
GM to offer buyouts to 46,000
Sharon Terlep / The Detroit News

General Motors Corp. CEO Rick Wagoner said Thursday that the company could have to shutter more U.S. factories or eliminate shifts at plants to bring the automaker's production in line with declining demand for cars and trucks in its home market.

He didn't say how many plants will close or whether GM has decided which facilities to shutter, but said the closures will include powertrain and stamping factories as well as assembly plants. Additionally, Wagoner said the company will offer buyouts to 46,000 of its 72,000 blue collar workers. GM wants to cut costs by about $5 billion by 2011.

GM will extend buyout offers to its entire U.S. work force next month and usher the workers out in April. GM hasn't announced how many workers it will accept from those who are eligible.

[Noob Saibot]

A couple interesting things I've seen recently suggesting that this downturn will not be very sustained:

* I read that the number of new homes built in 2007 was the lowest number in over 30 years. Not just lower than any of the peak-market years immediately preceding it, but lower even than at the height of a couple of recessions. That is bad for 2007, but also a sign that excess inventory has already been aggressively moving to correct itself, so maybe not so bad for 2008.

* I have seen that a lot of people trying to sell houses have been, largely at the prompting of their real estate agents, aggressively investing in upgrades to the homes they're trying to sell: new paint jobs, new appliances, new flooring, etc. These actions might be small comfort to the seller, but it suggests one factor partially compensating for the slowdown in home construction and sales.

* Probably more under-appreciated than any other factor, is the lack of slowdown in the ongoing rise of foreign demand for U.S. high-tech goods and services. I don't think "decoupling" is the right way to think of the emerging lack of critical dependence on the U.S. market by emerging economies; it's a more complex emerging interdependence. The softening domestic economy is helping propel the ongoing softening of the U.S. dollar, which is helping fuel ongoing growth in export markets, constituting another negative feedback mechanism on the lowering domestic economic growth.

It seems like the argument now is whether the downturn will persist through 2008, or whether the storm will break around halfway through the year. The best guess might be for the end of the bad news to roughly coincide with early November, helping to confirm voter sentiment against the incumbent party in the White House (if any further such confirmation might possibly be needed).

And yes, I agree particularly with one of Brad's side comments: the boom-and-bust in housing sure seems to hav been artificially driven by the Fed having been overly aggressive in compensating for the last recession. It was easily foreseeable 6 or 7 years ago that the extraordinarily low interest rates were fueling an artificial inflation in housing prices that turned the nation's residential real estate into a national credit card, on which we kept charging an ever higher balance -- which also acted as a massive, artificial transfer of wealth to pre-existing homeowners from those who bought homes late in the cycle, which would have tended to mean an artificial transfer of wealth from the younger and less well-off to the older and wealthier.

[Noob Saibot]

P.S. Another largely overlooked but major mechanism for reducing the inventory of excess homes is the de facto retiring of a huge sample of homes at the bottom of the barrel. It seems like a lot of the media attention has been on foreclosures of relatively new and desirable housing, such as featured in this month's Atlantic and discussed previously on this blog. But looking at detailed maps of foreclosures by city, at least for some that I've seen, shows a lion's share of foreclosures and abandoned homes have been in some of the poorest neighborhoods. For a lot of these, the municipal authorities are having a lot of trouble even figuring out who the mortgage-holders are, while in the meantime, the houses are often already in a bad state of repair and are deteriorating. Some have been demolished, and many more will have to end up the same way.

Perhaps many of the former residents of those homes will have to rent for a few years, at least until after prices have bottomed out and the market has fully stabilized. In the end then, we'll have effectively exchanged much of our old, less desirable inventory of homes for a large crop of overall much more recently built and more desirable homes, on a fairly aggressive and compressed schedule relative to the much milder replacement rate of residential homes that would have happened otherwise.

The end result includes a housing inventory with a higher overall value, so those in the market for a new home after the shakeout will have benefited from the current economic strains, and this might help drive higher demand for purchasing homes.

I also wonder if this forced retiring of a large portion of the bottom-end housing inventory has been adequately reckoned yet. It might suggest an earlier bottoming-out of the overall housing market, accompanied by some of the remaining economic pain transfered to the municipalities and remaining homeowners of the distressed neighborhoods.

But enough dilettante rambling for me. I'm an attorney, Jim, not an economist.

[Movie Guy]

Brad,

Appreciate the charts.

QUESTION: If you were still sitting over at Treasury, what recommendations would you be making to the SecTREAS? I assume you would bite off more than you have with this main post.

Care to step out on the plank? It's time for some leadership.

[andrew]

Brad,

Thanks for the overview, enjoyed this. One thing you've said seems bizarre to me, though:

"Wants, in fact, to raise interest rates--to make feckless over-leveraged financial institutions pay rather than to bail them out"

Surely the motivation for raising interest rates is rather to protect the value of the dollar and to combat inflation (which are just as important to millions of Americans as jobs and the economy)? Knowing what you've written on the subject of punishment in the past ("Mammon of unrighteousness" etc.), I smell a straw man ...

That said, I also have come around to thinking that raising interest rates at this stage would be tantamount to driving the car into the ground, so if I have to choose, I can live with a little Fed dovishness ATM.

*That* said, I still think the Polonius crowd at the Fed bears primary responsibility for the credit bubble that's brought us to this ugly pass.

It's pretty crappy of me only to write in to snipe at the Economist's Guild, my apologies, seriously; but eternal vigilance and all that.

[christofay]

Streaks are being broken. Movie Guy is back. Crooks & Liars reports that Matt Lauer asked Kramer a question that demands an unsettling answer. And C&L reports that a curt AP reporter asked a question to candidate Romney. Ret Gen Franks reports for duty and a shellacking. He should be taken to the woodshed.

Is $1,800 about 30 tanks of gas?

[Barry]

Brad, from your first chart, it seems to me like the Fed raised interest rates before the following recessions: 1973-4, 1979, 1981-2. The Fed had previously bumped up rates a bit, and was holding, whent the 1990-1 recession started. In 2000-01, it was again increasing rates.

So perhaps the Fed rate increases are a major contributor to recessions.

[kharris]

noob,

Don't believe everything you read. Housing completions in 2007 were the lowest in about 9 years, not 30. That will change this year as starts early in the year will be much lower than starts early in 2007. Even so, a 9-year low in completions against a 10-year or so low in new home sales, with inventory in the used home sector also offering competition to new homes, that 9-year low just ain't enough. There are lots of problems in the housing data, but they don't all make the problem look worse than it is. Many on the inventory and sales side make things look better than they actually are. It is too early to look for good news from housing.

[kharris]

noob,

Don't believe everything you read. Housing completions in 2007 were the lowest in about 9 years, not 30. That will change this year as starts early in the year will be much lower than starts early in 2007. Even so, a 9-year low in completions against a 10-year or so low in new home sales, with inventory in the used home sector also offering competition to new homes, that 9-year low just ain't enough. There are lots of problems in the housing data, but they don't all make the problem look worse than it is. Many on the inventory and sales side make things look better than they actually are. It is too early to look for good news from housing.

[William Smith]

Prof DeLong,
Very nice series of charts. The housing boom and bust to me is the most important. A prolonged period of construction of unique, highly-personal large-scale investments creates an inventory surplus that takes a long time to go away. Structures of all sorts tend to create distortions in the supply-demend continuium when they just sit there.

[Neal]

The recognition must come that the post dotcom, 9/11 economy was built entirely on the back of real estate inflation. At least $150
to $200 billion dollars a quarter will be required to return the economy to what it was in 2006. Where will this come from?

Mortgage resets will continue well into 2011. As the economy continues to crumble, more and more of these resets will result in default. What is the answer to that continuing problem?

Manufacturing jobs continue to move overseas. Their wages are gone, and will remain gone. Major sources of job growth have been government and health care. Does anyone think that falling governmental revenue from less income, sales and property tax will not affect governmental spending and employment. Likewise, when falling employment happens, what happens with health care--is private insurance a bottomless pit of money that will power on regardless of how many people lose their jobs and/or benefits?

Other job growth has occurred in construction, retail, service sectors--in genereal areas where there is plenty of discretionary income to make non-essential purchases. When money is tight, who will be making these buying decisions?

The money came in giant chunks to individuals during the great real estate inflation. The psychological impact of $50K in a cash-out refinance is very different than a $1000 tax rebate check. A $200K credit line on a house that is going up in value 15% every year is also very different than a $1000 tax rebate. As a result, spending patterns on a rebate are very different. No-one (or far fewer people) is going to make a decision to do a $50K kitchen remodel on the basis of a rebate. It is far more likely that the effect of a rebate will be to reduce the amount of existing debt rather than inspiring another round of grandiose spending.

The recession will last far longer than a year, and it probably eventually be classified as a depression (or more properly-a collapse). Too many problems are coming to the front. The great majority of the economy from dotcom forward has been the result of artificial and unsustainable bubbles.

There are no new bubbles on the horizon that will create the same level of wide-spread extravagant spending that has characterized the American consumer of the last decade.

We are in recession now, the recession will get far worse, it will last much longer than a year, and no-one has a solution for that.

[Gerard MacDonell]

I was amazed by the Bush speech today. I would have thought his job was to raise animal spirits by expressing confidence that he would come together with Congress to get some stimulus into the system. He did in fact confirm that short-run stimulus is coming.

But could not leave it at that. He could not resist making the talk partisan and about himself. So he tells us that failure to extend his tax cuts permanently will be very damaging to the economy. Everybody knows that Congress will not support his permanent cuts, in part because they have nothing to do with short run stimulus. So effectively, the president went on TV and announced that the most likley policy will be very damaging to the economy. Nice confidence lift! No matter how low you set the bar, he falls over it.

Separately, he should have put a flag or a fern, not Dick Cheney, in the background. Cheney scowling back there just reinforced the impression.

[Gerard MacDonell]

I was amazed by the Bush speech today. I would have thought his job was to raise animal spirits by expressing confidence that he would come together with Congress to get some stimulus into the system. He did in fact confirm that short-run stimulus is coming.

But could not leave it at that. He could not resist making the talk partisan and about himself. So he tells us that failure to extend his tax cuts permanently will be very damaging to the economy. Everybody knows that Congress will not support his permanent cuts, in part because they have nothing to do with short run stimulus. So effectively, the president went on TV and announced that the most likley policy will be very damaging to the economy. Nice confidence lift! No matter how low you set the bar, he falls over it.

Separately, he should have put a flag or a fern, not Dick Cheney, in the background. Cheney scowling back there just reinforced the impression.

[Kate G.]

I agree with Neal, and I can't see that anyone else is offering a clearer picture of what is going to happen. Neal's point also goes to contradict, I think that of the poster up above who thinks that we will end up (somehow) with the poorer housing stock magically dissapearing and the upper class/new homes somehow coming down in price. The interesting thing about real estate, to my mind, is that although people and banks have been treating it as unreal (always going up in value, source of imaginary equity etc) it actually remains really real in some very hard to manage ways. Its utility and its value are very dependent on its maintenance. And maintaining a property as we have become accustomed to seeing properties maintained is *very*, *very* expensive. I saw the same articles Neal did, and heard some interesting stuff on NPR, that reminds us all that once a house is boarded up and has no caretaker spending time and money on it it can be ruined in very short order and what the "owner" is left with, if there is an owner, is essentially a lot with a lot of trash and ruins on it. If people can't afford to pay for the maintenance of their current homes on their salaries (without fake home equity loans and cheap credit) we are going to end up seeing a long term decline in the actual status of those homes. An even faster decline is to be expected in the rental market where rents will need to go up to cover the costs of maintenance that the owner can't put off and where repairs will be put off as long as legally possible.

I am always a pessimist but I anticipate a huge crash and possibly the end of the upper middle class--the managerial sales and service executive class--and the concomittant end of all the lower living service professionals who used to help them pass their phony paper back and forth (the secretaries, admin assistants, bar and waitress staff, etc...etc...etc...).

Kate G.

[Bruce Webb]

One gets bemused.

One person tells you that the fundmental problem with the economy is a glut in housing inventory.
Another tells you that the sign of a recession is a drop in housing starts.
Could it possibly be that the latter is not only a rational response to the former but in fact a reasonable middle term solution? Build less houses until supply realigns with non-speculative demand?
Would we really have been assured if we knew the current response to housing was builders rushing to the Building Department to pull permits?

The ordinary citizen just can't win. Economist A tells us our real problem nationally is that we are not saving enough. Then Economist B turns around to say it is really a very worrying sign that retail sales were weak in December. Which means no matter how I allocate my dollar I end up being a national economic traitor, damned if I do, damned if I don't.

[bakho]

The Great Depression was characterized by a too large of percentage of population with not enough (or no) savings, too little income and no access to credit. Most recessions have similar characteristics but milder. The trick is to get money to circulate again so that what people produce is effectively used.

One problem with our consumer society is the overabundance of some types of goods with built in obsolescence and under-availability of important quality of life factors such as health care. In addition, our manufacturing is threatened long-term by global warming and limited resources such as oil. It seems that our economy is due for some restructuring of effort into improved health care and re-tooling infrastructure to meet the modern energy demands. We squandered the last 5 years with massive incentives to overbuild McMansions and not enough incentives to improve infrastructure or health care. The government has protected those with high stakes interests in the status quo and failed to provide enough incentives to move our economy to a more sustainable position.

[slomike]

From Marketwatch, "Most people know this is just political noise; our problems are a lot bigger than this," said Peter Boockvar, equity strategist at Miller Tabak. I feel the Bush/Obama/DeLong "check in the mail" will be spit in the ocean in a very short time.

[chris]

The entire Bush administration has been a stimulus plan. If deficit spending is stimulation, then we had gods bo it every year. At the peak stimulation per quarter was running close to the $145 billion is proposing now. As soon as the stimulation was tempered, remember halving the deficit, we run into trouble.

Let's not pull out the kids' Visa cards again. We can use this recession/depression to start making the structural changes that we need to. Just keep calling it the Greenspan/Bush/Republican depression and that will help to restructure our economy too.

[G]

The mortgage crisis is just a “catalyst”.

What the average American, Bush Administration, Fed and Wall Street can’t see coming is the American Economy, which purchases over 30% of all goods manufactured in the world, has been “debased.”

This is a small part of what the Neocon-Republican Bush Administration foisted upon the American Taxpayers-

• The Bush Administration has cooked the books concerning GDP, employment, inflation and other numbers released monthly by the US Bureau of Labor Statistics.

• The manipulation of energy prices and refineries by big oil has sucked trillions of dollars out of American Consumers’ pockets and the World Economy.

• Thirty-seven years of support by Republicans of Supply-side Economics, radical Think Tanks and PR Campaigns to convince Americans Unions are bad brought membership down to 11% of all Americans. Unfortunately, both wages and benefits went down with the loss of Union memberships.

• Bush’s Neoconservative Republican administration legislated tax breaks for corporations and the Elitist top1% of Americans at the expense of the other 99%. Couple this with a catalyst such as the collapse of the mortgage banking industry & housing prices, a liquidity crisis and pending credit card catastrophe. Then add in years of Union busting, NAFTA, CAFTA, Vietnamese, Central America and other Trade agreements, hundreds of thousands of H1-B & L-1 work visas, years of outsourcing jobs to 3rd world countries and open borders all which help eliminate the higher paying jobs, pensions and benefits for a majority of Americans.

• The huge amount of spendable income/benefits these high paying jobs formerly supplied America and the World Economy has disappeared… gone forever. Resulting in a gigantic transfer of wealth from average Americans to the world’s Elitist top 1% and coffers of Corporate America.

• The “staged” Iraq war has maimed and killed thousands of American Soldiers along with tens of thousands of innocent Iraqis’ while sucking billions of dollars of tax money out of the American economy that could have been used for social projects and paying down the national debt. America fights this war for Israel alone without their aid or troop support. Lobbyists, AIPAC and Radical Zionists within the Neoconservative Bush administration blindly led America into this war while they deregulated corporate America and channeled billions of US tax dollars to Israel, Armament companies, big oil, military contractors, corporate friends and “misplaced billions”. This helped place Americans and America on the road to bankruptcy as the country with the largest national debt, and growing, in the history of the world.

The Federal Reserve and Neocon-Republican Bush Administration offered only these solutions for the “depression” it has created--

• Throw money at banks, investment banking and more tax breaks for corporate America.
• Lower interest rates, increased the money supply and hope to inflate our way out of this crisis.
• Accept rapid inflation, stagflation and devalued currency along with loss of world trust in the dollar and federal debt.
• Accept lower USA debt ratings
• Indicate to Americans Social Security and the rest of Roosevelt’s
New Deal is the “Death Star” of our economy and will deliver the final blow to the Federal Reserve and Neocon-Republicans “Supply Side Economics” manufactured Depression.

Plus much, much more.

There is a solution to this crisis.

However, big business, Government and “Americans” have to feel the pain before it will turn around. The average American needs a really big wake-up call and this is it.

Maybe Americans will become a “we” society again instead of a “me” society, vote and demand accountability from their government. Maybe high schools will require students to take civics class and adults will discuss politics at the dinner table, church and with neighbors over the backyard fence.

Maybe Americans will again understand the meaning and importance of words such as rule of law, Constitution, Bill of Rights, accountability, voting rights, impeachment, treason, double talk, protests, separation of church and state etc..

Who knows whom you shall see at Federal cheese & bread give away, Salvation Army and soup kitchen. Maybe some of those VP’s from the former employer, a neighbor, preacher, Congressmen… maybe even Bush, Cheney, Pearl, Wolfowitz, Bolton or (I can only hope) Kristol???

[Brian]

The US is faced with an unavoidable depression. This should be no surprise to anyone. The dot.com boom was predicted to bust. The 2008 slow down was predicted 10 years ago. The math is still pretty simple, but everyone chooses to ignore it, which is how we get into the booms, which have to bust. The factors are too many to list here.
Baby boomers will retire, taking more money out of the stock market than is being put in. That will put supply and demand pressure on the markets to decline regardless of earnings. Medical cost will continue rise and the demand outpaces the supply. Baby boomers had bought two homes, but now as they retire they only need one.
Prices for oil will rise as China and India continue to expand their economy and buy cars. Cars not made in a America.
Companies with unfunded pensions will default. Someone will have to pay for that. The government will try to help, but they won't have the money.
The defense needs for spending are unlikely to slow. Even if the war in Iraq is solved, we will enter a new space race with China. A war we can't afford to loose.
We will start to loose investment from China as they no longer find it to their benefit to buy our debt. We will be forced to cut programs and closer to a balanced budget at a time we are already in debt.
Adding to the debt is the consumer debt, when people start loosing their jobs they will default adding more debt pressure to the government and hurting earnings.
The Fed solution, is to lower rates. Lowering rates to all time lows are fully expected, but unfortunately that will have to be held if we are to avoid inflation. My estimate is that the fed will go to far under pressure from the next president and we will get forced into inflation and then rising rates and then depression.
I would estimate double digit unemployment by 2012. This has nothing to do with political party or which president is elected.
As for the prior post, most of this should have been dealt with during the Clinton Administration. I predicted this slow down while Bush Sr was in office. There is no excuse. Clinton and Bush have created a situation by which we can not recover without a serious shock to the system. Americans will have to balance their personal budgets and the federal budget will have to follow. Its unlikely as the prior person comments are clearly liberal, the liberals will continue to borrow money to give more away.
The damage is already done, and only the correction will fix it, but that's not really fair to leave this post that way. So here are some thoughts on what could be, a far more difficult issue than predicting the problem:
1. American spending will have to decline to the point where they won't default putting that pressure on the government.
2. Wage parity needs to be achieved. CEO salaries vs. the people salaries do need to be controlled. Maybe unions are the answer, maybe government regulation. People need to be able to pay their debts, and afford fuel.
3. Spending by the federal government on government needs to cut dramatically. Dramatically means do away with IRS and reduce government dead weight like the EPA by 50%.
4. Some people will live in poverty, until they get jobs, but americans will have to adjust to a lower quality of life and greater disparity
between the poor and the middle class.
5. Keep taxes low and simple the cost of compliance is not so costly.
6. Deal with Health care. Make easier for small business to cover employees.
7. Raise the limits on collecting SS and Medicare taxes to 500K of income and don't collect it for the first 50K of income.
8. Allow more legal immigrants from Mexico. immediately be specific about the demographic and age brackets. We are trying to offset our low birth rate with their population and higher birth rates.
9. Get alternate fuels in the masses. Conress and Bush have let us down here. This has been around since the 70's. First mandate all cars are flex fuel capable. Yes it has side effects on the economy, but we aren't talking about using 100% of that fuel, we are looking at creating distribution capability. Get Fuel cell cars into the hands of the people via tax breaks that pay for the upgrade if needed. Make a battery hybrid, that runs on flex fuel, to cover the mileage gap with flex fuel... Dig in Alaska and off-shore.. build the windmills next to the pretty houses in Mass. Stop having rich people fly person jets to green events that tell me to walk to work.
These are some starter ideas. You get them all, probably none.