Two years on the road to economic recovery, and there are still miles to go before we sleep, warns
This article first appeared in the St. Louis Beacon, Nov. 29, 2010 - In this third holiday season since the U.S. financial meltdown, the road to economic recovery for many Americans continues to be a stressful journey over the river and through the woods, with the kids bickering in the back seat about whose turn it is to get a bailout.
Are we there yet?
No, says Bill Emmons, an economist with the St. Louis Federal Reserve, who suggests that a return to the pre-recession good times could be years down the road.
Emmons said the economy took a detour last summer after interventions following the crisis of American financial institutions in fall 2008 played themselves out.
The interventions were many: the emergency Troubled Asset Relief Program (TARP), the 2009 federal jobs stimulus, "cash for clunkers," the first-time homebuyer tax credit, the Fed's decision to drop the fed fund interest rate to zero and its $1 trillion-plus purchase of Treasury bonds and securities.
"When you take away the sugar high, what's left is a very weak economy," Emmons said. "That -- together with the problems in housing, which I don't think have been resolved -- makes me think that this is an unusually risky time right now."
Emmons notes that he speaks only for himself and not for the Federal Reserve.
Speaking for itself, the Fed officially downsized its economic optimism on Tuesday with the release of minutes from the Nov. 2-3 meeting of the Federal Open Market Committee. Officials from the nation's central bank now believe that after all is said and done, the economy will grow only about 2.5 percent this year. In June, they had forecast 3 percent to 3.5 percent growth for 2010.
The revised outlook suggests that 2011 will bring growth of just 3 percent to 3.6 percent. The outlook for 2012 was a little brighter -- projected growth of 3.6 to 4.5 percent. That would reflect the success of the Fed's latest effort to stimulate the economy: The Fed plans to buy $600 billion in Treasury bonds over the next eight months, an action aimed at lowering interest rates and encouraging spending.
The nation's employment picture also darkened, with the Fed now forecasting that the current 9.6 percent unemployment rate won't budge by much next year. The forecast for 2011 is an 8.9 percent to 9.1 percent unemployment rate and a 7.7 percent to 8.2 percent rate for 2012.
The Open Market Committee includes the six members of the Fed board and the presidents of the Fed's 12 regional branches, including James Bullard of St. Louis who last week suggested that now is the time to reform the house financing market.
Where Are We Now?
Emmons said that Americans are coping with a "new normal'' following the 2008 financial emergency, which had some of the nation's largest banking institutions teetering on the brink of collapse.
"We are post-traumatic at this point, but that doesn't mean that we're on the verge of a strong recovery," he said. "I think I'm more concerned now than a year ago, partly because of the complacency. I think people don't realize how weak the housing market is and the problems in the mortgage market."
Housing remains a crucial component to economic recovery, but Emmons points to indexes indicating that house prices are going to continue to fall, affecting a wide swath of Americans. The United States had 75 million homeowners in 2008, and two-thirds of them had mortgage debt.
"It's not just low-income communities. It's not just subprime mortgages," he said. "With the tremendous declines in house prices that we've already seen -- and I expect there's a fair amount to go yet -- it touches everybody who took out a mortgage in the past 10 years."
The problem that won't go away: low or negative equity in homes. As house prices fall, an increasing number of homeowners find themselves under water -- owing more on mortgages than their homes are worth. Between 20 and 25 percent of U.S. homeowners with mortgages are currently under water.
Emmons said that market analysts, and even Fed Chairman Ben Bernanke, are concerned that as house prices continue to fall, homeowners who currently have 10 percent equity, or less, in their homes -- about one-third of homeowners - will also be pushed into negative-equity situations.
"There's just so little equity left, and that's Bernanke's point," Emmons said.
Emmons said the term "crisis" doesn't accurately describe years of foreclosures in the aftermath of the burst U.S. housing bubble.
"This is a correction," he said, adding that just as it took years for the housing market to reach crisis point, it will take many years to "correct."
Emmons cited findings by economists Carmen Reinhart and Kenneth Rogoff, who conclude that in the aftermath of a serious financial crisis, it takes five to 10 years to get back to a normal setting.
"And so depending on how you rate it -- housing in 2006 was the peak, financial stresses in 2008 -- we're talking 2013, 2015, 2017 before you get back to something approaching what we think of as normal, with lower unemployment and higher growth," Emmons said.
Never Say Never
Emmons predicts that it will take years before the U.S. economy regains the 10 milion jobs shed during the recession that officially started in December 2007 and officially ended in June 2009. The economy added 150,000 jobs in October.
"One-hundred-fifty-thousand is better than a sharp stick in the eye, but it's just peanuts. It doesn't change the idea that the economy is still very weak," he said.
Emmons said that Bernanke has made the point that while the Fed will continue to be accommodative with its monetary policies, they would be more effective if joined by fiscal policy actions, such as tax and spending reforms. But Emmons doubts that Congress will act.
"The underlying strength of the economy is what we've seen over the last couple of months -- not much," he said. "In those circumstances you are vulnerable to any sort of shock, whether it be [the financial crisis in] Ireland or housing, once people realize their house prices are falling again. Then you have to expect the financial market reaction to that."
Emmons sees similarities with what Japan has been going through economically for the past 20 years. That nation's woes also started with burst bubbles: housing prices and commercial real estate prices.
"The problems tipped over into the financial system and the irony that everybody is pointing out: The Americans were front and center criticizing the Japanese for not facing up to their problems. 'Why are you hiding all of these problems in your banks? Why don't you face facts?' " Emmons said. "And guess what we're doing? We're hiding problems in the banks. We're not facing facts. So, I think it's logical to expect, we're going to be like Japan. It's going to take at least 10 years. That's my view."
Emmons said the alternative to dragging out recovery would bring consequences that most people would find "unthinkable."
"We can either take the pain now or drag it out, and we've chosen to drag it out," he said. "That gives you the five or 10 years, the so-called 'new normal.'
The alternative would get us through this quicker, but it's too awful to contemplate: That would be to get house prices down to market-clearing levels, which would probably be another 20 to 30 percent. You'd have to write down all the debt that was totally unpayable -- that would wipe out the banking system. You'd probably have to nationalize the banks. You'd have 10s and 10s of millions of people who would be insolvent."
The housing market is basically overbuilt, Emmons said.
"We built too many houses and put too high prices on them and paid for them with too much debt. So now it's all about trying to recalibrate," he said.
Emmons also tossed out some food for thought, regarding long-term solutions that would be discounted today as implausible.
Remember, for example, those old government programs that purchased commodities from farmers and then destroyed them in an effort to stabilize or boost prices? Even now, some cities -- on a very limited scale -- are choosing to buy foreclosed, abandoned properties, tear them down and land-bank the sites.
"It's an unthinkable thing right now, but I wouldn't be shocked if at some point, we say what we really should be doing is shrinking the housing stock that is putting so much pressure on existing houses, downward pressure on prices that is eating out the financial core of so many families," Emmons said.
He acknowledged that such programs might seem like "crazy stuff" that today people would say would never happen.
"But I remind you that some of the things that were done during the financial crisis by the Fed, the Treasury and Congress would qualify as things that two years earlier somebody would have said, 'Oh, they would never do that,' " Emmons said.