What Matters? The Long Climb Back From A Very Deep Pit

Often it’s easy to have the attention span of a gnat, a problem exacerbated by the 24 hour news cycle in which topics are headlined for a time, and then hit the public equivalent of the Lost and Found barrel.  Nevada’s economic situation in 2008 and early 2009, and how we got to our current position, are illustrative of the issue.  The Las Vegas Sun has a summation, a kernel of which says:

“Even though the government stepped in to stabilize the system, the economy still seized up. Only last year did we learn that the American economy saw an annualized decline of an astounding 8.9 percent in the fourth quarter of 2008, far worse than original estimates. By the time Obama took office, the private sector was losing 700,000 jobs per month, with state and local governments soon to follow with their own layoffs.”

The point made by Sun writer J. Patrick Coolican deserves repetition:  When something crashes this hard it takes more time to recover.

#1.  Recapitalize the investment institutions.  Done. Although the term “bank bailout” is as popular in some quarters as fire ants at a ‘clothing optional  beach’ picnic, the lending institutions had become so baffled in 2008 that they couldn’t properly determine the price of their own financial products, nor could they assess the price of their risks — hence the seizure.

#2. Enact legislation to prevent the repetition of the banking issues. Done. The Dodd-Frank Act (pdf) is far from perfect, however it does (a) require more regulatory oversight of the derivatives markets, a major component of the initial problem, (b) revise regulations involving the ratings agencies, another important issue, (c) create a Financial Stability Oversight Council to act as an Early Warning System to evaluate the financial viability of our banking institutions, (d) require banks to draft a type of Living Will, in the form of a plan for orderly liquidation, (e) seek to prevent “regulator shopping” in which institutions sought to slide under the jurisdiction of the least restrictive regulator, (f) include the Volcker Rule, and (g) create the Consumer Financial Protection Bureau.

This item on the check-list is a work in progress. While, the legislation has been enacted, the drafting of regulations associated with the new law is still a work in progress.  The Federal Reserve Bank of St. Louis has an updated time line of the drafts, and is a good resource for those wanting to see what has been done and what remains.

There are two essential points included in the Dodd Frank Act which are extremely important, and speak directly to avoiding another crash based on the lack of adult supervision associated with the 2008 Debacle.  First, is the oversight of the derivatives markets — an activity loudly criticized by some on Wall Street, but nevertheless necessary for insuring that the next amalgam of Quants, Wizards, and Masters of the Universe, doesn’t repeat their performance of 2008.  The second is the inclusion of an independent panel to warn banks of impending problems combined with the Orderly Liquidation Authority provisions.   The bankers are still squawking about being subject to the Financial Stability Oversight Council because they believe in “self regulation;” however, they were “self regulating” prior to 2008 and they drove the system into the ditch.

#3.  Stabilize the housing market.  Getting there.  This is crucial for Nevada, and for middle income Americans in all 50 states.   The Crash of 2008 was a cruel blow to everyone, but middle class Americans whose wealth was in large part a function of home-ownership were particularly hard hit.  Between 2007 and 2010 the average American middle class family lost about 40% of their total wealth as property values plummeted. [CNN]  However, we need to be realistic and remember that part of that wealth was illusory:

“For the vast majority of families, “wealth” essentially means, “home equity”. And the relatively high wealth levels of the mid-2000s reflected the inflation of the housing bubble. The bursting of the bubble exposed the wealth gains as having been unreal and produced the sizable declines in net worth revealed in the government data.”  [RCM]

As mentioned previously, American families are de-leveraging, i.e. paying down debt and restructuring their family finances.  At this juncture it appears that stagnating wages and job losses are more pressing concerns than loss of home equity for most families.*  The inflated equity is already gone, the problems associated with wages and job losses remain.

The housing sector is adjusting to reality, home construction may be declining but if we compare year-over-year numbers building permit requests are up 21.5% over last year. [LAT]

#4. Halt the suppressed demand cycle.  Stalled.  Deleveraging is good.  American consumers had piled on the debt during the Housing Bubble. They needed to deleverage.  Financial institutions which grabbed up the mortgages and repackaged them in altogether too many creative ways needed to deleverage.  However, the down side to deleveraging is that when people stop spending  our economic growth slows down.

The necessity of looking at the demand side of the economic equation has been covered here, here, here, and here.  I believe at one point I’ve even threatened to rename this blog something like the Aggregate Demand Review.

At the risk of even more redundancy, let’s review — the formula for aggregate demand is AG = C + I + G + (X-M).  That would be consumer spending + business spending + government spending – (exports – imports).  Demand drives orders, orders drive hiring.  Economic policies which depress orders will depress economic growth.  The current case of Republican obsessive-compulsive discussion of reducing government spending threatens to further diminish the “G” part of the equation AND the layoff of public sector employees tends to decrease the “C” part of the equation.  As if we needed any more reduction in aggregate demand, the Republicans would very much like to reduce government support for SNAP and other social safety net programs which act as our old friend, the economic automatic stabilizer — the shock absorbers on our economic vehicle.

Then there’s the American Jobs Act which is stalled in the 112th Congress.  Obviously, when people have jobs they have money to spend.  When they spend money that creates — you guessed it — demand.  Demand drives orders, orders drive hiring.  The economic concepts involved really aren’t very complicated.

One of the more interesting features of the Republican argument is the “government doesn’t create jobs” line,  but eventually every subsequent argument about cutting defense spending includes a recitation of the number of jobs which will be lost by those employed by defense contractors.   If it’s true in the defense sector, then it ought to be true in the education business — cuts to defense spending mean job losses in defense industries, and cuts to education funding lead to job losses in the education sector — the public safety sector, etc.   Job losses depress demand, depressed demand reduces economic growth.  Now, how hard was that?

The Bottom Line

All it takes to comprehend the terrain on the long hard slog we have ahead of us, is to focus on what really matters.   Reducing the likelihood of another Wall Street Debacle matters.  Stabilizing the housing market matters.   Enacting and implementing measures to increase demand for goods and services matter.  Everything else falls into two general categories: (1) Self serving promotion of policies designed to protect the 1% of the American population already doing well; and (2) Ideological assertions which describe neither the current American economic system, nor present solutions to contemporary American economic problems.   There is a choice.

We can either follow the Voodoo economics of the Supply Side Hoax and dig ourselves more deeply into the pit, or we can pay attention to both sides of the economic equation and start digging some ‘stairs’ in the side and climb up.

* At least one source is counseling against being too optimistic about the current decline in foreclosures, because there is still an inventory of properties in the pipeline, and although foreclosures have hit a five year low, realistically there is more to come.

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