Source: Automatic Data Processing, Inc.By the end of 2005, it should have been apparent that the U.S. economy was fundamentally misaligned. We had significantly overinvested in housing and significantly underinvested in factories, plants, and equipment. In effect, we needed a recession: a period to readjust the balance between the different types of capital.
More broadly, failure is an essential aspect of free markets. Failure shows capitalism is working, because it means resources are moving from bad uses to good uses.
The number of people setting up their own households has fallen to some of the lowest levels in a generation, a trend that threatens to prolong the recession.
Many people, young and old, who in more promising times would be out on their own, are finding themselves ... stuck at square one. ...
The recession has wreaked havoc on all sorts of life plans. Tumbling stock prices have cut retirements short. Layoffs have forced middle-aged children to move in with mom. Falling home prices prompt unhappy couples to rethink divorce. The larger consequence of all these discrete decisions is that Americans are forming fewer households, which in turn helps prolong the downturn.
Government data suggest that the recession has helped push down household formation. ...
Household formation rates could keep falling, said Richard Moody, chief economist for Forward Capital, a real estate investment and research company, because of the strong correlation between job loss and household formation. With unemployment not expected to peak until next year, "a lot of that isn't reflected yet" in the data, he said.
Apparently more journalists watch 60 Minutes than watch Congressional testimony.
Here is a little diagram I drew to point out the chain of events that is occurring in our current recession. I marked "falling housing prices" as being caused by the free market to emphasize that it is the natural result of high housing prices. However, in reality every item along the chain is being caused by the free market. The actions in red represent the federal government's attempts to weaken the link between falling housing prices and rising unemployment.My research shows that government actions and interventions — not any inherent failure or instability of the private economy — caused, prolonged and dramatically worsened the crisis.Regarding the housing bubble:
The classic explanation of financial crises is that they are caused by excesses — frequently monetary excesses — which lead to a boom and an inevitable bust. This crisis was no different: A housing boom followed by a bust led to defaults, the implosion of mortgages and mortgage-related securities at financial institutions, and resulting financial turmoil.
Monetary excesses were the main cause of the boom. The Fed held its target interest rate, especially in 2003-2005, well below known monetary guidelines that say what good policy should be based on historical experience. Keeping interest rates on the track that worked well in the past two decades, rather than keeping rates so low, would have prevented the boom and the bust. Researchers at the Organization for Economic Cooperation and Development have provided corroborating evidence from other countries: The greater the degree of monetary excess in a country, the larger was the housing boom.Regarding the financial crisis:
The effects of the boom and bust were amplified by several complicating factors including the use of subprime and adjustable-rate mortgages, which led to excessive risk taking. There is also evidence the excessive risk taking was encouraged by the excessively low interest rates. ...
Other government actions were at play: The government-sponsored enterprises Fannie Mae and Freddie Mac were encouraged to expand and buy mortgage-backed securities, including those formed with the risky subprime mortgages.
A third policy response was the very sharp reduction in the target federal-funds rate to 2% in April 2008 from 5.25% in August 2007. This was sharper than monetary guidelines such as my own Taylor Rule would prescribe. The most noticeable effect of this rate cut was a sharp depreciation of the dollar and a large increase in oil prices. After the start of the crisis, oil prices doubled to over $140 in July 2008, before plummeting back down as expectations of world economic growth declined. But by then the damage of the high oil prices had been done.His conclusion:
After a year of such mistaken prescriptions, the crisis suddenly worsened in September and October 2008. We experienced a serious credit crunch, seriously weakening an economy already suffering from the lingering impact of the oil price hike and housing bust.
Many have argued that the reason for this bad turn was the government's decision not to prevent the bankruptcy of Lehman Brothers over the weekend of Sept. 13 and 14. A study of this event suggests that the answer is more complicated and lay elsewhere.
While interest rate spreads increased slightly on Monday, Sept. 15, they stayed in the range observed during the previous year, and remained in that range through the rest of the week. On Friday, Sept. 19, the Treasury announced a rescue package, though not its size or the details. Over the weekend the package was put together, and on Tuesday, Sept. 23, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson testified before the Senate Banking Committee. They introduced the Troubled Asset Relief Program (TARP), saying that it would be $700 billion in size. A short draft of legislation was provided, with no mention of oversight and few restrictions on the use of the funds.
The two men were questioned intensely and the reaction was quite negative, judging by the large volume of critical mail received by many members of Congress. It was following this testimony that one really begins to see the crisis deepening and interest rate spreads widening.
The realization by the public that the government's intervention plan had not been fully thought through, and the official story that the economy was tanking, likely led to the panic seen in the next few weeks. And this was likely amplified by the ad hoc decisions to support some financial institutions and not others and unclear, seemingly fear-based explanations of programs to address the crisis.
It did not have to be this way. To prevent misguided actions in the future, it is urgent that we return to sound principles of monetary policy, basing government interventions on clearly stated diagnoses and predictable frameworks for government actions.One problem with this narrative is that we were already well into the housing bubble by 2003. Many economists say that the housing bubble was initially caused by excessive savings in China and the Middle East, which resulted in ultra-low interest rates in the U.S. Rather than creating the housing bubble, it is much more likely that the Federal Reserve poured gas on an already burning fire.
Massive responses with little explanation will probably make things worse. That is the lesson from this crisis so far.
Rite Aid. This drugstore chain tried to boost its performance by acquiring competitors Brooks and Eckerd in 2007. But there have been some nasty side effects, like a huge debt load that makes it the most leveraged drugstore chain in the U.S.A lot of teenage girls will be disappointed if Claire's goes under. A lot of fat people will be disappointed if Krispy Kreme goes under. Sbarro makes great pizza and salad. I'd be disappointed if they go out of business, but I can't say I go there very often. Perhaps you should rent your movies from Blockbuster this year, hoping that if they close their doors while you've got the DVD checked out, it's yours to keep!
Claire's Stores. Leon Black's once-renowned private-equity firm, the Apollo Group, paid $3.1 billion for this trendy teen-focused accessory store in 2007, when buyout funds were bulging. But cash flow has been negative for much of the past year and analysts believe Claire's is close to defaulting on its debt.
Chrysler. Of the three Detroit automakers, Chrysler is the most endangered, with a product portfolio that's overreliant on gas-guzzling trucks and SUVs and almost totally devoid of compelling small cars.
Dollar Thrifty Automotive Group. This car-rental company is a small player compared to Enterprise, Hertz, and Avis Budget. It's also more reliant on leisure travelers, and therefore more susceptible to a downturn as consumers cut spending. Dollar Thrifty is also closely tied to Chrysler, which supplies 80 percent of its fleet.
Realogy Corp. It's the biggest real-estate brokerage firm in the country, but that's a bad thing when there are double-digit declines in both sales and prices, as there were in 2009. Realogy, which includes the Coldwell Banker, ERA, and Sotheby's franchises, also carries a high debt load, dating to its purchase by the Apollo Group in 2007 — the very moment when the housing market was starting to invert from a soaring ride into a sickening nosedive.
Station Casinos. Las Vegas has already been creamed by a biblical real-estate bust, and now it may face the loss of its home-grown gambling joints, too. Station — which runs 15 casinos off the strip that cater to locals — recently failed to make a key interest payment, which is often one of the last steps before a Chapter 11 filing.
Loehmann's Capital Corp. This clothing chain has the right formula for lean times, offering women's clothing at discount prices. But the consumer pullback is hitting just about every retailer, and Loehmann's has a lot less cash to ride out a drought than competitors like Nordstrom Rack and TJ Maxx.
Sbarro. It's not the pizza that's the problem. Many of this chain's 1,100 storefronts are in malls, which is a double whammy: Traffic is down, since consumers have put away their wallets. Sbarro can't really boost revenue by adding a breakfast or late-night menu, like other chains have done.
Six Flags. This theme-park operator has been losing money for several years, and selling off properties to try to pay down debt and get back into the black.
Blockbuster. The video-rental chain has burned cash while trying to figure out how to maximize fees without alienating customers. Its operating income has started to improve just as consumers are cutting back, even on movies. Video stores in general are under pressure as they compete with cable and Internet operators offering the same titles.
Krispy Kreme. The donuts might be good, but Krispy Kreme overestimated Americans' appetite — and that's saying something. This chain overexpanded during the donut heyday of the 1990s — taking on a lot of debt — and now requires high volumes to meet expenses and interest payments.
Landry's Restaurants. This restaurant chain, which operates Chart House, Rainforest Café, and other eateries, needs $400 million in new financing to finalize a buyout deal dating to last June.
Sirius Satellite Radio. The music rocks, but satellite radio has yet to be profitable, and huge contracts for performers like Howard Stern are looking unsustainable.
Trump Entertainment Resorts Holdings. The casino company made famous by The Donald has received several extensions on interest payments, while it tries to sell at least one of its Atlantic City properties and pay down a stack of debt. But with casino buyers scarce, competition circling, and gamblers nursing their losses from the recession, Trump Entertainment may face long odds of skirting bankruptcy.
BearingPoint. This Virginia-based consulting firm, spun out of KPMG in 2001, is struggling to solve its own operating problems. The firm has consistently lost money, revenue has been falling, and management stopped issuing earnings guidance in 2008.
The one lesson we learned was never allow the banking system to collapse.Milton Friedman made roughly the same argument here.
Japan’s rural areas have been paved over and filled in with roads, dams and other big infrastructure projects, the legacy of trillions of dollars spent to lift the economy from a severe downturn caused by the bursting of a real estate bubble in the late 1980s. During those nearly two decades, Japan accumulated the largest public debt in the developed world — totaling 180 percent of its $5.5 trillion economy — while failing to generate a convincing recovery.
Now, as the Obama administration embarks on a similar path, proposing to spend more than $820 billion to stimulate the sagging American economy, many economists are taking a fresh look at Japan’s troubled experience. ...
It matters what gets built: Japan spent too much on increasingly wasteful roads and bridges, and not enough in areas like education and social services, which studies show deliver more bang for the buck than infrastructure spending.
“It is not enough just to hire workers to dig holes and then fill them in again,” said Toshihiro Ihori, an economics professor at the University of Tokyo. “One lesson from Japan is that public works get the best results when they create something useful for the future.” ...
In the end, say economists, it was not public works but an expensive cleanup of the debt-ridden banking system, combined with growing exports to China and the United States, that brought a close to Japan’s Lost Decade. This has led many to conclude that spending did little more than sink Japan deeply into debt, leaving an enormous tax burden for future generations.
In the United States, it has also led to calls in Congress, particularly by Republicans, not to repeat the errors of Japan’s failed economic stimulus. ...
Economists tend to divide into two camps on the question of Japan’s infrastructure spending: those, many of them Americans like Mr. Geithner, who think it did not go far enough; and those, many of them Japanese, who think it was a colossal waste. ...
Most Japanese economists have tended to take a bleaker view of their nation’s track record, saying that Japan spent more than enough money, but wasted too much of it on roads to nowhere and other unneeded projects.
The National Bureau of Economic Research—a private, nonprofit research organization—said its group of academic economists who determine business cycles decided that the US recession began last December.Based on the currently available numbers, it does not (yet) look like this recession is deeper than the early 1980s recession, but it will almost certainly be longer—possibly much longer. What should the government do in response to this extended recession? See here.
The news pushed US stocks lower and renewed calls for another economic stimulus program.
The current recession, which many economists expect to persist through the middle of next year, is already the third-longest since the Great Depression, behind only the 16-month slumps of the mid-1970s and early 1980s.
"I think that we've got a ways to go, that this is going to be probably a deep and long recession," Jeffrey Frankel, a Harvard University economist who sits on the NBER's committee, told CNBC. "It could be the worst post-War recession. We don't know yet." ...
Many Wall Street financial institutions already had declared that the US recession began in December 2007, when there was a sharp increase in the US unemployment rate.
The last two recessions have been so short—about eight months—that the NBER's official prenouncement came after the downturn had actually ended. ...
What's been confusing for economists this time around is that a contraction in gross domestic product—what laymen consider a key recession indicator—did not happen until the third quarter of this year.
Other key barometers, such as payrolls and the jobless rate, have clearly been in a recessionary trend for most, if not all, of the year, economists say. ...
A senior adviser to U.S. President-elect Barack Obama said news that the United States has been in a recession for a year underscored the need for an economic stimulus package.
Lawrence Summers, tapped by Obama to become director of the White House National Economic Council, said the slump may be worsening.
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