http://www.cqpolitics.com/wmspage.cfm?docID=news-000002991269
CQ TODAY ONLINE NEWS
Nov. 26, 2008 – 5:44 a.m.
Recession Realities: Why The Worst is Yet to Come
By Madison Powers, CQ Guest Columnist
When President-Elect Obama announced the members of his economic team
this week, he tried to prepare the country for the fact that economic
recovery would take time. He stated pointedly that things are likely to
get worse before they get better. He might well have added that, if the
past is any indicator, things are likely to get much worse for many of
those who already are among the worst-off and that the worst that is yet
to come is well down the road past the point at which economists
formally declare the recession at an end.
We are in for more bailouts beyond what we have seen thus far, and we
are likely to see more mistakes no matter how talented the new economic
team is. In particular, they are likely to be wrong both in initial
response and estimation of how much money is at stake, and an added
political challenge will be that of navigating a course after public
trust in experts has eroded.
The first round of bailouts got off to a bad start, both in terms of
public policy and public confidence. Almost everyone asserted that there
was one and only one available solution and that they had just days to
pass necessary legislation. The plan was to buy up “toxic” assets known
as mortgage-backed securities, and the theory was that doing so would
get the backlog of bad debt off the books so that stock prices would
stabilize and banks could once again lend money.
Congress demanded in return accountability and transparency, but they
got neither. In fact, they did not even get the plan they voted for. In
a matter of weeks, the Secretary of the Treasury reversed course.
The new plan is to inject capital into failing banks in exchange for a
stake, usually in the form of preferred stock, raise the $100,000 cap on
FDIC insurance of bank deposits to $250,000, and set aside a few hundred
billion more to shore up banks that might weaken under the strain of bad
loan debt over the course of the coming months. This was in precise
detail the alternative favored by dissenting voices such as James K.
Galbraith only ten days into the crisis.
The public has to be prepared for more mistakes and more mid-course
correction, in part, by being informed in advance that we are and will
remain in uncharted territory with little option but to experiment. Even
if the current bad debt problem is contained, the economy should not be
expected to recover for quite a long time. The reasons are instructive,
both for the sake of managing the political expectations and for
preparing for the next policy choices we will face for years to come.
Three points are especially important.
First, there is no easy fix for the housing crisis. Median home prices,
as of last week, fell 11.3% over the last year, but a more important,
less reported benchmark is the fact that prices are nearly 20% off the
peak in third quarter of 2005. While the immediate focus is (rightly) on
how to aid those estimated 20% of mortgage holders who owe more than
their homes are worth, the longer-term threat is that the housing
problem is not merely a product of a short-term imbalance of supply and
demand for which we simply have to wait a few quarters for correction.
The more likely scenario we will face is a staggering and prolonged
housing glut lasting through 2025. Moreover, the likely continued
decline in values due to oversupply will hit hardest among some of the
economically most vulnerable members of society living in the outer
suburbs and exurbs of the nation’s largest cities.
Second, the real burden of job loss typically lags months or even years
past the point that the official definition of a recession indicates
that a recovery has begun. In the last recession that lasted for eight
months of 2001, for example, the unemployment figures peaked only in
2003 (at about the current unemployment rate). So the economic pain will
be greatest for ordinary middle class workers long after those fortunate
enough to have generous 401(k) plans see some improvement in their stock
portfolios. Whatever we spend now will reduce greater need for
expenditures later, but we have to be prepared to spend in deficit mode
for many years to come, even under the best case scenario.
The third long-term economic problem is the massive deterioration of
state and local budgets. Some large city mayors have petitioned for a
share of the credit lines guaranteed under the bailout plans designed
for the financial institutions. Their near-term credit crunch is urgent
but it is but a tip of the iceberg.
At least 41 states face budget shortfalls. In some states, the
percentage is quite large, at or above 10% in the hardest hit states.
But the worst impact comes later. During the first year of any recession
the inevitable decreases in tax revenues are partially offset by
previous year surpluses and “rainy day” funds. Many of those funds never
got replenished adequately from the last recession, in part because they
had cope with the peak of unemployment well into their 2004 budgets.
Looking ahead, then, we have to prepare for the fact that the heaviest
burdens on the states are still years out from now. Past experience also
shows that even the richest states have been unable to make up for the
losses on their own and, in the case of the 2001 recession, the federal
government undertook bailout schemes totaling $20 billion. This time
around, the combined mid-year shortfall for the 2009 fiscal year alone
is well beyond that amount.
The important lesson for the federal government is that they need to
prepare now for that bailout, and it is likely to cost less and avert a
worsening recession if they deal with it now. The reason is
straightforward. States can’t ride it lean times with deficit spending
or engage in their own Keynesian pump-priming. Balanced budget
provisions in their constitutions won’t let them. They have to choose
between expenditure reductions or tax increases, and the latter is no
real option.
Recession Realities: Why The Worst is Yet to Come
To make matters worse, just as the federal government undertakes public
works projects designed to create jobs and stimulate the economy, the
states will be retrenching their public works programs, thereby making
the size of the necessary federal government initiative that much
larger. Federal policy makers might as well plan for that now as well.
Moreover, state and local property taxes always fall substantially in
periods of economic recession. In many states, various taxes are enacted
with specific purposes, such as school finance, rather than general
revenue. The predictable consequence is that large budget reductions
will disproportionately affect the very things most important for future
economic development. The standard mechanisms for funding education are
problematic in good times, but they are disastrously short-sighted
during an economic downturn.
In economically difficult times, social safety net programs are often
the first and deepest cuts in state budgets. For example, the Center on
Budget and Policy Priorities notes that “in the last recession, some 34
states cut eligibility for public health programs, causing well over 1
million people to lose health coverage, and at least 23 states cut
eligibility for child care subsidies or otherwise limited access to
child care.” We can expect more of the same this time around.
As banks, automobile manufacturers and others get in line for federal
assistance, it is certain that the line will only get longer, and the
last in line will be some of the neediest.
Madison Powers is Senior Research Scholar, Kennedy Institute of Ethics,
Georgetown University. His column appears weekly in CQ Politics on
Wednesday.
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