Our Economy May Be in a Death Spiral -- Will Washington Stop the Bleeding?
In September, Treasury Secretary Hank Paulson sold his $700 billion bailout to Congress on the premise that banks were hoarding money to prop up their balance sheets and that this was bringing the economy to a screeching halt.
Paulson has thrown a big chunk of that money at the banks -- all but $60 billion of the first $350 billion authorized by Congress has been committed -- and they've started lending to each other. But it has done virtually nothing to prevent the worst-case economic scenario we are all worried may come to pass -- a meltdown of the "brick and mortar" economy -- because the banks still aren't lending to the general public.
That's not just a result of the banks restricting loans that would allow businesses to stay afloat, if not expand, and individuals to buy so much of the stuff that the global economy produces. It's also because there are fewer American families and businesses that are credit-worthy.
In the housing market, that's indicated by a drop-off in the number of new loan applications. Mortgage applications are down by about a third from this time last year. As economist Dean Baker noted this week, "If people with good credit were being turned down, we would expect the number of applications to be rising, as they apply to several banks before finally finding one that will issue a loan. The fact that applications are actually declining ... is solid evidence that the problem is not that otherwise credit-worthy borrowers can't get loans. The problem is that people are not credit-worthy."
With the housing and financial crises hitting home after the middle class had already absorbed an almost decade-long pummeling during the Bush years, the economy is starting to spiral dangerously downward as a vicious cycle begins to take hold. What started as a housing crisis that shook the financial system is now hitting all kinds of businesses hard, and they're shedding jobs at a rapid rate -- over a half-million were lost in the course of the past two months. And that only tells part of the story, as official jobless rates don't count the underemployed or those who have given up trying to land a gig. The broadest measure of underemployment is now a hair under 12 percent; 1 in 8 American workers aren't getting the number of hours on the job they need to make ends meet.
Those people aren't spending much. Neither are the rest of us. Even people who have a safe job fear for their futures, and the belts are tightening.
With the bottom dropping out of the consumer market -- responsible for two-thirds of the American economy -- businesses across the board are feeling a major crunch. Electronic giant Circuit City filed for bankruptcy this week, a move that came on the heels of bad news from Neiman Marcus, Starbucks, Gap, Best Buy and Nordstrom that, as the Washington Post reported, "show consumer spending contracting and retail revenue shrinking." On Friday, Sun Microsystems announced that it would slash 6,000 jobs; DHL killed off its U.S. business entirely this week, sending 10,000 people to the unemployment lines, including 7,000 in the tiny town of Wilmington, Ohio (out of a population of 12,000).
Best Buy's CEO, Brad Anderson, told the <i>Post</i> that recent economic changes were "seismic" and that the company was facing "the most difficult climate we've ever seen." The New York Times reports that America's "buying binge is grinding to a halt."
As profits drop, businesses are expected to lay off even more workers, which will mean even less consumer spending. Firms are pulling back across the board. The deflation in real estate values, which began in residential, is now spreading into the commercial market. Commercial real estate sales are expected to fall by half from last year's levels. Already this year, $15 billion worth of planned commercial real estate projects have been canceled. The Washington Post reported that "growing layoffs and falling profits mean companies are giving up office space at rapid rates. Nationwide, more than 19 million square feet of space -- enough to fill more than 300 football fields -- has been emptied by office users this year, the most since the months after the Sept. 11, 2001, attacks."
As real estate values continue to dive, institutional investors are unloading assets, often at fire sale prices, which decreases the value of everyone's properties. Property taxes are the main source of revenues for municipal governments, so they're feeling pinched and are starting to lay off more people, which can only aggravate an already bleak situation. They're also cutting back on public services at the time when they're most needed. New York state is pondering $2 billion in cuts, "led by aid to schools and health care for the poor." California, home to one of the nation's largest real estate bubbles, is facing a $28 billion shortfall this year.
American households have gotten through other recent downturns by taking out chunks of home equity or borrowing on their credit cards, but this time they're tapped out. One in 6 homes is "under water" -- carrying more debt than it's worth -- and credit card companies are lowering their exposure by limiting people's credit lines. And Americans read the bad news every day, so they're socking away what money they have rather than spending it. That's a good thing in isolation -- we have one of the lowest savings rates in the world -- but it's coming at the worst possible time.
There's a real risk now of a "deflationary spiral." That means that as unemployment creeps up and corporate profits fall, people and companies fearing for their economic futures rein in spending even more, leaving larger stocks of everything from tractor parts to children's toys on the shelf. If the demand for stuff falls below the supply, prices will drop, pushing revenues further down and causing companies to trim workforces further, which would in turn depress demand further -- hence the "spiral."
And remember that Americans are deeper in debt than ever before. Inflation is bad for bankers because the money being repaid to them is worth less than when they lent it. The reverse -- deflation -- is bad for debtors because the dollars they have to repay are worth more -- could buy more stuff -- than the dollars they borrowed.
There's a major risk this will spill over into the entire global economy. China is already suffering from American consumers' pullback, and China buys raw materials from all over the world and components for its manufactures from Japan and the East Asian "Tigers." Up until now, our consumption has given the East Asian economies the cash to buy up our debt -- but the whole merry-go-round is threatening to grind to a halt. This week, it was announced that both Hong Kong and the "Euro Zone" had officially entered into recession.
There's broad consensus that Washington lawmakers have the tools to put a halt to this process if they use them effectively. But so far, the $700 billion bailout -- which will be much greater than that when all is said and done -- has been ineffective.
In large part, that's because even as they throw hundreds of billions at the private sector, they're trying not to look too much like Hugo Chavez as they do so. As the Washington Post reported, the bailout has been managed by Paulson's "most ardent disciples of free-market principles." Chief among the "principles" they've adhered to -- which should have been taken out with last week's trash -- is that even as the government shovels mountains of tax dollars at companies, it shouldn't tell them what to do with the money. So, while the British made demands of their financial institutions in order to be bailed out, namely that they start making loans to businesses and individuals, the Paulson team has not.
This week, it announced a set of "guidelines" urging banks to make loans, trim dividend payments and keep bloated CEO pay in check. it also urged banks to work with distressed homeowners to limit the number of foreclosures. But, these are just guidelines, and when Paulson announced them, there was no mention of penalties for institutions that didn't comply.
According to the New York Times, Neel Kashkari, the man managing the bailout, opposed a proposal by the FDIC to provide $24 billion in aid to firms that cut mortgage payments for distressed homeowners, prompting even Darrell Issa, R-Calif., a very conservative lawmaker, to say, ''It's very clear that Treasury cannot and will not make the effort to keep people in their homes."
A number of news reports suggests that financial institutions are using taxpayers' largesse to bolster their bottom lines, set aside bonus pools for top execs and, for the big boys, acquire ailing firms.
The foxes are in effect bailing out the henhouse; as the New York Times reported, the bailout has led to "one of the biggest lobbying free-for-alls in memory" with Treasury "under siege by an army of hired guns for banks, savings and loan associations and insurers," among others.
Ultimately, that probably explains the biggest problem with the bailout: The money is being poorly targeted. This week, Paulson acknowledged that "Main Street" -- the overused cliche of 2008 -- remains in peril, and he said that he is shifting the focus of the bailout from buying "toxic securities" to other measures, including efforts to "make loans more accessible for credit-worthy borrowers seeking car loans, student loans and other kinds of borrowing." But that doesn't touch the underlying issue of strained household budgets that are resulting in fewer and fewer people being "credit-worthy." The housing market has lost $5 trillion in wealth -- if there were a million-dollar bill, you'd need to stack 5 million of them to reach that amount -- along with another trillion that has vanished from the stock market; American families are now stretched to the breaking point.
And there is a massive effort under way to assure that losses from the real estate bubble's burst are mostly shouldered by homeowners rather than lenders. This week, for example, the Federal Housing Authority announced a new effort to keep foreclosures in check by streamlining the process of modifying home loans. But there are a couple of catches that are likely to limit the effectiveness of the plan, and they have the banks' fingerprints all over them. First, and most significantly, it will require homeowners to pony up 38 percent of their income to pay their mortgages, which might be OK if they weren't paying for a house that's worth less than what they owe on it. But the banks aren't being asked to take even a partial hit on the huge losses in underlying home values -- the full amount of the original mortgage will come due when properties are sold. If you know that when you eventually unload your house you'll owe more than you can sell it for, why struggle to make that heavy nut every month?
The program also only modifies FHA-approved loans -- mostly those made by Fannie Mae and Freddie Mac. That's only 40 percent of home loans, and, contrary to the right-wing myth, those are the loans that are in the best shape. Most of the remaining 60 percent have been sliced and diced and sold off in little pieces as mortgage-backed securities. The government might have mandated that those institutions getting a chunk of the bailout cash offer similar "work-outs," but it didn't (to be fair, even if it had done so, it's uncertain how those infamous mortgage-backed securities might have been disentangled).
To be clear, any effort to keep homeowners from ending up on the street is a good thing. And smart intervention to keep the financial system afloat is a necessity at this point (the devil obviously being in the details).
But without addressing what appears to be a sharp drop in demand for goods and services, the traditional tools for staving off a "deflationary cycle" -- printing lots of money and slashing interest rates to next to nothing -- aren't going to work. At times during Japan's lengthy period of malaise in the 1990s and early 2000s, interest rates were set at zero. But even free money didn't make the economy go because people just weren't buying.
At heart, then, averting disaster at this point appears to depend on keeping demand in the United States from plummeting. That doesn't mean more $600 "stimulus checks;" people are stretched so thin that those bucks will just pay down the MasterCard or get socked into a savings account.
What we need to do right now is throw concerns about the deficit out the window and spend money on programs that will create jobs, keep more homeowners from foreclosure and limit the pain of those who are already in trouble. As Bob Pollin, co-director of the Political Economy Research Institute at the University of Massachusetts, suggests, a massive "green jobs" program, combined with more food stamps and beefed-up unemployment benefits, addresses economic problems over both the short and long term.
This week, China unveiled the largest stimulus package in history -- equal to about 20 percent of its annual economic activity. The plan is instructive; the Chinese government's massive infusion of capital will "focus overwhelmingly on construction" and improving social services. In addition to beefing up its health care system, the cash will go to "projects including low-income housing, rural infrastructure, water, electricity, transportation, the environment (and) technological innovation."
China is not in the same position as the United States -- they've got huge cash reserves and a trade surplus, while we've got massive debt and a trade deficit. China also isn't hemorrhaging cash to maintain 700 military bases and occupy a couple of far-flung countries. But the "full faith and credit" of the U.S. government is still worth something, and we may not have any option but to follow their lead.