A little over a year ago, when it seemed that things just couldn’t get any worse, I was optimistic about the likelihood of an economic recovery. Pessimism was pervasive and the idea that the economy would recover seemed almost quaintly naive. To see a recovery on the horizon one had to either believe that the economic stimulus package would work, that the Fed’s money printing would induce something other than inflation or that markets would continue to function as they always have - that a faith in the mysterious interaction of supply and demand would be rewarded. I didn’t believe then the “stimulus” package would have much in the way of positive economic effects or that printing up pretty pieces of paper sporting portraits of dead Presidents could magically produce anything other than a desperate attempt by consumers to rid themselves of something so intrinsically worthless and obviously overvalued. And I still don’t. I do however still believe in markets.
I realize that for a lot of people, still believing in markets is akin to unicorn worship at this point, but nothing I’ve witnessed in the last two years is enough to shake the capitalist monkey from my back. In fact, everything that has happened in the last year is consistent with how we would expect markets to react. If anything I believe the attempts of the government to mitigate the damage of the recession have impeded the recovery but that is, of course, impossible to prove. It is equally impossible to prove that disaster would have ensued absent the government interventions but that sure hasn’t stopped those with a political agenda - or a true belief in Keynesian economics - from trying. It is amazing - at least to me - that economists such as Mark Zandi can state categorically and without challenge, as I saw him do Friday on CNBC, that without the government efforts we would now be in the throes of the Great Depression II - the sequel. How does he know? As best I can tell it is nothing more than a blind faith in the ability of government employees to direct the spending of our $14 trillion economy more efficiently than millions of people acting independently. From where this faith in the super human government employee - let’s call him G-Man - springs I cannot tell you; there seems little evidence to support such a notion.
The housing market has been a direct recipient of some of this enlightened spending over the last year from the Fed purchasing $1.25 trillion in mortgages to the numerous attempts at foreclosure mitigation championed by the Obama administration. One can’t help but notice that the housing market remains a rather weak link in the chain of events that we call an economic recovery. It is hard to say what shape the housing market would be in without the superhuman efforts of G-Man but considering that a majority of modified loans go on to re-default and that geographic areas with the highest foreclosure rates are also the areas with the most rapid sales growth, well one can be excused for believing that his efforts have actually delayed the recovery of the housing market. Would prices be lower if the government hadn’t intervened so heavily? I would guess so but then, lower prices do seem to be the only real cure for slow sales and high inventories
And it isn’t just that G-Man has slowed the recovery. He has also caused real harm that cannot be reversed. Like everything in economics there are tradeoffs involved with these decisions. Some groups of individuals benefit from these programs but it is mostly a zero sum game; they can only benefit to the degree that some other group is harmed. Mitigation efforts that are successful are only successful in the sense that they reduce the amplitude of the necessary changes that the market would force. The tradeoff is that the wavelength of the change is extended. The fall in housing prices may be mitigated only at the expense of a higher than normal inventory for an extended period of time. And there are consequences beyond that of duration; those who are hurt by these mitigation efforts "“such as those who could buy a home if prices were just a bit lower "“ are permanently injured. You can't make them whole again. Institutions that would have failed without government intervention will remain, in many cases managed by the same people who made the intervention necessary. The prudent financial institutions that would have gained market share from the failure of the imprudent will not get that chance.
And that brings me to my worries about the durability of the economic recovery that is now obvious to everyone. The efforts of the G-Men may have mitigated the depth of the recession - things indeed may have been worse without the intervention - but I wonder at what cost? Unfortunately, I don't see any evidence that we have legitimately addressed, much less solved, the problems that led us to the dark days of a year ago. The stimulus plan has mitigated the drop in consumption by increasing transfer payments, funded through increased government debt, to maintain income levels. Rather than extinguish the excessive debt in our economy, we have merely changed its composition. Private debt has fallen while public debt has risen. How long this can continue is a matter of some contention but it cannot go on indefinitely. Eventually - and that may be sooner than some expect - interest rates will have to rise to compensate bondholders for the risks of lending to a Congress with the self control of an ADD addled teenager facing a Ritalin shortage.
House prices are probably higher than they would have been without the government intervention but how long will GDP remain depressed waiting for the inventory to clear and construction to pick up again? The Fed’s intervention in the mortgage market and generally low interest rates has probably reduced the losses of the banks, but there is no free lunch. The extra profits being generated for the banks come out of the pockets of savers. How can moving the rightful interest earnings of prudent savers into the pockets of bankers who have proven again and again that they will not act prudently unless forced through stringent regulation, be a proper resolution of the financial crisis
A true economic expansion is built on savings and prudent investment, not by forcing people to take risks they can’t afford or to consume what they don’t need. The recovery to date has been generated through an income maintenance program of increased transfer payments paid for through increased government borrowing. The consumption has run down inventories that now must be rebuilt and while that is a form of investment it isn’t enough to generate a self sustaining economic expansion. For that we need productive capital investment in equipment, software, training and education. But first we need capital and that has to come from savings. The recent report on income and spending is not encouraging. Real disposable income is stagnant and the savings rate which early last year was over 6% is now closer to 3% and falling.
Just as last year most people couldn’t see the bottom of the recession, most will also miss the apex of the recovery. For now, there are a number of indicators that point to more growth in the near term but the rate of positive change may be peaking. For instance, the ISM reports have recently been very positive but the recent readings are near the highs that we’ve seen since the mid 80s. Unless this is a recovery more like 1982 - and there are lots of reasons to doubt that - then this is about as good as it gets. That doesn’t mean that we’re necessarily headed for a double dip back into recession but it seems like this could be the apogee of the rate of expansion. If G-Man is running out of tools in his utility belt then Investment Man better show up soon to save the day or Recovery Girl is in deep trouble
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