Barack Obama will almost surely assume the presidency in the midst the most severe recession in a quarter-century. Nonetheless, the depth and intensity of this recession still depends in part on the actions or lack thereof taken by a lame duck Congress and president. If Congress and the president cannot agree on a large, well-targeted economic reconstruction program, this economy may experience a deep and prolonged recession, analogous to Japan’s decade of economic stagnation after the collapse of its real estate and equity bubble.
Contrary to some of the business press, the current fall-off in consumer spending, business investment, and residential construction is more than the consequence of a weak or poorly regulated banking and finance sector.
That sector has surely exacerbated the problem through its reckless securitization and circulation of poorly collateralized mortgages.
The collapse of an asset bubble in housing that may eventually destroy as much as $8 trillion in homeowner wealth has triggered the current recession. We are in the early stages of experiencing the consequences of that collapse.
Home prices in many markets still must fall a long way before reverting to historic trend lines. Business leaders, bankers, and Fed-sponsored low interest rates encouraged homebuyers at all income levels to borrow up to and beyond any reasonable limit. No one need worry, because if worse came to worst, the homeowner could sell for more than the purchase price or borrow more on the growing value of the house. In the next few months, teaser rates on many home mortgages well above the subprime category will be reset. More houses will be dumped into an already glutted housing market.
As the equity in homes all across regions and socioeconomic categories diminishes, homeowners feel less secure and adjust their consumption accordingly. Nouriel Roubini, professor of economics at New York University, estimates that the wealth-related decline in consumer and business spending will be in the neighborhood of $300 billion to $400 billion. States and local governments, anticipating diminished revenues, are already cutting programs. The resulting decline in jobs will further depress demand.
Neither Europe nor Asia is likely to bail us out with imports. As Roubini points out, all the advanced economies, representing 60 percent of world GDP, were in recession or slower growth even before our housing and
financial market collapses. Many European banks are even more highly leveraged than their U.S. counter-parts.
Even if the Bush administration’s badly managed bailout of the U.S. financial system were to restore the solvency of banks, most still will be reluctant to lend money into a slumping economy. Businesses will be hesitant to borrow. The longer we wait, the more unemployment grows, confidence declines, and the longer it will take to resume even modest growth.
Neither this Congress nor this president has a legacy of which they can be proud. Nonetheless, constructive bipartisanship in the lame duck session could both restore some faith in our politics and improve our economic fortunes. Congress must enact an economic reconstruction program far superior to its embarrassing effort last spring. Tax cuts for the wealthy and even the middle class won’t work. In a climate of fear and heavy debt burdens, those funds will not be spent. Government must take up the slack.
Surprisingly even some of the more conservative voices on CNBC and some centrist Democrats such as Robert Rubin recognize that in an economy spiraling downward, deficits will not “crowd out” private investment or occasion inflation. Speed is of the essence. Money must go to those who will spend it. An effective and just package would expand unemployment benefits, increase funding for food stamps, provide block grants to state and local governments for programs now in retrenchment, and fund infrastructure spending, especially for projects already planned.
The final test of this president and Congress and the fist test for President-elect Obama is now. If for whatever reason Obama is reluctant to assume the leadership in pressing for such a package, Democrats in Congress should take the initiative. If President Bush vetoes a progressive stimulus or Republican senators filibuster it, their actions will show the electorate where responsibility for a deepening recession lies. It is incumbent on this Congress and president to leave one positive legacy.
John Buell is a political economist who lives in Southwest Harbor. Readers may reach him at firstname.lastname@example.org.