A Precarious Balance: Outlook for the U.S. Economy Dr. John Caldwell Director of Economics Edison Electric Institute
What Constitutes a Recession? Source: Federal Reserve Board Interruptions in Long-Run Growth
The Business Cycle Since WWII Note: Average annual real GDP growth during this period has been 3.4%.
Causes of Recessions Which Was Responsible for This One?
___ Speculative “Bubble”
___ Sudden and/or Extreme Rise in Energy Prices
___ Failure of Regulators/Auditors to Identify Systemic Problems in Business/Accounting Practices
___ Tightening of Money Supply by Central Bank
___ Credit Crisis – Insolvency of Financial Institutions
___ Excessive Reliance on Foreign Sources of Funding
√ √ √ √ √ √
The Economic Crisis: Timeline 2000 2005 1995 1990’s U.S. Stock Market Boom Asian Financial Crisis Start of Housing Bubble “ Dot-Com” Recession; Collapse of Stock Bubble Energy/Commodity Prices Soar Start of Current Recession Housing Prices Peak
The Financial Meltdown: Timeline of Events Oil tops $100/bbl S&P’s/Moody’s downgrade several hundred subprime bonds & securities Fitch downgrades Countrywide to BBB+ Bank of America buys Countrywide Bush signs Economic Stimulus Act of 2008 Northern Rock nationalized Housing and Economic Recovery Act of 2008
Fannie May / Freddie Mack seized by government
Lehman Brothers files bankruptcy
House rejects bailout plan
Congress approves bailout plan – Bush signs Barack Obama elected President Obama signs stimulus bill Subprime lender New Century files for bankruptcy Diminished liquidity in interbank lending markets JP Morgan buys Bear Stearns
Causes of the Financial Crisis
Abundance of Low-Cost Sources of Money
Housing Boom Encouraged Consumers to Over-Extend in Borrowing
Faulty Lending Practices
Government policy aggressively encouraged expansion of homeownership
Reward structure in lending based on fees rather than interest income
Risky loans repackaged into complex investments
“ Capture theory” – Ratings agencies had incentive to give these investments positive evaluations
America’s Growing Reliance Upon Debt Source: Federal Reserve Board
Recent Trends Indicate A Rise in Both Poverty and Debt
State of the Economy Some Disturbing “Vital Signs”
How Serious is This One? Comparison with Past Recessions 1929 = 42 months 1929 = 25% 1929 = 27% 1929 = 89%
The National Debt
Currently at $10.8 trillion (78% of GDP, $35,000 per person)
Why is the National Debt a Problem?
Leads to inflationary pressures / high interest rates
25% of it is owed to foreign countries
Interest expense on debt becomes significant share of government budget
Social Security / Medicare A Huge Bill Looming Ahead
“ Pay as you go” entitlement programs are underfunded:
Social Security needs an additional $13.6 trillion to meet future needs . . .
But Medicare needs an additional $85.6 trillion !!!
How bad is this? Consider some alternative “fixes”:
Bill every American today $330,000 (or $840,000 per household).
Raise income taxes by 68%.
Cut government discretionary spending (e.g., national defense, education, the environment) by 97%.
National Debt Will Continue to Grow Source: Congressional Budget Office Will reach 85% of GDP in 2010
“ Follow the Money” Why Government Spending Is Not a Long-Term Solution Private Sector Investment Government Spending Private Savings Taxes Foreign Investment (from Trade Deficit) $ $ $ $ $ $ $ $ $ $
Prognosis for the Economy When Can We Expect a Recovery?
Necessary Preconditions for Recovery :
Housing Prices Bottom Out
Borrowing / Spending Resumed
Consumer Confidence Restored
Banks’ “Toxic” Assets Eliminated/Managed
Potential Roadblocks to Recovery:
Second Banking Crisis
Stimulus Program Has No Effect
Too Little, Too Late, or Channeled into Wrong Areas
Trade Wars Due to Protectionist Elements in Plan(s)
Financial Sector Restructuring Ineffective
The Road to Recovery The Long View
Borrowing and Lending
Remove “Toxic Assets”
New Regulation of Financial System
Rein in Deficit Spending
Reduce National Debt
Businesses / Consumers Banking / Financial Sector Federal Government