Greg Ip

New figures suggest that America has at last moved out of recession

Getty Images

[Greg Ip] ON October 29th the government reported that gross domestic product rose at an annualised rate of 3.5% in the third quarter compared to the second. This was the first increase since the second quarter of 2008. It backs up other evidence that the recession ended in the third quarter or just before, though the official decision, by the National Bureau of Economic Research, a group of academic economists, is still some way off. Robert Gordon, a member of this group, is confident that the recession, which began in December 2007, ended in June. But at 18 months that would still make it the longest since 1933.

Consumers are sceptical. Read the rest of this entry »

A slump in September prompts thoughts of new stimulus

[Greg Ip] AFTER riding a wave of improvement since the spring, the economy stumbled in September according to the latest figures. Non-farm employment sank by 263,000, which was 62,000 more than in August, and the unemployment rate rose by 0.1% to 9.8%. Car sales tumbled as the federal “cash-for-clunkers” programme expired. Manufacturing activity cooled a bit.

All this is probably an air pocket; overall economic output almost certainly began to rise in the third quarter of the year and employment will eventually follow. Leading indicators such as the stockmarket and new claims for unemployment benefits are signalling recovery. But it is taking a painfully long time. Read the rest of this entry »

Pummelled by recession, manufacturers face an uncertain future

[Greg Ip] AFTER the worst slump in modern memory, American factories are showing signs of life. Manufacturing production rose in August for the second straight month, and a survey of purchasing managers says new orders are rising briskly.

Yet manufacturers remain gloomy. Both output and employment are down 15% from the start of the recession in December 2007, far more than overall GDP and employment. Shipments collapsed when the near-paralysis of the financial system a year ago caused businesses worldwide to cancel orders and run down their stocks. On September 15th Dan DiMicco, head of Nucor, a steel company, said operating rates would be higher in the third quarter than the second, but only because of inventory replenishment. “Real demand is in for a long, slow recovery,” he said. Bad as this year has been, John Engler, president of the National Association of Manufacturers, a trade group, says many of his members “think next year will be worse”. Read the rest of this entry »

The original article is linked here.

GREG IP plus another Economist correspondent

The economy may be pulling out of recession but unemployment is still surprisingly high. Celebrations should be delayed

Illustration by S. Kambayashi

WHEN Barack Obama visited Elkhart, Indiana, in early February, a few weeks after his inauguration, it was a sombre affair. In the previous 12 months the area’s unemployment rate had more than tripled to 18.3 %. The president pleaded for the passage of a massive fiscal stimulus, insisting that “doing nothing is not an option.” By the time he returned to Elkhart on August 5th he was quite a bit sunnier. Local factories are “coming back to life”, he proclaimed. A few days earlier he had declared the economy to have done “measurably better” than expected.

Mr Obama’s good spirits are well grounded: America’s recession appears to be coming to an end. Read the rest of this entry »

The original article is available here.

Employees are proving stoical in the face of pay cuts and compulsory unpaid leave

Illustration by David Simonds

BACK when times were better and the newspaper industry wasn’t fighting for dear life, reporters at the Cleveland Plain Dealer would regularly grumble at the measly pay increases their union negotiated. Last month, when the union announced it had negotiated a 12% pay cut in exchange for a promise of no lay-offs, there was applause. “It took me aback,” says Harlan Spector, a medical reporter and one of the negotiators.

Like many long-standing economic relationships, “wage stickiness” is being tested by the savagery of the recession. Read the rest of this entry »

The original story is linked here.

Apr 2nd 2009 | WASHINGTON, DC
From The Economist print edition
     
THE current recession has broken many of the rules of business cycles, but not this one: when something gets cheap enough, buyers emerge.

America’s housing bubble seems mostly deflated. According to the S&P/Case-Shiller 20-city index, house prices through January were down 29% from their all-time peak. Relative to incomes, houses are now 10% undervalued, and relative to rents they are fairly valued, thinks Paul Dales of Capital Economics, a consultancy.

 
This is luring buyers back. House sales rose unexpectedly in February. Read the rest of this entry »

Jan 30th 2009
From Economist.com

America’s economy shrank sharply in the fourth quarter. There are few reasons for optimism

The original article appears here.

Shutterstock

IT IS a measure of the prevailing gloom that the worst economic performance in 26 years could still be described as better than expected. Real gross domestic product fell at an annual rate of 3.8% in the fourth quarter, below the decline of 5% or more that many economists had anticipated.

However, there is precious little reason for optimism. Read the rest of this entry »

After the recession, the deluge

Barack Obama must couple short-term stimulus with long-term fiscal reform

FOR all his talk of change, Barack Obama will start his presidency much as George Bush did: with a huge fiscal stimulus aimed at boosting an ailing economy and promoting some pet objectives. The need for stimulus is far greater than in 2001. America is in what could be its deepest recession since the Depression. With interest rates close to zero, the Federal Reserve is out of conventional monetary ammunition, so fiscal policy must do the lion’s share.

The problem with this is that higher spending and tax cuts will only make a big budget deficit even bigger. This danger does not justify penny-pinching now: that could merely prompt a bigger collapse in economic activity and even larger deficits. But Mr Obama should do what Mr Bush never did—and link the upcoming splurge to long-term fiscal reform.

The hole in America’s balance sheet is clearly partly Mr Bush’s fault. Even if you strip out the cyclical economic effects, the 1% surplus he inherited had become a deficit of more than 2% of GDP last year. But other things are at work. The collapse of the credit bubble will reduce tax revenues. The government has taken on big liabilities in its efforts to prop up the banking system. Above all, the first baby-boomers retired last year: as their numbers grow, the cost of the two big retirement programmes, Social Security (pensions) and Medicare, will soar.

The Congressional Budget Office says that, even without Mr Obama’s stimulus plans, America’s publicly held debt could rise from a perfectly reasonable 41% of GDP in 2008 to 54% in 2010, a 55-year high (see article). Under current tax and spending policies it is headed towards 400% by mid-century. Investors, fearing America will have to inflate its way out of such debt, could push the dollar down and interest rates up.

Mr Bush and the Republicans in Congress repeatedly gave voters goodies without paying for them: tax cuts without tax reform, subsidised prescription drugs without Medicare reform, and so on. Mr Obama must not make the same mistake. His stimulus plans may include cherished giveaways such as tax credits for low-paid workers, expanded unemployment insurance benefits, and investments in alternative energy. All have their merits; all will also increase the hole in the books. Despite some earnest waffle about addressing the long-term fiscal challenge, Mr Obama has been short on specifics.

The expiration of Mr Bush’s tax cuts at the end of next year imposes a deadline for dealing with the tax code. There is a powerful case for a grand bargain that overhauls the tax system, Social Security and Medicare all at once. The three are interconnected. Subsidised health insurance for the working poor, for example, could be paid for by eliminating the tax deduction for employer-provided insurance. The tax code could be made more progressive by reducing the payroll tax for low-income workers, but that would make it essential to rein in benefits, starting with a higher retirement age. Almost everyone would feel some pain. But in return Americans would get a tax system and budget that would be good for future growth.

If the economics of such a grand bargain are compelling, the politics are daunting. Armies of entrenched interests ring the tax system, Social Security and Medicare. Yet there may be no time like the present. Mr Obama has political capital and his party comfortably controls both houses of Congress (see article). He would also find some allies. Kent Conrad and Judd Gregg, the leading Democrat and Republican respectively on the Senate budget panel, have helpfully proposed a bipartisan task-force of congressmen and administration officials. It would come up with a single proposal that Congress could accept or reject but not amend, sidestepping the objections that would surely derail piecemeal reform.

Mr Obama does not need to produce a detailed solution right now. But by committing himself to a process that leads to such a solution, he could reassure investors that the grisly fiscal scenarios painted by the CBO will not come to pass.

Waiting for God-only-knows-what

Jan 8th 2009 | WASHINGTON, DC
From The Economist print edition

America’s grim fiscal outlook could either be a nightmare or an opportunity for Barack Obama

DURING one of his debates with Barack Obama, John McCain, the Republican candidate, kept referring to the “fiscal crisis” when he meant “financial crisis”. Perhaps he was on to something.

On January 7th the Congressional Budget Office (CBO), a non-partisan outfit, released projections that show the financial crash and the resulting recession are already wreaking havoc with America’s finances. It reckons that the budget deficit will soar from $455 billion in fiscal 2008 (which ended last September 30th) to an astonishing $1.2 trillion in the current year. At 8.3% that would be the most as a share of gross domestic product since the second world war. (The CBO does, however, see it dropping to 1.1% of GDP by 2019.)

The reality is both better and worse than these numbers imply. Of this year’s total, $420 billion represents the one-off subsidy implicit in the Treasury’s planned $700 billion of injections of capital and loan guarantees into the financial system and its “effective” guarantees of the two big mortgage agencies, Fannie Mae and Freddie Mac. Neither is a cash outlay in the usual sense.

But the underlying picture is worse for several reasons. First, it does not include any estimate of the cost of Mr Obama’s planned fiscal stimulus, which he will seek from Congress soon after being inaugurated. Second, the CBO assumes all of George Bush’s tax cuts will expire as scheduled at the end of next year and that the Alternative Minimum Tax, a parallel levy aimed at the wealthy, is allowed to ensnare a growing share of the middle class each year. True, that is what current law, as opposed to current practice, lays down; but neither is at all likely to happen. (The AMT has repeatedly been “patched” to lessen its baleful effects, and surely will be again.)

But the real problem is that the first baby-boomers retired last year. In coming decades spending on entitlements—the three main ones being Social Security (pensions), Medicare (health care for the elderly) and Medicaid (health care for the poor)—will drive deficits and so debt up sharply. Publicly held debt will climb from 41% of GDP last year to 54% next year, the CBO predicts, then decline (on the assumption that the recession will start to come to an end). But the CBO has previously said that, as America ages and if current policies continue, it could theoretically hit an otherworldly 400% by mid-century.

The situation sounds like a nightmare for Barack Obama. The figures hang over his negotiations with Congress on a fiscal stimulus plan. As currently envisioned, it would include business and individual tax cuts and, for those who pay little or no tax, tax credits. That would include a $500 per worker or $1,000 per household credit that was a centrepiece of Mr Obama’s campaign. It would include substantial funds for public works spending, additional Medicaid funds and other aid for cash-strapped states, and money to broaden the availability of unemployment insurance and provide health benefits to the unemployed. On January 7th Mr Obama said the package would be at the high end of estimates—which his team had previously pegged at $675 billion to $775 billion over two years—but not as high as some economists have urged.

Mr Obama faces three sceptical constituencies: Republicans, fiscal conservatives in his own party, and the markets. The addition of so many tax breaks to the package appears to have won over the co-operation of Republican leaders, although lengthy negotiations remain.

Fiscal conservatives are resigned to a big expansion of deficits in the short term but they want an early commitment to deal with entitlements as well. This is where the confluence of the economic and budgetary crises creates an opportunity. Since Mr Bush’s tax cuts expire at the end of next year, Mr Obama could try to reform the tax and entitlement systems simultaneously, which makes economic sense since so many aspects of health care and retirement impact the tax code.

Politically, a reform that antagonises so many constituencies is hardly appetising. “When you start making choices, you start losing friends,” says Kent Conrad, the Democratic Senate Budget Committee chairman and a leading fiscal hawk. He argues the job should be handed over to a bipartisan task force. But Thomas Kahn, the top staffer on the House Budget Committee, notes that some legislators worry that such mechanisms undermine the democratic process by limiting the opportunity for amendment and debate.

For his part, Mr Obama has acknowledged the urgency of addressing entitlements, but said more specifics would have to await his draft budget proposal, due for submission in mid-February. He has aimed his anti-deficit rhetoric, both before the election and since, principally at waste and earmarks, the pet projects legislators insert into spending bills. But as Maya MacGuineas of the Committee for a Responsible Federal Budget, a watchdog group, notes, such spending is at most $30 billion a year, or 1% of total expenditures. By contrast, entitlements amount to $1.2 trillion, or 41% of the whole; and, left unreformed, will grow to 60% by 2030.

Still, Ms MacGuineas thinks Mr Obama has to start with waste and earmarks to build the necessary credibility for bigger steps. “Before you say, ‘Ladies and gentlemen, your Social Security and Medicare benefits are going down and your taxes are going up,’ they want to know there are no more bridges to nowhere.”

Will the markets co-operate? Since November stock and credit markets have rallied partly as previous initiatives gain traction and partly in anticipation of more aggressive actions by the incoming administration. Record deficit projections have not spooked investors: the dollar has strengthened as the overseas outlook turns grimmer, and deflation worries have driven Treasury yields to their lowest in over half a century. But as financial panic subsides, the prospect of huge current deficits combined with the coming entitlements crunch could cause investors to worry America will one day inflate its way out of the debt or even, in the extreme, default. The resulting higher interest rates would elevate the cost of servicing the federal debt, further aggravating the deficit. The threat of such dangerous debt dynamics is ample incentive for Mr Obama to hurry up and explain how he will tame the deficit once the recession is over.

Plan C

As their economy slides, America’s policymakers are turning to unconventional devices. Our first article looks at the bold new steps taken this week by the Federal Reserve and the Treasury. Our second examines policy in Europe

Illustration by James Fryer

THE Federal Reserve’s interest-rate target is at 1%. The recession is deepening. And the question is being asked repeatedly: when will America’s economic policymakers start using truly unconventional measures to stimulate the economy?

The answer is that they already have. Without making any formal declaration, since early September the Fed has expanded its balance-sheet rapidly to counter the credit crunch. Under the guise of successive new programmes, each with a less memorable acronym than the last, the Fed is substituting its balance-sheet for that of the contracting private financial system to keep the American economy from being starved of credit. This week the central bank and the Treasury unveiled their latest big initiatives.

America’s financial system is undergoing a radical reassessment of what are acceptable levels of capital, leverage and interest rates. Some institutions have failed; those that have not are intent on reducing their leverage (ie, their volume of loans for each dollar of capital). The Fed has no hope of stopping this: it is merely trying to slow it down, by providing a home for the assets that the financial sector is shedding. The alternative would be plunging asset values, a complete withdrawal of credit and economic catastrophe.

Ben Bernanke, the chairman of the Fed, has repeatedly promised to use “all of the powers at our disposal” to get credit flowing again. This week’s initiatives are another demonstration of what he means. The Fed and the Treasury agreed to guarantee $306 billion-worth of assets belonging to Citigroup (see article). They then created a $200 billion facility to purchase asset-backed securities. Most radically, the Fed promised to buy up to $500 billion-worth of mortgage-backed securities (MBSs) guaranteed by government-sponsored enterprises (GSEs), including the now nationalised mortgage agencies, Fannie Mae and Freddie Mac, and up to $100 billion-worth of their direct debt. The effect was immediate: yields on the securities plunged by 40 basis points, and the 30-year mortgage rate fell from a shade over 6% to 5.8%.

The MBS purchases are significant; for the first time they turn the Fed into a direct lender to consumers. Many homeowners, though they do not know it, will be sending their monthly mortgage payments to the Fed. The Fed will finance these programmes with newly created reserves: that is, it will print money. Its balance-sheet, which has ballooned from $900 billion to $2.2 trillion since August, could grow by another $800 billion, making it a larger lender than any commercial bank.

It is tempting to look to Japan for a map of where the Fed may be heading next. Faced with sinking asset prices, insolvent banks, moribund growth and deflation, the Bank of Japan (BoJ) eventually lowered its policy rate to zero in 1999. In 2001 it announced “quantitative easing”: through large-scale purchases of government bonds, it would fill the banks with excess reserves that it hoped they would lend out, stimulating loan growth.

These routes are open to the Fed. It could cut its federal funds rate target from 1% to zero, though that would make it hard for some parts of the money market to function. It may not do much good, since the actual funds rate is already trading well below the target. To give it more impact, the Fed could commit itself to keeping the funds rate at zero for some time or until the economy or inflation meet some predetermined conditions. Such a commitment could drag down long-term Treasury-bond yields. Academics have concluded that Japan’s quantitative easing had little benefit except to buttress expectations that its policy rate would be zero for a long time. Alternatively, the Fed could target long-term rates via purchases of Treasuries, as it did from 1942 to 1951. That strategy could gain in appeal if big government deficits start to press bond yields higher.

Yet these options are not the most appealing for the Fed. The reason is that while it, like the BoJ, is now involved in a form of quantitative easing, it is doing so with completely different goals and in a very different environment.

One way to see this is to compare Japan in April 1995, when the BoJ’s policy rate was 1%, with America in October (see chart 1). Core inflation was slightly negative in Japan at the time, against 2.2% in America last month. That means real interest rates were significantly higher and conventional monetary policy less stimulative in Japan than in America today, says Tom Gallagher of ISI Group, a broker-dealer, who made the comparison.

Where America fares worse is in credit conditions. In 1995 Japanese corporate-bond yields were just 16 basis points higher than government-bond yields; the spread in America last month was 350 basis points. In a nutshell, Japan’s problem was deflation and moribund investment; America’s is rising fear of default, illiquidity and the need of so many lenders to reduce leverage, which collectively are choking off private credit and blunting conventional monetary policy. Although the federal funds rate target is far below the 5.25% of last summer, mortgage rates are only a little lower (see chart 2). Corporate borrowing rates are much higher.

The change in the perception of credit risk since the crisis began is similar to the change in the perception of terrorism risk after September 11th 2001. What investors once deemed safe levels of capital and liquidity they now consider dangerously thin. Before, banks “had just-in-time capital available, just-in-time funding…a lot of liquidity,” Vikram Pandit, Citigroup’s chief executive, said this week, “We’ve gone from that to, if you really need sizeable funding, you have got to go to a central bank. If you need to raise a lot of debt, you need an FDIC guarantee.” (The FDIC, or Federal Deposit Insurance Corporation, is a bank regulator.) Citi’s assets, which peaked at $2.4 trillion a year ago, were down to a little over $2 trillion by the end of September. With the Treasury’s injection of equity this past week, Citigroup’s core capital is now almost 15% of total assets, once an astronomically high ratio but one that many banks will now be expected to attain.

The pressure on investment banks to reduce leverage is even greater, because they rely more on fickle wholesale funding and less on stable, federally insured deposits. As a firm that depended heavily on proprietary trading and underwriting, Morgan Stanley boasted $33 of assets for each dollar of capital a year ago. By the end of October, the leverage ratio was below 16, according to the company. To get it there it both raised new capital (from sources including the federal government) and shrank its balance-sheet, to “significantly less” than $800 billion by the end of October from more than $1 trillion in May. “Clearly we’re in a world of reduced leverage,” Colm Kelleher, the firm’s chief financial officer, told investors recently.

The deleveraging of firms like Morgan Stanley and Citigroup creates problems for borrowers throughout the economy because the yields on the assets they sell rise. Borrowers must fight for a shrinking supply of new credit. Those that get it must pay far more. The rest cancel investments, lay off employees and hoard cash.

Initially Mr Bernanke sought to ease the pressure to deleverage by offering to finance banks’ holdings of illiquid securities on easy terms. But investors began to question the ability of bank capital to withstand a wave of recession-related defaults. The Treasury’s Troubled Asset Relief Programme (TARP) aims to quell those fears by injecting equity into banks so that they can reduce their leverage without shrinking their balance-sheets.

However, there are limits even to this. The Treasury has stuck to purchasing preferred equity to minimise the risk of loss and avoid having any say in running the bank. But the high interest rate the Treasury receives on such stock reduces banks’ profits. And rating agencies and regulators consider preferred stock a less permanent and therefore inferior form of capital to common equity.

Simon Johnson, an economist at the Massachusetts Institute of Technology, thinks the Treasury should start purchasing common equity instead, as the British government has done. With banks’ market values so low, that would leave the government with large stakes, and perhaps majority ownership of some banks. Mr Johnson suggests creating an arm’s length control board to oversee the government’s ownership, free of political meddling.

Still, helping banks recapitalise only partly mitigates deleveraging. Many large buyers of debt assets have simply disappeared, such as “structured investment vehicles”, or SIVs, that used short-term financing to buy up asset backed securities, often from banks seeking to free up capital. At one point they held up to $400 billion in assets. But, unable to roll over their funding, they have been either reabsorbed by banks or closed. In October one of the last big SIVs, Sigma Finance Corporation, with $27 billion in assets, collapsed. Its liquidation by creditors is thought to have contributed to the plunge in prices of asset-backed securities which has made it impossible for new securities backed by student, credit-card and car loans to be issued.

When the average person hears the term “asset-backed securities” he may well think of some of the crazier structures built on the rickety base of subprime mortgages. That would be wrong. Securitisation is decades old, mundane and vital. Banks and other lenders routinely pool their student, car, small-business and credit-card loans, and residential and commercial mortgages into securities and sell them to investors, leaving room for them to make new loans. The deleveraging of banks may be inevitable and healthy, but the disappearance of the securitisation market is not. Without it, “millions of Americans cannot find affordable financing for their basic credit needs,” Hank Paulson, the treasury secretary, said on November 25th. The facility he and the Fed unveiled that day will buy up to $200 billion of newly issued, top-rated asset-backed securities. The TARP will absorb the first $20 billion of losses; the Fed will lend the rest. It may eventually purchase commercial and residential MBSs that are not guaranteed by a GSE.

The facility may thus eventually do what TARP was meant to: relieve banks of their illiquid assets. But it does so by in effect leveraging each TARP dollar many times over via the Fed’s balance-sheet. “Policymakers seem to have concluded that leverage got us into this mess and leverage can get us out,” quipped Stephen Stanley, an economist at RBS Greenwich Capital. “Is it just me, or can you see a future for these guys running a hedge fund?”

The Fed’s decision to purchase MBSs is in some ways even more radical: it represents a direct foray by the Fed into lending to consumers: Though it has had the authority to buy the MBSs and debt of Fannie Mae or Freddie Mac since 1966, it has not done so since 1997 for fear of conferring government backing to ostensibly private companies. Those concerns disappeared when the Treasury in effect nationalised the companies in September.

Illustration by James Fryer

The Treasury and the agencies themselves had been buying MBSs but in spite of that the yields continued to rise, in part because of the government’s mixed signals on whether it stood behind the companies. The Fed’s announcement carries clout because of the size. There is no reason why the Fed need stop at $500 billion; between them, Fannie and Freddie have $4 trillion of MBS outstanding and $17 billion of their own debt. In going further, the Fed would in effect take over the roles of the mortgage agencies itself. And in theory, it could find creative ways to do the same for the corporate-bond market. Mr Bernanke is willing to try almost anything.

Yet these strategies do carry risks. One is inflation. Having expanded its balance-sheet so rapidly, the Fed may not have the foresight or courage to shrink it fast enough once the crisis passes, and the extra liquidity could fuel an overheating economy. But with unemployment perhaps heading for 9%, from 6.5% now, that risk seems remote.

Another risk is that the Fed and the Treasury have taken on more commitments than they can credibly keep. With budget deficits that could top $1 trillion a year, plus trillions of dollars more in guarantees to mortgages and bank debt, some investors may question America’s ability to shoulder all this debt. They could react by selling the dollar, although with the entire world in recession, the lack of appealing alternatives makes that less plausible.

More likely, they could just back away from Treasury bonds until the yields rise enough to compensate them for the higher risk of default. Ireland represents a cautionary tale: since it guaranteed the debts of its banking system, credit-default swaps have widened sharply on its sovereign debt, implying rising concern that the Irish government may one day default. America is a much bigger country and its currency happens to be the world’s premier reserve currency. So it can print as much as it likes. For now, anyway.