Storms on the Economy’s Horizon

Storms on the Economy’s Horizon

November 18, 2009

The high economic anxieties that most Americans felt six months ago may have faded, but count me among economists who are still very concerned. Sure, the last GDP report came in at 3.5 percent, and the next one should show comparable gains. Virtually all of those gains, however, come from the temporary stimulus and unusual inventory corrections. Once those factors run their course — mid-2010 for the stimulus and maybe earlier for inventories — a second dip down becomes very possible, and it could be even worse than the first. And the main reason we remain so vulnerable is the series of political stumbles which have left largely unchanged many of the forces that drove us off the cliff.

Just today we learned that new residential construction fell again last month, while home foreclosures continue to rise. It could hardly be otherwise: Washington still has done little to address the pressures from falling home prices colliding with rising mortgage payments, even though they were the largest single factor in the financial meltdown. We did warn that the government’s housing plan wouldn’t work: A small government benefit to encourage banks to offer better terms to strapped homeowners couldn’t overcome the basic rule that anyone facing foreclosure becomes a poor credit risk, and banks don’t refinance mortgages for poor credit risks. So, as jobs have continued to disappear and incomes fall, foreclosures continue to rise. We could still declare a brief moratorium on foreclosures while putting in place some measures that might actually work — for example, directing Fannie Mae, which we taxpayers now own, to provide better terms to strapped homeowners whose mortgages are held there.

Washington also gave financial institutions hundreds of billions of tax dollars without ever requiring them to get rid of their toxic assets and reboot credit to businesses — and so, they largely didn’t. Now, as foreclosures continue to rise, those financial institutions face more losses from the mortgage-backed securities and their derivatives they still hold. Those losses will continue to limit the credit flows needed to keep the economy going once the stimulus fades. And that doesn’t factor in the increasing pressures on financial institutions from growing problems with commercial real estate.

And by the way, oil prices are up to $80 per-barrel again and headed higher if the dollar continues to weaken. You may have forgotten, but it was the run-up in oil price in 2007 that actually triggered the recent recession, with the financial crisis coming a little later and making it so much worse. If oil prices keep on rising now, on top of weak credit flows and anemic consumer spending, and the economy heads down again, its trajectory could well be even worse this time, since it will come in the context of already weak demand and high unemployment.

This possibility brings us to Washington’s largest failure of all — okay, the second largest after its astonishing incompetence dealing with the financial bubble and bust. Throughout the last expansion, Washington sat on its hands as jobs continued to disappear for two years after the 2001 recession ended, and then finally began to grow but at less than half the rates seen in the 1990s and 1980s. This political failure means that we now face double-digit unemployment for a long time, even if we manage to avoid returning to recession.

At least the administration and Congress finally are noticing the jobs problem. What we don’t know is whether they’ll do anything effective to address it. They have real options here. For example, for the short-term, they can provide more money to states squeezed by falling revenues and balanced-budget requirements, so the states can keep their teachers, police and other employees working. An even better idea would be to jumpstart new job creation by exempting the first few thousand dollars of wages from payroll taxes. And they could pay for it with a small, Tobin-type tax on financial transactions.
What really scares me and some other economists, however, is the possibility of another large shock to the financial system. For example, while it’s not likely, we could see a sudden collapse in the markets for securities backed by commercial mortgages. The real nightmare on Wall Street, however, is an international crisis that suddenly drives up the dollar’s value. That would present terrible problems, since much of the near-record profits being reported by Goldman “We’re doing God’s work” Sachs and others come from nearly a trillion dollars in complicated financial plays that depend on a weak dollar.

If this somehow should come to pass, Washington’s incapacity to deal effectively with the recent crisis will create very scary scenarios. At a minimum, even President Obama’s legendary skills of persuasion won’t be enough to convince the public to bail out Wall Street a second time. It’s may not be too late, however, for the administration and the Fed to privately jawbone Wall Street to reduce this new risk exposure — and ours. Whether they’re willing to accept smaller bonuses, which usually come with less risk, could be a good test of whether they deserve to ever be rescued again.

Health Care’s Raw Deal for Middle-Class Families

November 10, 2009

Health care reform advocates often point out that the costs of reform should be weighed against the costs of doing nothing. Unfortunately, that’s very hard to do, since our health care and tax arrangements mask those costs so well. I suspect that if middle-class Americans had a better grasp of what health care really costs them, and how those costs are shaping their economic futures, the public demand to control costs could spark political changes akin to the tax revolt of the 1970s.

These are my thoughts, at least, reading a new piece from Eugene Steuerle, a tax economist at the Urban Institute with a knack for collecting data that can help us see the world in fresh ways. From the data Steuerle presents, we can calculate that within just five or six years, the average middle-class family will have to devote nearly one-third of its income to health care costs. That’s right: one-third. According to the CBO, the average family will earn $54,000 a year in 2016, when a moderate-priced family policy will cost $14,700. Employers will pay much of that insurance bill for most middle-class families; but that’s just a mask, since those employer payments come out of people’s wages, not a company’s profits. In real effect, a middle class family’s earnings in 2016 will come to $68,700 ($54,000 + $14,700), of which $14,700 or 21.4 percent will go for health insurance. And that won’t be their only health-related costs. Their co-payments and other uninsured expenses, on average, will come to another $5,100. They’ll also be paying taxes to help cover other people’s health care — 2.9 percent of their cash wages for Medicare ($1,566), plus perhaps $750 more in federal and state income taxes for Medicaid and for Medicare costs not covered by the 2.9 percent payroll tax. Add up all of that, and it comes to $22,116, or 32.2 percent of the middle-class family’s adjusted income of $68,700.

While Steuerle is concerned — rightly so — about provisions in health care reform that will treat people with the same incomes differently, depending on the rules the legislation applies to employers, I’m more incensed about the current, raw deal for middle-class Americans. Why should an average family expect to pay one-third of its income in 2016 on a health care system which, in that same year, should claim 16 percent of our GDP? The biggest part of this puzzle lies in the fact that most of the costs are roughly the same for most people, regardless of their income. The worker earning $68,700, a manager who makes $100,000, and the company’s CEO who earns $1 million all will pay the same $14,700 for their families’ health coverage. Their out-of-pocket expenses do rise with income but not by very much; and while the manager and CEO pay more Medicare taxes than our average worker, they all pay at the same 2.9 percent rate. There also are other factors which reduce the burden on other groups — and so tacitly increase it for those middle-class families. For example, people on Medicare and Medicaid bear much lower insurance costs, although they also pay relatively more for their out-of-pocket expenses; and families without children pay relatively less for both insurance and out-of-pocket expenses.

Whatever the causes, the data show clearly that health care costs have become a core economic issue for middle-class Americans. Unless we can contain them, and over time even reduce them, realistic prospects of upward mobility for most middle-class families will simply slip away. Health care, in short, has to be an essential part of a new economic strategy.

The last political upheaval over the economic prospects of the middle class began with Proposition 13 in California and went on to fuel a conservative realignment that held sway for a quarter century. The next one may well have begun already with these unsustainable health care costs. President Obama, whose talent for reading the American mood rivals Ronald Reagan’s, tried to respond quickly with several reasonable ideas for cost containment. His proposals went nowhere when healthcare providers and insurers countered, in effect, by threatening to withhold people’s care. The next time, this issue will be recast in terms that everyone understands — people’s real incomes — and the results could be very different.

A New Economic Strategy for Hard Times and Good Times

November 3, 2009

You might not know it from what passes for economic commentary on cable TV, but the U.S. economy remains pretty sick. Last week’s report of 3.5 percent GDP growth in the third quarter seemed like cause to celebrate — until you looked more carefully at the data and saw that virtually all of the upside came from temporary government stimulus. As the head of a revered British firm told a crowd of fellow CEOs in Washington the same day, “If we gave that many drugs to a dead man, he’d dance too.” The next day, the report on personal incomes showed consumption continuing to slump, along with incomes. In coming months, the media and the administration will trumpet more reports of “good news,” which actually will provide little comfort to most American businesses and households. GDP may grow even faster in the fourth quarter as the stimulus continues to run its course and businesses stop cutting inventories that already are down to the bone. After that, we could yet face a second dip down, a possibility raised last week by Harvard economist Martin Feldstein.

We could even face more upheaval in financial markets already growing giddy again. In fact, Nouriel Roubini, the NYU economist who warned us in 2006 and 2007 that the end of the housing bubble could wreck the financial markets, now sees a new bubble forming from trillions in new investments by financial institutions playing the declining dollar off of other currencies. Moreover, he also sees an inevitable bust coming, with devastating new costs. He’s certainly correct that currency plays are very risky, since exchange rates can turn unexpectedly on a dime. That’s actually a variant of what happened to the Long Term Credit Management fund in the late-1990s. The big bets placed by that single fund, and the liabilities of its Wall Street investors, nearly brought down the financial system. What’s happening now is on a much bigger scale, and the underlying system is a lot more vulnerable.

If we do dodge Roubini’s latest bullet, the bad news eventually will run its course — though it probably will take at least another year, and longer than that for employment to recover. By that time, it will be more obvious that we don’t have a national strategy to avoid another boom-and-bust cycle and produce sustained gains for most people. It’s hard to face, but the Treasury and Congress have to give up their comforting assumption that the handful of financial institutions which dominate our capital markets are driven to behave in ways that ultimately produce good times for everyone. In some periods, markets do work nearly as well as that — from the latter 1950s and through the 1960s, for example, and again in the latter 1980s and through the 1990s. At other times, distorting new conditions bound the system, and markets go a little haywire. That’s what unfolded in the latter 1920s and through the 1930s, again in the 1970s, and now it’s happening again. So it’s time to retire the economic strategies of the last 25 years or so, which relied on efficient markets to drive those who run its largest institutions to work their will for everyone else’s benefit.

What we need now is a new debate over the terms of a new economic strategy. One place to begin is by limiting some of the risks taken by institutions that dominate critical markets, which the rest of us also depend on. It’s hard to do, because it’s very difficult to even measure and monitor those risks. It also means effectively limiting the profits available to the society’s richest companies, and how often does that happen?

A greater challenge will involve facing up to the way that the fast-evolving global economy has undermined our capacity to create jobs and deliver rising incomes for most people. It’s not about sending jobs to China. Rather, it’s about how hard it’s become for many companies, facing intense competition from tens of thousands of new foreign and domestic businesses created in globalization, to raise their prices when their cost go up. So as their health care and energy costs have marched up, they’ve cut other costs — starting with jobs and wages. And whenever this crisis and downturn truly end, the intense competitive pressures that indirectly eat into the American incomes will be as strong as ever.

The debate has to begin with the recognition that in this period at least, markets won’t cure these problems. If we truly want to restore steady wage gains, there will be no way to avoid serious government steps to slow future cost increases in health care and energy. A new strategy also has to acknowledge our only certain competitive edge in a global economy. In the country where the idea-based economy took hold first, our companies and workers still do better than most of their counterparts elsewhere in developing powerful new innovations, adopting them across the economy, and adapting them to their own particular circumstances. We have to generously fund both the seeds and the infrastructure of innovation. And we should help everyone develop the flexibility demanded to operate effectively in innovation-dense workplaces, by funding universal opportunities for people to upgrade their skills and education every year.