The Troubles With Bubbles
Wednesday, February 04, 2009 at 9:25 am
Last July, as the extent of the nation’s housing collapse was just being realized on Wall Street, The Onion ran the classic headline: “Recession-Plagued Nation Demands New Bubble to Invest In.”
The device, of course, was satire. But the clever message raises a question that some experts hope lawmakers will consider as they haggle this month over legislation to buoy the sinking economy: How to measure the bill’s success in the wake of an economy propped up by an inflated housing market? Some economists fear the goal is an attempt to return to the same unsustainable levels of consumer spending the housing bubble allowed.
“There’s a hankering to return to bubble levels,” said Jagadeesh Gokhale, an economist at the Libertarian Cato Institute who opposes the stimulus package. “But the bubble, by definition, is a deviation from normal consumption. We should give up the idea that we can return to those levels of spending. They’re clearly unsustainable.”
The criticism arrives as the Senate debates a proposal to treat the ailing economy with nearly $900 billion in new federal spending and tax credits. House Democrats approved an $819 billion version of the bill last week, and Senate Majority Leader Harry Reid (D-Nev.) has said he wants to pass the upper-chamber’s proposal by the weekend. Lawmakers on both sides of the aisle say an enormous spending package is necessary to prevent the recession from lasting as long as it otherwise might, though Republicans, who want more tax cuts, are threatening to stall the Democrats’ proposal.
Recent economic indicators explain the urgency. In December, unemployment rates climbed to 7.2 percent — the highest rate in 16 years. (Roughly 2.6 million Americans lost their jobs in 2008 alone.) And without government intervention, the jobless rate is projected to hit 9.2 percent early in 2010 — up from 4.4 percent just three years earlier — according to the Congressional Budget Office.
Even with the arrival of an enormous spending bill, most economists expect that unemployment rates will continue to rise through this year. “It’d be remarkable if we stopped shedding jobs in 2009,” said Dean Baker, co-director of the Center for Economic and Policy Research.
In bailing out the finance industry with the Troubled Assets Relief Program (TARP), Washington sought to be the lender of last resort; now with the stimulus bill, it’s aiming to be the buyer of last resort. Yet even some supporters of the stimulus concept concede that, with the recession threatening to be the deepest in the postwar period, the yardstick for success will be tough to define.
Heidi Shierholz, an economist at the Economic Policy Institute, said that one measure of the bill’s effectiveness would be in keeping the jobless rate below 9 percent. Yet, much like the Wall Street bailout, she added, that gauge remains nebulous.
“That’s been the huge black hole with the TARP,” Shierholz said. “How do you measure its success?”
Some economists insist that returning to the spending levels of the bubble days has never been the intent of the stimulus bill. “Nobody wants to get back to the overheated bubble economy of the last few years,” said Alice M. Rivlin, former director of the Congressional Budget Office and now a scholar at the Brookings Institution. “We’ve got to return to a more stable situation in which Americans are consuming less … and saving more.”
Yet for a country in which consumer spending represents roughly 70 percent of the entire economy, a move toward savings won’t come without repercussions. Though it might be in the best interest of the individual family to forego the restaurant meal or the new car, those decisions do nothing to support the waitress and the auto dealer.
Chad Stone, chief economist at the Center on Budget and Policy Priorities, said that the idea behind the stimulus is to boost individual consumption immediately for the sake of the larger economy. The savings stage, he added, can come later. “After you get the patient up off the floor, then you start the diet and exercise,” Stone said.
Supporters of the stimulus proposal — including President Barack Obama — have made a habit of claiming that it will create or preserve 3 million to 4 million jobs. Yet most of the spending takes place in 2009 and 2010, leaving some experts wondering how to sustain those jobs when the funding runs dry.
“When the economy starts to turn up again, perhaps as early as next year, the president will have the real tough decisions to make,” Robert Reich, former labor secretary under President Bill Clinton and now an economics professor at the University of California-Berkeley, wrote on his blog this week. “He’ll have to choose which spending will continue — or whether any of it will continue at all.”
It’s widely agreed that the housing bubble, which marked much of the decade, brought with it a spending bubble, as homeowners leveraged the rising value of their homes to buy things they otherwise couldn’t afford. When the housing bubble burst, consumer spending fell — and the rest of the economy with it. “That’s gone,” Shierholz said, “and it’s not coming back.”
Indeed, in the fourth quarter of 2008, U.S. home values were down 11.6 percent from a year ago and 17.5 percent relative to their peak in 2006, according to Zillow.com, an online real estate analysis company.
Baker, of the Center for Economic and Policy Research, estimates that $6 trillion in housing wealth has been lost since the market peaked. Considering that each $1 in housing wealth translates into between 5 cents and 7 cents in consumer spending, Baker added, the housing crash represents between $300 billion and $420 billion in lost spending each year.
Tack on the roughly $7 trillion in stock-market wealth that has been lost since the finance industry collapsed (which represents another $200 billion to $300 billion loss in annual consumer spending, Baker estimates), and you’ve got a hole between $500 billion and $720 billion to fill annually. The Democrats’ two-year stimulus bill — even if it reaches $900 billion — simply “isn’t enough,” Baker said.
There are other criticisms of the stimulus package as well. Peter Morici, an economist at the University of Maryland, argues that the proposal does nothing to mitigate the trade deficits he says are at the root of nation’s financial troubles. “It just buys time,” Morici said. “But the Chinese aren’t going to continue buying [debt] from us forever. They’re not that stupid.”
Asked Tuesday about borrowing from abroad to save America’s economy, House Majority Leader Steny Hoyer (D-Md.) told reporters that he’s “not comfortable with that,” but added that “there is no alternative” in the short term. “Failure to get the economy moving will cost us perhaps … twice as much more than spending the $800 billion or $900 billion,” Hoyer said.
Republicans, as well, are criticizing the Democrats’ stimulus blueprint, contending that it doesn’t go far enough to cut taxes or address the foreclosure crisis many finger as the cause of the financial meltdown. Senate Republicans have offered an alternative plan that would cut tax rates — a more permanent move than the temporary rebates proposed by the Democrats. The Republicans are also pushing to attach a provision offering qualified borrowers government-backed 30-year mortgages at a fixed rate of 4 percent interest.
“This simpler, targeted plan gets at the root of the problem, which is housing,” Senate Minority Leader Mitch McConnell (R-Ky.) said on the chamber floor Tuesday. “And it puts money in people’s pockets immediately.”
In the eyes of Cato’s Gokhale, however, the best course remains non-interventionist. The markets, he says, will fix themselves, allowing consumers, in time, the same sprees they enjoyed a few years ago.
“The economy will limp back,” Gokhale said, “and many years from now, incomes can support that level of spending.”
Unless, of course, another bubble comes along before then.
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