The Blinder-Zandi Report

A paper by economists Alan Blinder, an economist at Princeton and a former vice chairman of the Federal Reserve, and Mark Zandi, the chief economist at Moody’s Analytics, finds that without the Troubled Asset Relief Program (TARP) that bailed out the nation's financial sector, the bank stress tests, the emergency lending and asset purchases by the Federal Reserve, and the Obama Administration’s fiscal stimulus program - the much maligned American Recovery and Reinvestment Act of 2009 (ARRA) - the nation’s gross domestic product would be about 6.5 percent lower this year.

Additionally, Dr. Blinder and Dr. Zandi find that the US economy would have lost an additional 8.5 million jobs, on top of the more than 8 million lost so far; and the economy would be in the midst of a deflationary asset spiral, instead of low inflation. Overall, they conclude that the aggregate effects of the TARP and the ARRA "probably averted what could have been called Great Depression 2.0." I am not quite sure why economists apart from Paul Krugman always seem to forget about the Panic of 1873, a five-year long financial downturn marked by deflation, price instability and the first sustained period of mass unemployment in world history.

More on the Blinder-Zandi report from the New York Times:

Mr. Blinder and Mr. Zandi emphasize the sheer size of the fallout from the financial crisis. They estimate the total direct cost of the recession at $1.6 trillion, and the total budgetary cost, after adding in nearly $750 billion in lost revenue from the weaker economy, at $2.35 trillion, or about 16 percent of G.D.P.

By comparison, the savings and loan crisis cost about $350 billion in today’s dollars: $275 billion in direct cost and an additional $75 billion from the recession of 1990-91 — or about 6 percent of G.D.P. at the time.

But the new analysis might not be of immediate solace to officials in the Obama administration, who have been trying to promote the “summer of recovery” at events across the nation in the face of polls indicating persistent doubts about the impact of the $787 billion stimulus program.

For one thing, Mr. Blinder and Mr. Zandi find that the financial stabilization measures — the Troubled Asset Relief Program, as the bailout is known, along with the bank stress tests and the Fed’s actions — have had a relatively greater impact than the stimulus program.

If the fiscal stimulus alone had been enacted, and not the financial measures, they concluded, real G.D.P. would have fallen 5 percent last year, with 12 million jobs lost. But if only the financial measures had been enacted, and not the stimulus, real G.D.P. would have fallen nearly 4 percent, with 10 million jobs lost.

The combined effects of both sets of policies cannot be directly compared with the sum of each in isolation, they found, “because the policies tend to reinforce each other.”

Oddly enough, the New York Times failed to link to the report but here it is: How the Great Recession Was Brought to an End (pdf). The title is perhaps a bit over optimistic given that we are not quite out of the economic doldrums as yet but I do think their conclusion is inescapable:

It is clear that laissez faire was not an option; policymakers had to act. Not responding would have left both the economy and the government’s fiscal situation in far graver condition.

Still no one has ever won an election with the argument that it could have been worse. 

Understanding GOP Economics, An Exercise in Futility

Though I largely hold that trying to understand Republican economics is an exercise in futility, credit Martin Wolf, the chief economics commentator at the Financial Times, for writing the single most brilliant takedown of the GOP's economic approach that I've read perhaps ever. In a column entitled The Political Genius of Supply Side Economics details the transformation of the GOP from the party of the responsible frugality of Dwight D. Eisenhower to the party of the irresponsible profligacy of Ronald Reagan and George W. Bush.

To understand modern Republican thinking on fiscal policy, we need to go back to perhaps the most politically brilliant (albeit economically unconvincing) idea in the history of fiscal policy: “supply-side economics”. Supply-side economics liberated conservatives from any need to insist on fiscal rectitude and balanced budgets. Supply-side economics said that one could cut taxes and balance budgets, because incentive effects would generate new activity and so higher revenue.

The political genius of this idea is evident. Supply-side economics transformed Republicans from a minority party into a majority party. It allowed them to promise lower taxes, lower deficits and, in effect, unchanged spending. Why should people not like this combination? Who does not like a free lunch?

How did supply-side economics bring these benefits? First, it allowed conservatives to ignore deficits. They could argue that, whatever the impact of the tax cuts in the short run, they would bring the budget back into balance, in the longer run. Second, the theory gave an economic justification – the argument from incentives - for lowering taxes on politically important supporters. Finally, if deficits did not, in fact, disappear, conservatives could fall back on the “starve the beast” theory: deficits would create a fiscal crisis that would force the government to cut spending and even destroy the hated welfare state.

In this way, the Republicans were transformed from a balanced-budget party to a tax-cutting party. This innovative stance proved highly politically effective, consistently putting the Democrats at a political disadvantage. It also made the Republicans de facto Keynesians in a de facto Keynesian nation. Whatever the rhetoric, I have long considered the US the advanced world’s most Keynesian nation – the one in which government (including the Federal Reserve) is most expected to generate healthy demand at all times, largely because jobs are, in the US, the only safety net for those of working age.

True, the theory that cuts would pay for themselves has proved altogether wrong. That this might well be the case was evident: cutting tax rates from, say, 30 per cent to zero would unambiguously reduce revenue to zero. This is not to argue there were no incentive effects. But they were not large enough to offset the fiscal impact of the cuts (see, on this, Wikipedia and a nice chart from Paul Krugman).

Indeed, Greg Mankiw, no less, chairman of the Council of Economic Advisers under George W. Bush, has responded to the view that broad-based tax cuts would pay for themselves, as follows: “I did not find such a claim credible, based on the available evidence. I never have, and I still don’t.” Indeed, he has referred to those who believe this as “charlatans and cranks”. Those are his words, not mine, though I agree. They apply, in force, to contemporary Republicans, alas,

Since the fiscal theory of supply-side economics did not work, the tax-cutting eras of Ronald Reagan and George H. Bush and again of George W. Bush saw very substantial rises in ratios of federal debt to gross domestic product. Under Reagan and the first Bush, the ratio of public debt to GDP went from 33 per cent to 64 per cent. It fell to 57 per cent under Bill Clinton. It then rose to 69 per cent under the second George Bush. Equally, tax cuts in the era of George W. Bush, wars and the economic crisis account for almost all the dire fiscal outlook for the next ten years (see the Center on Budget and Policy Priorities).

Today’s extremely high deficits are also an inheritance from Bush-era tax-and-spending policies and the financial crisis, also, of course, inherited by the present administration. Thus, according to the International Monetary Fund, the impact of discretionary stimulus on the US fiscal deficit amounts to a cumulative total of 4.7 per cent of GDP in 2009 and 2010, while the cumulative deficit over these years is forecast at 23.5 per cent of GDP. In any case, the stimulus was certainly too small, not too large.

The evidence shows, then, that contemporary conservatives (unlike those of old) simply do not think deficits matter, as former vice-president Richard Cheney is reported to have told former treasury secretary Paul O’Neill. But this is not because the supply-side theory of self-financing tax cuts, on which Reagan era tax cuts were justified, has worked, but despite the fact it has not. The faith has outlived its economic (though not its political) rationale.

The sad fact remains that too many Americans believe that taxes are too high (reality: among OECD countries only Mexico, Turkey, Korea, and Japan have lower taxes than the United States as a percentage of GDP) and perhaps worse too many Americans believe that the only road to economic prosperity is cutting taxes. In this they have been duped by the GOP but we too are culpable in that we have not successfully made the case that a progressive tax scheme not only produces a more egalitarian country but a more broadly prosperous one.

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The Housing Market's Double Bubble: The Big One Still Has Yet To Pop

Look what the Republicans have done to our economy by following their core "trickle down" economic ideology, which really means borrow and spend.  They have run up a massive debt which combined with no oversight, a near total removal of regulations on corporate conduct, and watched and let Neil Bush run a savings and loan (oh, sorry, that was that other Bush presidency -- when S&L owners and Republican campaign contributors robbed us blind and bribed Senators like John McCain and then got a massive government bailout.)

We have all been hearing a lot about housing prices falling, and about the effect housing prices have on the economy.  The impact to date, while real, is actually overstated. Why? Well, housing markets and their impact are the turtle of economics, they happen very very slowly. Prices have to fall and people have to sell, when they sell they, if they get less than they expected, may not spend as much as they would have if they had reaped a huge profit.

Of course, the lack of higher equity is hurting those home equity lines people were tapping like McCain at an open bar.  But ask yourself, honestly, how many people do you actually know who have either been forced to sell or have sold and not made a profit? Not that many -- yet.  People are still holding out.

Unquestionably the economy is slowing. Consumer debt is massive, companies are cutting jobs, inflation is rising, unemployment is a full percentage point ABOVE where it was a year ago, and with a work force of 200 million plus, that's 2,000,000 newly unemployed Americans.

Just this morning, we saw that planned July Job Cuts skyrocketed to over 100,000 meaning that unemployment will continue to climb, the economic impact of those layoffs won't be felt till mid-fall at the earliest when severance packages run out and the reality becomes apparent, new jobs are hard to come by.

But now the time is arriving when we will start to see and feel the real impact of the slowing economy -- layoffs will pick up over the next year and the forecast is for increasing and increasing unemployment, it almost surely will be another point or more higher next year than it is now.

Slowing economies manifest themselves in many ways. But the most prominent is in the corresponding fall in housing prices. In every modern recession, the fall in housing prices follows the economy slowing down. What we have yet to see is the falling economy's effect on housing prices. So if you think prices have already dropped, and might even be reaching a bottom, we think it's the other way around:  prices are about to start dropping.  

Even Alan Greenspan agrees with us.  Greenspan Says Housing Prices Not Yet Near Bottom

Former Federal Reserve Chairman Alan Greenspan said falling U.S. home prices are "nowhere near the bottom'' and the resulting market turmoil isn't showing signs of abating.

How can this be?

How can prices that have fallen 25% in Los Angeles year over year be about to start falling? Well, because unlike every other real estate boom of the past century, this past boom was, in fact, a boom and a bubble. This numbers below, from the Case-Schiller Housing Index showcase that and how the first bubble may have popped, the excess speculation bubble, but the underlying bubble remains, and now will begin to deflate.

Prices in San Francisco were set to an index of 100.00 in January of 2000.

By January 2004 prices had jumped to 155.93, a massive jump by historical standards. This alone is a real estate bubble.

By January 2007, they had already softened a bit but still were at 211.78. This is the second bubble.

Now the index stands at 162.70. Still up 60% since January 2000.

The prices have lost some of the home equity / no money down madness bubble, but have let to be impacted by the slowing economy. And they will be

How far will they go down? Well, economics is ruled by larger trends and post bubble, prices eventually revert to the historical mean.  

For example in the ten years from January 1987 to January 1997, prices increased 22%. And, fyi, that's after inflation, meaning a house purchased for $400,000 in January 1987 was actually worth less, in real dollar terms, in 1997, ten years later.

That's not a rant, that's a fact, all of these prices don't include inflation.

In real dollar terms, house prices really don't escalate much. Some studies of ONE HUNDRED YEAR time frames of the US Market show, in real dollar terms, that house prices remain flat.

How can that possibly be?

Well, we've been inundated with ten years of powerful powerful advertising messages that tell us, "housing prices always go up."

We borrowed money and spent it like good Republicans, because housing prices always go up.

We just know we can buy more and more because housing prices always go up.

But they don't.

So how can you estimate what the actual value of a house in San Francisco really is? How far can they fall? Another 40% to historical norms of growth? More?  Well, Dave recently calculated how far prices in the San Francisco Bay Area could fall using three different methods.

The first was the rent to price ratio.  With this method you take the average rent and calculate the amount of money you need to put into a decent investment to make the same amount.  For example, if you are clearing about $833.33 per month ($10K oer year) from a rental property unit (remember to account for maintenance and property taxes and something for your time...) then the price of the property would be around $100,000 for a 10% return ($10K is 10% of $100K) and $200,000 for a 5% return (sufficiently higher than a CD pays right now).  

So if houses in your area are renting for about $1400-1500 per month this is a rough way to tell that similar houses might be worth around $150K at best.  If you double that and they rent for $2800-3000 then house prices would be $300K.  And those prices assume that rental prices are not dropping.

James lives in a rental house in Boston which at market peak might have sold for $800,000 or $900,000 but now rents for $2,400. What does the landlord clear? Not $28,000 because he pays the taxes so more like $20,000. If you had $400,000 in the bank would you be happy with 5% return? Perhaps. But that's the highest amount you can estimate the house is worth in the market. And guess what? 10 years ago, the house was worth about $350,000. So it actually is about the right value.

The next method involved the average person in the area's income affording an average priced property.  Look around at prices in your area, and average wages.  At what price can the average person (or husband-wife) (or husband-husband/wife-wife in Dave's California and James' Massachusetts) buy a house?  Right: uh-oh.

The third method is to look at the historic mean plus inflation.  When prices triple in a few years, then when they correct they have to fall to 1/3 of the peak (plus inflation).  It's just the way it is.

When Dave calculated these for the Bay Area all three methods came out the same and showed that prices can still fall as much as 30-40%.   We say "can" but an economist might say "should." 

If it falls 30% from that index where it is now, it only drops to 112. Can't happen? Well, remember that 1987 - 1997 DECADE, it was up 22%. Now, after 8 years, it would be up 12% on that index. That's pretty normal growth to be honest.

And what is cumulative inflation of the past 8 years?  Let's make it easy on ourselves, and we'll say an average of 3%. The 100 Index goes from 100 to 126 with the combined effect of eight years of Inflation at 3%.

You see, housing is not the perfect "always goes up" investment. And it is clear that the housing prices in San Francisco and many more places could have 30% - 40% to go down from where they are today.

But, you guessed it, the news is actually worse than this.  First, there is a huge amount of excess housing inventory on the market.  So this needs to be factored into your thinking about where prices can go.  On top of the need for prices to revert to the mean, these extra houses have to find buyers before prices can stabilize. This is supply and demand, nothing more, nothing less.

Next is the effect of gas prices.  Many, many housing developments have gone up in areas that are far from city centers and far from non-automobile transportation like light rail or even buses, and buyers are going to be factoring the price of gas now.  Along with this, the price to heat and cool the monster homes that developers tended to build will become a consideration and will reduce demand for these houses.  

Another factor is that the "boomers" are starting to retire, and will be selling the larger homes in which they raised their families or ended their careers, looking for apartments, condos and even senior facilities.  This will also reduce demand.

And, just as the price of energy was not considered when these houses were designed and built but has lately become a factor, one day the implications of global warming will start to sink in.  In particular, is the house sufficiently above sea level?  Is it located near an area that is experiencing increased fire danger?  LOTS of Californians are starting to think about these issues.

But if you think we're wrong, and the above factors are non factors. Consider the recent decline in the stock market, General Motors and their 15.5 billion dollar quarterly loss, that's the recession that's here.  

This is the big one: A falling economy always forces housing prices to fall.  Even when housing prices are not in a bubble to start with a recession forces prices down.  And this hasn't even started acting on housing prices yet -- the falling prices we have seen are not because the economy is slowing, they are causing the economy to slow.  The slowing economy will make this worse as people are laid off around the country.  The foreclosures we are seeing today are not the result of people losing their jobs, but they are causing people to lose their jobs.  THEN the foreclosures that come FROM people losing their jobs will start.

There are no, none, nada, zilch factors that we see driving any hope for a "bottom" in housing prices any time soon.  

Thanks Republicans for ignoring the country's problems for so long, refusing to regulate the financial companies, refusing to address the need to find alternative energy sources, refusing to fund mass transit alternatives and refusing to provide oversight and enforcement of our laws.  Thanks for bringing us to where we are today.  

They borrowed and spent. We borrowed and spent and drove the housing prices up through a double bubble. One bubble may have popped. The next one will soon.

Post-Script: We worked on this post last week and over the weekend. This morning, The New York Times has this article: Housing Lenders Fear Bigger Wave Of Defaults. It echoes many of our arguments in this piece.

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