Tag Archives: economic crisis

Home Prices Stagnate, at Levels Similar to Those of 2003

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US home prices, Case-Shiller 10-City index, 1987 to 2011

US home prices continue to stagnate, at levels well below the peak reached in 2006 during the housing bubble. They fell sharply in 2007 and 2008 during the last two years of the Bush Administration and then stabilized under Obama, first rising a bit and then falling back a bit, but with no overall trend so far.  Based on the 10-city composite home price index of S&P / Case-Shiller, the prices of single-family homes in September 2011 were 33% below the peak reached in April 2006.

It is useful to view this in the longer term context, as presented in the graph above.  While home prices are fully a third off their peak, they are still higher than they ever were prior to 2003.  The sharp fall in prices is a reflection of the sharp rise in the middle of the decade, as a bubble built up and policy makers decided not to try to do anything to moderate it.  Indeed, many politicians, as well as many existing homeowners, felt quite good about the rapidly rising prices.

Then the bubble burst, and the consequences for the economy have been clear, as the economy collapsed in the sharpest downturn since the Great Depression.  This was then followed by an anemic recovery, with still high unemployment.  Recovery from such “balance sheet recessions” are normally slow, as the entities with the over-extended balance sheets (mortgage holders in the US; the corporate sector in Japan in the 1990s) seek to hunker down and save their way out of their predicament.  Asset prices recover only slowly at best.

If nothing is done, US home prices are likely to continue to stagnate, and may well fall further.  As indicated above, while prices after the bubble burst fell by a third, they are still only at the level seen in 2003.  Yet between 1997 and 2003 they had already doubled.  That home prices have not now fallen further than simply to 2003 levels is therefore even a bit of a surprise.  They could fall more.  And as seen prior to 1997, there can be long periods when prices are basically just flat.

Those households with negative equity in their homes (commonly referred to as “underwater”) face major difficulties, even if they can afford to make continued payments on their homes.  They cannot refinance at the current low rates for mortgages, unless they can come up with extra cash to bring the mortgage down to 80% (generally) of their current lower home value.  And they cannot sell their house to someone else, perhaps to move elsewhere for a new job, without bringing extra cash to the closing to pay off the remaining mortgage balance.  The housing market remains frozen, and with that, the economy remains in the doldrums.

Unless something major is done, this weak housing market will likely keep the economy in the doldrums.  And there is no reason to believe that there will be a jump in housing prices to levels similar to those at the peak of the bubble, with this then curing the problem of the underwater mortgages.   Rather, a comprehensive program, led by government, will be necessary to restructure these mortgages, to unfreeze this market and allow the economy to recover.

The Eurozone Crisis: The Much Praised “Convergence” as a Cause

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Eurozone crisis, Eurozone and UK Government borrowing rates, 10 year yields, January 1993 to October 2011

The Eurozone crisis is complicated, and a mess.  Europe as a whole is probably already in an economic recession.  But one of the seeds for this crisis (there are several) can be found in what was seen then as the remarkable, and at the time much praised, “convergence” in government borrowing rates among the Eurozone members from the introduction of the Euro on January 1, 1999 (and Greece from its entry on January 1, 2001), until the Lehman Brothers collapse in September, 2008.

The graph shows how markets drove interest rates on government bonds to equality for Eurozone members, until the Lehman collapse in 2008.  It is really quite remarkable that the markets acted this way.  They treated the Government of Greece as if the probability it would default or otherwise reduce the value of the loans made to it (e.g. by an involuntary restructuring), were the same for it as for Germany (or any other Eurozone member).  Even if the markets thought that Germany would in the end always bail out any member otherwise unable to repay its debt, one would have thought that the markets would have at least viewed this as not 100% certain, and that they would in any case ultimately face some degree of loss even with a German bailout.  That the markets did not act this way shows how unbridled faith in markets acting rationally and fully informed is dogma, and is not supported by history.

The graph also shows the 10 year borrowing rate by the Government of the UK.  The UK has its own currency, and it must have been painful for it to see that the markets treated Eurozone members such as Greece and Ireland as better risks than the UK in the middle of the last decade.  I have included the UK in the above graph in part to show how tightly bound the borrowing rates were for the Eurozone members during this period. And despite a UK fiscal deficit which is now higher than all Eurozone members other than Greece (and in fact close to that of Greece, where the Greek fiscal deficit is projected to be 9.1% of GDP in 2011, vs. 8.8% projected for the UK), and public debt ratios similar to the EU average (and a third higher than that of Spain, for example), the UK 10-year borrowing rate is now almost the same as Germany’s (as of this writing on December 12, the 10 year UK rate was 2.10%, vs. 2.02% for Germany).  An independent currency helps.

The Eurozone crisis has reached the point that it has, threatening a renewed world-wide downturn and a possible break-up of the euro itself, because the traditional tools to manage a crisis are not there, due to the euro and the rules under which it was established.  The European Central Bank says it is not permitted to be a lender of last resort to Euro member governments, thus forgoing an important mechanism normally available to countries with a sovereign currency.  And as a member of the Eurozone, individual countries cannot devalue, where a devaluation could improve competitiveness and spur growth.  Many conservative economists have argued that putting nations is such straightjackets is the way to prosperity.  The Eurozone crisis shows that is simply not correct.

There are no good alternatives in what to do now.  The time for corrective actions should have come much earlier, including from the launch of the euro when the convergence in government borrowing rates was observed, despite the clear differences in capacity to service public debt among the Eurozone members.  But in coming up with a resolution to this crisis, one element will need to be that losses are taken by the lenders who had earlier treated all Eurozone governments as the same.  It was this failure of the market to differentiate across the Eurozone members that supported both profligate governments (such as Greece) and profligate private borrowers (such as banks in Spain and Ireland that  drove real estate bubbles), and more broadly financed at too low a price the trade imbalances that developed among the member countries.

Ensuring the lenders suffer such losses is not only morally justifiable (that is, all the costs should not be imposed Greece, Italy, Spain, and others, even if this would suffice, and it won’t), but also important to ensure another such crisis does not develop again in a few years.  Angela Merkel and Germany are trying instead to impose strict fiscal rules on public sector deficits and the accumulation of public debts, but it is unlikely that such blunt rules will suffice to cover the complexities of any real world situation the countries find themselves in.  Furthermore, such fiscal rules, if seriously applied, will limit the ability of governments to respond as they should to economic downturns, even recognizing that the rules in principle allow for some flexibility in such circumstances.

And by Germany insisting that banks and other lenders not take losses on the loans they made to the riskier countries (other than Greece), where such loans were made at rates that reflected an assumption of no risk, lenders might well feel that in other than extreme cases (like Greece) they will in the future again be bailed out.  While one should hesitate in relying solely on the markets, given their poor track record, the markets would function better if lenders were forced to take losses on their bad lending decisions.  That would then act as a check on excessive government borrowing in circumstances when such borrowing truly was excessive rather than a reasonable response to the real world situation the countries might find themselves in at some point in the future.  And such market discipline would function better than crude, one size fits all, fiscal rules that limit a government’s ability to respond appropriately to downturns.

Contracting Government Has Hurt Job Growth

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(change, in thousands of jobs) Jan 2001 to Jan 2005 Jan 2005 to Jan 2009 Jan 2001 to Jan 2009 Jan 2009 to Nov 2011
Total Employment -16 +1,110 +1,094 -1,855
Private Sector -916 +263 -653 -1,262
Government Sector +900 +847 +1,747 -593

Obama has repeatedly and emphatically been charged by Republican politicians as fostering  a huge expansion in government job growth, with this a major cause for the weak recovery in private job growth.  The facts do not support this.  The government sector has in fact been contracting sharply during the Obama period, in distinct contrast to the expansion during the Bush presidency, and it is this contraction which indeed can explain a significant share of the drop in overall jobs in the economy.

The table above, drawn from Bureau of Labor Statistics (US Department of Labor) figures on employment levels by the major sectors, shows the change in the number of those employed, for the periods between January 2001 and January 2005 (the first Bush term), between January 2005 and January 2009 (the second Bush term), between January 2001 and January 2009 (the two Bush terms together), and between January 2009 and November 2011 (the most recent figures, for the Obama term so far).

In the first Bush presidential term, overall job growth was basically zero.  But it is striking that it only comes to zero because a decline of 916,000 private jobs is almost fully offset by a nearly identical rise in government jobs of 900,000.  Note that while the time periods we are examining are the presidential terms, government job growth is largely affected by changes at the state and local level, as these account for about 87% of government jobs.

During the second Bush term, private sector job growth became positive, by a modest 263,000 for the period (with growth early on offset by the downturn in his final year), while government job growth continued at a roughly similar positive rate as during his first term.  With both positive, total job growth was then about 1.1 million.

For the Bush presidency as a whole, it is then interesting to note the overall job growth of about 1.1 million (all in his second term), only came about due to a growth in government jobs of about 1.75 million:  Private jobs in fact fell by about 650,000.

During the Obama presidency so far, government job growth went into reverse, with a decline of almost 600,000 jobs.  It is interesting that the pace of the decline for the first 34 months of Obama’s 48 month term (that is, through November 2011), matches almost exactly the pace of the increase during either of the Bush terms.

Suppose government job growth had increased during the Obama period at the pace it had during the Bush terms.  There would then have been a growth in government employment of over 600,000, rather than a decline of almost that amount, for a swing of 1.2 million jobs.  Assuming the same decline as now of over 1.2 million private jobs, overall jobs would have still fallen, but by only about 600,000 rather than over 1.8 million.

Of course, with such a different policy on government job growth, one would not expect private job growth to be the same.  Conservatives might argue that the government job growth would “crowd out” the private sector, leading to even an even larger fall in private jobs.  But there is no evidence to support this, in an environment where unemployment is high and interest rates on government borrowing are close to zero as the economy suffers from a liquidity trap.

Indeed, the basic insight of John Maynard Keynes is that in such a situation, government job growth (and its accompanying spending) will not only not displace private job growth, but will add to it at a multiple of what is spent directly, as the newly employed by the government will add to demand for privately produced goods and services as they spend their wages.  A reasonable estimate of this government employment multiplier would be at least two, and many would argue higher.  At a multiplier of two (that is, each additional government job leads to one additional private job, for two total), the swing in government employment of 1.2 million (that is, a rise of 600,000 rather than a decline of about 600,000), would have led to 1.2 million additional private jobs, and total employment growth would then have been a positive of 600,000 rather than a negative of over 1.8 million.  This is a swing of 2.4 million jobs.  With current unemployment in the US of 13.3 million, and a civilian labor force of 153.9 million, the unemployment rate would then be 7.1% rather than the current 8.6%.  It was 7.8% when Obama took office.

One can quibble with the specific figures, and what multiplier to assume.  But the basic point is that the contraction in government employment in recent years (primarily at the state and local levels) is a major reason why the overall job picture is still so bad.  If government employment had continued to expand at the pace it had during either of the Bush terms, rather than contract at a similar pace, then under quite plausible estimates, unemployment would be less now than when Obama took office.