Posts Tagged ‘Great Recession’

One major reason the economy has yet to gain momentum is the sluggishness of the labor market. Not only are many workers still unemployed, but many others are employed below their capacity either in the type of job or the number of hours.

In a New York Times Economix blog post yesterday, Jared Bernstein of the Center on Budget and Policy Priorities in Washington, DC, makes some excellent points about the anemic progress of job creation in this economy, and how harmful it is not only to overall economic health, but also to the personal economy, if you will, of anyone who isn’t rich. One of his main points is that because most of depend on our jobs rather than our investment portfolios for economic sustenance, the fact that employment is still on a slow track is a huge issue.

There are a couple of problems that impact the economy and individuals when job creation is weak, regardless of how well the rest of the economy is doing. Here’s the cliff-notes version:

  • Millions still can’t find a job: Despite the fact that the unemployment rate has fallen significantly since it’s recession high, there are 12 million unemployed workers, and more than four million of those have been out of work for more than six months.
  • More millions are underemployed: Again, as noted above, millions of workers are underemployed below their capacity — college grads working in jobs that don’t require a degree, for example as well as those working part time who would rather work full time.
  • Slow wage growth: Because of the slack in the labor market, as the economists would say, there is no pressure on employers to raise wages. And while the “official” inflation rate may be low, costs are rising for the average family in the grocery store, at the gas pump and in bills related to the home.

Because we are very far away from the full employment of the 1990s, those at the bottom of the wage scale are suffering the most. When there are lots of unemployed and low demand, workers at the higher end of the food chain — those aforementioned college graduates, for example — move down the food chain and displace other workers, who are then forced to move down themselves.

So college graduates are filling jobs previously filled by high school grads, high school grads are filling jobs that non-high school grads had, and inevitably someone gets pushed out of the labor market, usually the least skilled or the ones who have been unemployed the longest, who become less skilled as their skills degrade from lack of employment.

So while it’s a good thing that other segments of the economy are perking up in and of itself and because those trends will likely spill over into employment, the economy is not, by any means, in a sustainable growth mode. It may be closer to getting there, but until the employment problem is solved or at least shows ongoing signs of significant improvement — and that means more than the creation of 100,000 or 150,000 a month — we aren’t out of the woods yet.

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Ever since Fannie Mae and Freddie Mac collapsed and were bailed out by the U.S. government in 2008, in one of the largest government bailouts in history, the future of the 30-year fixed mortgage has been in doubt. Both President Obama and the Republicans have expressed support for the idea of eliminating Fannie and Freddie and  privatizing the U.S. mortgage guarantee process.

But it hasn’t happened yet, and it’s been nearly 5 years. The reason why is that killing the 30 year mortgage, which an editorial in Bloomberg espoused yesterday, is extremely unpopular politically. Consumers love fixed-rate mortgages because they provide certainty in terms of the monthly payment, lessening risks that are posted by adjustable rate mortgages.

Interestingly enough, adjustable rate mortgages are the rule in Europe, where the government never developed the role in the mortgage process or the investment in the idea of homeownership that the U.S. government did. Here in the U.S., the government has for more than the past half century played a central role in the mortgage process, either outright owning or guaranteeing many fixed rate mortgages.

From a risk point of view, assuming the interest rate risk on a 15 or 30 year basis is something that few, if any, financial institutions are willing to take on given what happened in the financial crisis and what has happened with interest rates over the past few decades.

That’s because if interest rates increase — and they, will eventually — a financial institution would be stuck paying out higher interest rates on savings accounts, certificates of deposit and IRAs, while receiving a very small return on interest on fixed rate long term mortgage commitments made years ago. In contrast, an adjustable rate mortgage will eventually increase to market rates, which poses much less risk for banks and other lenders.

That leaves the U.S. government as the default lender of last resort for fixed rate mortgages. Today, the U.S. government owns or guarantees 90 percent of all new mortgages, which is a major increase from the 50 percent it owned or guaranteed in the mid-1990s. Given the boom and bust nature of U.S. real estate markets, that means it’s all too likely that at some point the U.S. government will be left holding the bag when the real estate market goes bust again and large numbers of homeowners default.

That’s not as likely with rates so low, because the underwriting environment is so conservative currently and payments are affordable. However, as underwriting standards loosen and rates go higher, the table will be set for another housing market disaster. After all, the most recent real estate market boom/bust wasn’t the first, just the latest in a long line of U.S. real estate market ups and downs.

So when the next bust happens, the U.S. government, as the guarantor of last resort will be on the hook for all those defaults, obligated to pay — wait for it — billions of dollars to banks for the homeowners who are unable to make those payments. And since the U.S. government is us, the taxpayers, we could be left footing the bill for another expensive bailout.

The solution, many say, is to abolish fixed rate mortgages altogether and leave adjustable rate loans as the only option for consumers. This would take the long-term interest rate risk out of the picture for both the government and financial institutions. Unfortunately, that leaves consumers holding the bag and assuming the vast majority of risk surrounding interest rates.

Well, that’s hardly fair. Why should consumers bear most of the risk from an unpredictable, speculative real estate market? We saw the impact of a variety of adjustable rate loans during the real estate bust. Lax underwriting standards, outright fraud on the part of some unscrupulous mortgage brokers and appraisers and exotic loans left homeowners at the mercy of sky high payments and many lost their homes or were stuck making unsustainable payment that they could barely afford.

The Bloomberg editorial mentions some creative solutions that could help fill the gap if the 30 and 15-year fix rate mortgage is abolished. These intriguing options include:

  • Pegging monthly mortgage and interest payments to neighborhood home values
  • Allowing borrowers to pay more up front for the ability to make lower payments later if home prices go down

If the 30-year mortgage is indeed toast, we need to see more innovative ideas like those above so that homeowners aren’t forced to bear all the risk from unpredictable real estate markets. It’s certainly not fair to expect the government or financial institutions to do so and there is no reason why consumers should have to either.

I’m a bit late to the party on this, but here goes: last week the St. Louis Fed released its U.S. Recession Probabilities chart, which shows the risk of a U.S. recession near zero. I’ve been following the progress of the U.S. economy pretty closely for the past couple years as it has struggled to emerge from the Great Recession and gain a more steady footing, so I’m finding this assessment interesting.

While I believe that the risk of recession is less than it has been in the past few years, I wouldn’t say that it is near zero. Although the recovery does seem to be gaining more traction, that’s happened before. The last couple of Springs, the economy will seem to firm up on a couple of different fronts, whether that’s housing, consumer spending, business investment, industrial production or whatever, only to fallback later in the year because of external or internal issues.

Last year the political uncertainty surrounding the election and the Fiscal Cliff slowed the economy down in the second half, the year before — and the year before that — Europe was the focus of economic fears along with the continuing housing crisis. This year, we’re into Sequestration and the debt ceiling battle is coming up.

Risks from Europe seem to be on the back burner and less fraught than they used to be, but the fact is that nothing fundamental has changed about the European situation except that the European Central Bank is printing a lot of money. Austerity is taking a huge tool, unemployment is sky high and EU leaders are no closer to solving the region’s problems than they were a few years ago.

Anyone of these risks, or a combination of them or other risks that we are unaware of at this time could push the economy into recession. There are a number of positive developments that could continue to keep the economy on a growth track, including the recovering housing market and the brightened employment picture — I’m hopeful because I want a growing economy and it’s benefits just as much as the next person.

Re big picture risk, whether the risks of a recession are low or high, I do believe that we eventually will experience another financial crisis. I actually had an argument on Twitter the other day based on expressing the opinion that another global financial crisis is all but inevitable.

I base that belief on the fact that the fundamental problems in the global economy that lead to the Great Recession haven’t been solved in any meaningful way and that the systems that we have are so complex and interact in so many unforeseen ways that it is a matter of when, not if, another crisis occurs. It could be next month, next year or in five years. I have no idea.

But if you look at economic cycles and the recent history of boom and busts, it is evident that these crises occur periodically and that they are happening more frequently. I would love to be wrong, because the havoc they create causes so much suffering. We’ll just have to wait and see.