Kevin Hassett attempts to debunk five common myths about what a recession is – or is not – in today's Washington Post. It's worth a read even if you already know the facts versus the legends. It might help you explain something more clearly to the truly clueless.
When Scottish historian Thomas Carlyle branded economics the "dismal science" in 1849, he gave it a name that would stick. (Some theorize that he picked on economists since, like most Scots back then, Carlyle had never visited a dentist.) Fortunately for economists, 1849 was a pretty good year. If Carlyle had seen how economists behave during recessions, he probably would have dubbed their subject something far worse.
Economists have the same occupational hazard as baseball managers and football coaches: Every person on the street knows their job better than they do. And if you listened to the economic stimulus package talk last week from the White House and Capitol Hill, not to mention Federal Reserve Board Chairman Ben Bernanke, you could be forgiven for thinking that the recession is just around the corner. But the main result of all this chatter is that far too many myths about recessions have made their way into popular culture.
1. We're already in a recession.
The truth is, nobody knows. The responsibility for declaring the stages of the business cycle is informally held by that most dreaded of concepts — a committee of economists. The Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) uses a number of economic indicators, including personal income, unemployment, industrial production and sales and manufacturing volume, to determine the health of the economy. It's not true that they declare a recession if economic growth is negative for two quarters in a row. If it were that simple, we wouldn't need a committee.
If you want to know about the state of the economy in real time, you can't rely on the NBER. If the NBER did the D.C. weather forecast, here's how it would work. The bureau would gather precipitation data from every neighborhood, then interview residents to make sure that the data are accurate. After much deliberation, it would tell us whether it had rained last month. Same with recessions: The NBER's pronouncements historically come long after recessions have begun, a whopping seven months on average. By the time the bureau announced the recession of 1991, it had already ended.
Hassett works for the American Enterprise Institute, so he knows a bit about the subject. The thing that bugs me about all the 'stimulus' talk in recent days is explored by Hassett. Frankly, that technique never has worked. It is always too little, too late. Unfortunately, the politicians are utterly intent on passing out lollipops to the people. We're going to get some intervention – that will again prove too little, too late. I wish the politicians would read this piece.
I agree with Hassett, you can only see a recession clearly in the rearview mirror. Everything today has been accelerated to “warp speed”. A mild stretch of weather means the ice caps are going to melt, a 2 month period of slow growth occurs and we want to hand out money to everyone as a stimulus. If everyone in the country went out and bought a flat-screen TV there would only be a short-lived blip in the GDP. We do not manufacture TVs so only retailers would briefly show an improvement.
That said, (I hate that term), we are at an economic precipice that has us staring at something far more serious than a recession. Our entire financial system is at risk. Trust is the foundation of our economy. The basis of that trust is now in question. After the market closed on Friday, Fitch, a rating agency, downgraded Ambac, the second largest bond insurer. It appears the largest bond insurer, MBIA, is next.
Ambac may not be able to insure top-ranked debt. This is due to a series of events which created debt instruments that cannot be evaluated and so are now being priced at 25% of their original face value.
Real estate appraisers were pressured into appraising properties at inflated values. Mortgage lenders were pressured to lend money to anyone who would take it. Wall St. firms bought mortgages and other debt, packaged and securitized them into “asset-backed securities,” then pressured rating agencies to rate them as investment grade. They sold like hot cakes to any institution who wanted a high yield, which was just about anyone, including pension funds. No one is sure what these SIVs (Structured Investment Vehicles) contain. There is some bad debt blended into most of them, but because they were “sliced and diced” with highly-rated debt, it is impossible to evaluate the risk. Now no one trusts the bond rating.
We might get through this with just a severe headache if we are lucky, but there be a bigger downside.
Update to the above comment:
Asian and Europeon markets have dropped 5-7% on Monday with our markets closed for the holiday. Most markets finished near their lows. The fear is due to credit and bankrupcy issues. Ambac has been mentioned by a number of European lenders, Ambac and MBIA insure $2.4 trillion in bonds, $700 billion of municipal bonds.
The headlines are already blaming GW Bush for too little to late stimulus package. This has more to do with credit issues which can not be fixed with a stimulus package. Watch the spin tomorrow when the Dow drops 700 points.