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Thursday, February 11, 2010

Joseph Stiglitz describes a recovery that is not recovering

One of the great points of Joseph Stiglitz' book FREEFALL is that the crash was only the beginning of the damage to the economy. The half-baked remedies and non-action that have followed are deepening and extending that damage. Here is his latest Project Syndicate post.
Muddling Out of Freefall
Joseph E. Stiglitz
February 5, 2010
Project Syndicate

Defeat in the Massachusetts senatorial election has deprived America’s Democrats of the 60 votes needed to pass health-care reform and other legislation, and it has changed American politics – at least for the moment. But what does that vote say about American voters and the economy?

It does not herald a shift to the right, as some pundits suggest. Rather, the message it sends is the same as that sent by voters to President Bill Clinton 17 years ago: “It’s the economy, stupid!” and “Jobs, jobs, jobs.” Indeed, on the other side of the United States from Massachusetts, voters in Oregon passed a referendum supporting a tax increase.

The US economy is in a mess – even if growth has resumed, and bankers are once again receiving huge bonuses. More than one out of six Americans who would like a full-time job cannot get one; and 40% of the unemployed have been out of a job for more than six months.

As Europe learned long ago, hardship increases with the length of unemployment, as job skills and prospects deteriorate and savings gets wiped out. The 2.5-3.5 million foreclosures expected this year will exceed those of 2009, and the year began with what is expected to be the first of many large commercial real-estate bankruptcies. Even the Congressional Budget Office is predicting that it will be the middle of the decade before unemployment returns to more normal levels, as America experiences its own version of “Japanese malaise.”

As I wrote in my new book Freefall, President Barack Obama took a big gamble at the start of his administration. Instead of the marked change that his campaign had promised, he kept many of the same officials and maintained the same “trickle down” strategy to confront the financial crisis. Providing enough money to the banks was, his team seemed to say, the best way to help ordinary homeowners and workers.

When America reformed its welfare programs for the poor under Clinton, it put conditions on recipients: they had to look for a job or enroll in training programs. But when the banks received welfare benefits, no conditions were imposed on them. Had Obama’s attempt at muddling through worked, it would have avoided some big philosophical battles. But it didn’t work, and it has been a long time since popular antipathy to banks has been so great.

Obama wanted to bridge the divides among Americans that George W. Bush had opened. But now those divides are wider. His attempts to please everyone, so evident in the last few weeks, are likely to mollify no one.

Deficit hawks – especially among the bankers who laid low during the government bailout of their institutions, but who have now come back with a vengeance – use worries about the growing deficit to justify cutbacks in spending. But these views on how to run the economy are no better than the bankers’ approach to running their own institutions.

Cutting spending now will weaken the economy. So long as spending goes to investments yielding a modest return of 6%, the long-term debt will be reduced, even as the short-term deficit increases, owing to the higher tax revenues generated by the larger output in the short run and the more rapid growth in the long run.

Trying to “square the circle” between the need to stimulate the economy and please the deficit hawks, Obama has proposed deficit reductions that, while alienating liberal democrats, were too small to please the hawks. Other gestures to help struggling middle-class Americans may show where his heart is, but are too small to make a meaningful difference.

Three things can make a difference: a second stimulus, stemming the tide of housing foreclosures by addressing the roughly 25% of mortgages that are worth more than the value the house, and reshaping our financial system to rein in the banks.

There was a moment a year ago when Obama, with his enormous political capital, might have been able to achieve this ambitious agenda, and, building on these successes, go on to deal with America’s other problems. But anger about the bailout, confusion between the bailout (which didn’t restart lending, as it was supposed to do) and the stimulus (which did what it was supposed to do, but was too small), and disappointment about mounting job losses, has vastly circumscribed his room for maneuver.

Indeed, there is even skepticism about whether Obama will be able to push through his welcome and long overdue efforts to curtail the too-big-to-fail banks and their reckless risk-taking. And, without that, more likely than not, the economy will face another crisis in the not-too-distant future.

Most Americans, however, are focused on today’s downturn, not tomorrow’s. Growth over the next two years is expected to be so anemic that it will barely be able to create enough jobs for new entrants to the labor force, let alone to return unemployment to an acceptable level.

Unfettered markets may have caused this calamity, and markets by themselves won’t get us out, at least any time soon. Government action is needed, and that will require effective and forceful political leadership.

Copyright: Project Syndicate, 2010.


  1. The big city banks have been morons. While they got the bail out that they needed they failed to get the bail out for their customers. While bankers bail outs could be valued in the trillions of dollars the bail out for Main Street has been pitiful. First a tax cut that was saved rather than spent, then a $787 billion bail out that is still in the process of being spent. So Main Street still suffers. So while their accounts look on the surface healthy they hide all manner of time bombs. Commercial real estate is tanking and taking billions of valuable capital with them. The housing bubble is still deflating and affecting the consumers greatly. With no assistance for the states to balance their budgets then another 900,000 will lose their jobs directly, and millions more indirectly. This will not help stabilise the residential property market. That could detonate the residential time bomb for banks. Struggling consumers will not help struggling commercial real estate valuations either, so taking yet more capital. Rising unemployment and falling wages will mean that residential property valuations will have further to fall than would have been necessary.

    That ignores the impact of the consumer on the stock markets. With rising unemployment and the long term unemployed remaining unemployed, then retail sales will suffer. That will hit the stock markets hard. They are currently finding it hard to justify price to earnings ratios of mid twenties. When they should be in high single digits at this stage of a recession. That only supports further substantial falls in the stock markets. It could also end the retirement dreams of millions of people as they find their 401k devastated or their company pension scheme insolvent.

    That will have further ramifications. The insurance industry which so far has not struggled excepting AIG will then hit the rails as the stock market reverts to sensible valuations. This will impact on their investment returns and mean that insurance rates will rise to make up for investment losses. It will also mean that many insurance run pension funds become insolvent as they simply cannot pay the pensions already committed to. That will further impact retail sales as pensioners suddenly come under pressure. The collapse has some way to go. Unfortunately I think that this is all required to kill off the bubble mentality at least for a generation or two

    I have to agree with Joseph Stiglitz that markets will not get us out of this crisis, that will take many years. I doubt that there will be a meaningful stimulus while there are deficit hawks around. It will also not address the fact that assets have been caught in a bubble and until these have reached sensible values that any prospect of healthy investment will resume.

  2. And it is investment we need. The kind of investment we will not see from the private sector for a decade, in all likelihood.

  3. I seem to remember 10 years ago, that China said they'd own us by 2025. Guess I'd better look for a Chinese landlord and bank.