Barely six months in office, President Obama already finds himself in an economic box. For despite his aggressive and costly economic policy initiatives, the jobs market shows no sign of healing. At the same time, the housing market foreclosure crisis continues apace, while renewed questions are again surfacing about the soundness of the U.S. banking system. To complicate matters, financial markets are now starting to fret about the longer-run inflationary consequences of the unusually large budget deficits in prospect for as far as the eye can see.
In January 2009, on presenting its $780 billion fiscal stimulus package, the Obama administration assured the public that because of that stimulus package U.S. unemployment would not exceed 8 percent. Yet already by June 2009, unemployment had risen to 9.5 percent; including part-time workers, who would prefer to be working full time, unemployment rose to a staggering post-war high of over 16 percent. Worse still, the jobs market shows every sign of being far from bottoming out.
The degree to which unemployment has exceeded the administration’s forecasts has to raise basic questions about the appropriateness and coherence of President Obama’s economic policy approach.
The degree to which unemployment has exceeded the administration’s forecasts has to raise basic questions about the appropriateness and coherence of President Obama’s economic policy approach. These questions pertain not simply to the very poor design of the fiscal stimulus package. Rather they pertain to the adequacy of the measures aimed at stabilizing the housing market and at resolving the country’s most wrenching credit crisis in the post-war period.
At the most basic level, one has to question how much sense it made for President Obama to allow the fiscal package to become excessively back-loaded at time when the economy needed immediate large scale support. If a large fiscal stimulus was indeed needed, why has only $60 billion of that package been dribbled out by June? And why is less than a third of the package scheduled to come into effect in 2009, the year when the package is most sorely needed?
Similarly one has to wonder about the heavy price that the Obama administration paid for effectively outsourcing the package’s design to House Speaker Nancy Pelosi and the rest of the Democratic congressional leadership. Should it really have come as a surprise to us that the resulting stimulus package would be laden with pork and with expenditures that are going to be very difficult to roll back? Or should we now be shocked that the package fell sadly short of including fast acting and effective fiscal stimulus measures that might have gotten the most bang for the buck?
Perhaps the most troubling aspect of the Obama fiscal stimulus package is the serious way in which it compromises the country’s long-run public finances and fans long-run inflationary expectations. The nonpartisan Congressional Budget Office estimates that the Obama budget not only implies unusually large budget deficits over the next two years but it implies that, even when the economy eventually fully recovers, the deficit will remain in the region of between 4 and 6 percentage points of GDP. As a result, over the next decade, the public debt will rise in a manner that has never occurred before in peacetime, from around 41 percent of GDP in 2008 to 82 percent of GDP by 2019.
Over the next decade, the public debt will rise in a manner that has never occurred before in peacetime from around 41 percent of GDP in 2008 to 82 percent of GDP by 2019.
The rising tide of unemployment must also raise questions about the Obama administration’s efforts to stabilize the housing market, which the administration correctly views as a necessary condition for producing a meaningful economic recovery. One has to expect that a weaker job market will only exacerbate the country’s present foreclosure crisis, which is adding supply to an already glutted housing market. The Center for Responsible Lending estimates that 2.4 million homes could be in foreclosure in 2009 and as many as 8.1 million homes over the next four years. Yet, the Obama administration’s loan modification program announced earlier this year has to date only resulted in 190,000 offers at mortgage loan modification.
Rising unemployment also has to raise questions about whether the Obama administration is not being overly sanguine about the health of the U.S. banking system. For it would seem that unemployment will now well exceed the worst-case scenario in the bank stress test presented by the administration earlier this year. Yet, despite a weakening unemployment outlook that is sure to boost bank losses, the Obama administration is now cavalierly backing away from its earlier initiatives to reduce the toxic assets that remain on the banks’ balance sheets.
Less than six months into his term, President Obama already faces difficult economic policy choices. He can choose, as he now seems to be doing, to counsel patience and assure us that all is well at considerable cost to his credibility on economic policy management. Or he can own up to the facts that he misread the economy in January and that his economic team now needs to go back to the drawing board. For the sake of the U.S. economy, one has to hope that he has the courage to review the overall coherence of his policy approach before it is too late.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was managing director and chief emerging market economic strategist at Salomon Smith Barney and a deputy director in the International Monetary Fund’s policy and review department.
Obama Is Stuck In an Economic Box – Desmond Lachman, The American
By Kathleen M. Howley
June 29 (Bloomberg) — Driving through Riverside, California, Bruce Norris pointed to a half-dozen empty houses with “For Sale” signs stuck in untended lawns that he said investors might buy if banks would just extend some credit.
“People today look at us as the enemy,” said Norris, 57, head of Riverside-based Norris Group, which purchases and renovates homes to rent or sell. “That’s a big problem for housing because if we can’t get the financing we need, a lot of these properties are going to sit vacant.”
Four months after President Barack Obama pledged $275 billion to shore up home sales, the engine that powered every U.S. recovery since 1960 is stalled. Bankers’ reluctance to finance buyers who won’t live in properties is one barrier to a turnaround. Stricter qualifying rules and a rise in the cost of residential loans to 5.42 percent have impeded new mortgage lending, which is at a 13-year low. An inventory of 2.1 million unoccupied houses on the market, created by the fastest foreclosure pace in history, may be a drag on a revival.
The $8,000 first-time homebuyer tax credit in the U.S. economic stimulus package and a government program to subsidize some mortgage payments have had little effect, according to Eric Belsky, executive director of Harvard University’s Joint Center for Housing Studies in Cambridge, Massachusetts.
“It hasn’t been much more than a see-sawing of data,” Belsky said in an interview. “Housing has led the U.S. economy out of every recession for at least 50 years, and for that to happen again more stimulus is going to be needed.”
Leading Indicator
The residential real estate market improved ahead of the end of the past seven contractions, with home construction starts beginning to climb an average of seven months before gross domestic product picked up and sales gaining about four months in advance, according to data compiled by David Berson, chief economist of PMI Group, a mortgage insurer in Walnut Creek, California.
Expenditures by homeowners — first on transaction fees, then on necessities and luxuries including furniture, gardening tools, kitchen renovations, basic upkeep and property taxes — kept the momentum going, Belsky said.
Existing U.S. home sales in May rose 2.4 percent to an annual rate of 4.77 million, lower than forecast, and the median price was down 16.8 percent from the same month in 2008, according to the Chicago-based National Realtors Association.
There’s little chance the turnover will increase enough this year to end the housing recession, said Andres Carbacho- Burgos, an economist with Moody’s Economy.com in West Chester, Pennsylvania.
‘Lousy Job Market’
“We have a lousy job market and an excess of around 1 million extra homes that has to be worked off,” he said in an interview. “The housing market is not going to hit bottom before mid-2010.”
Housing starts are at their lowest level since 1945, even with a 17 percent increase in May that pushed the annual rate to 532,000 from a 454,000 pace the prior month. So many properties are for sale — 3.8 million as of last month — that it would take 9.6 months to unload them at the current sales pace, according to the Realtors group. The inventory averaged 4.5 months in the six years from 2000 to 2005.
While there is pent-up demand that would eat away at the stock, “people are scared to spend the money because they’re worried about losing their jobs,” said Nariman Behravesh, chief economist at IHS Global Insight in Lexington, Massachusetts, in an interview.
6 Million Jobs
The unemployment rate, which reached a 26-year high of 9.4 percent in May, will probably exceed 10 percent this year, Obama said at a June 23 White House news conference.
“The American people have a right to feel like this is a tough time right now,” Obama said, calling it “pretty clear” payrolls will continue to shrink. About 6 million jobs have disappeared since January 2008, marking the biggest employment loss of any retrenchment since the Great Depression.
Personal bankruptcies rose 37 percent in May from a year earlier, according to the American Bankruptcy Institute, based in Alexandria, Virginia. Credit card defaults in the first quarter went to 7.79 percent from 4.83 percent a year ago, Federal Deposit Insurance Corp. data show. While the share of loans entering foreclosure moved to 1.37 percent, the highest ever, the first-quarter mortgage delinquency rate climbed to a record 9.12 percent, the Washington-based Mortgage Bankers Association said.
Housing in Peril as Financing Breakthrough Fails – Bloomberg
In the past three weeks there have been several indications that the Federal Reserve is reconsidering the extent and perhaps necessity of its extraordinary liquidity provisions to the Treasury market. How far have the chairman and governors pulled back from their quantitative easing policy?
On June 3rd Chairman Bernanke commented in Congressional testimony that federal deficits cannot continue forever. In fact the deficits can continue, but the Fed’s $300 billion Treasury purchase plan will end unless additional funding is authorized by the Fed governors. At this past week’s FOMC meeting the board specifically did not authorize further Treasury purchases. The Fed is also letting one of its emergency liquidity programs expire and curtailing two others. None of these developments is an overt change in policy, but they are assurances that the chairman and the board view these liquidity measures as crisis expedients and not as permanent institutions of monetary and economic policy.
It is easy to forget that the Fed policy of direct support for credit markets was an emergency response to the crisis of confidence that overwhelmed the financial system last fall. Fed purchases of various securities supplied liquidity to non-functioning markets; they were not intended to be permanent. The Fed said as much at the time, though in the ensuing months market focus shifted from the programs themselves to the lack of a clear strategy for absorbing the excess money supply from the economy.
In March the market reaction to the financial crisis was at its peak. Treasury prices had been driven to historical highs by sustained panic buying of US Treasuries. Treasury interest rates and rates on 30-year fixed rate mortgages were at record lows. But even though mortgages rates were extraordinarily low the Fed judged that the reeling economy could not tolerate the surge in interest rates that would occur if Treasury prices began to fall. The governors may have suspected that the Treasury market would begin to drive prices lower and rates higher on its own as credit conditions normalized
In that context the Fed announced its $300 billion Treasury purchase in the FOMC statement of March 18th. The governors may also have been worried about the impact of the federal deficit on the bond market whose reaction was then an unknown quantity. But despite the Fed backstop the Treasury market fell relentlessly after March 18 with the 10-year rate rising more than 1.5%. More dangerously the dollar index fell 10% from March 18th to June 2nd. For the currency markets the Fed Treasury program has had one meaning, monetization of the Federal debt. Judging by the subsequent rise in Treasury rates the Fed governors may have known that the $300 million committed would be insufficient to hold the line on Treasury rates. But that relatively minor amount had a deadly effect on the dollar. The merest suspicion that monetization of US debt was possible sent the dollar into a three month swoon. The inflation that would result from a rapidly falling dollar and the effect of a collapsing dollar on the Treasury market itself could undo much of the economic and rate stabilization that the Fed was striving to achieve.
The Fed concern about the Treasury market was for the economic effect of higher interest rates on the US economy, particularly on the housing market thought by many to be at the heart of the economic collapse. But higher Treasury yields and mortgage rates have not, at least so far, choked whatever positive change in the economy has occurred since March. 30-year fixed mortgages have gained more than a point but the housing market has stabilized; new home and existing home sales in May were both in the center of the range they have exhibited since January.
The Personal Consumption Expenditures Index has revived since last December. It gained 0.9% in January, 0.4% in February, 0.3% in May, was flat in April and lost 0.3% in March. The half year prior to January had six negative months in a row. Non Farm Payrolls were substantially improved in May at -345,000, with the three month moving average (-500,000) having gained almost 200,000 since March (-691,000). Consumer sentiment numbers have moved up steadily since the beginning of the quarter. The economic situation that prompted the Fed quantitative easing has returned to more normal territory.
The Treasury market has also stabilized in the past two weeks. After reaching 4.00% the yield on the 10-year note had declined to 3.54% on the Friday close. The government Treasury auctions, a record $104 billion in the past week alone, have been subscribed at higher rates than normal. The bond markets are not demanding substantially higher rates on American debt, despite the vast continuing supply of US issuance.
The key to the extension of the Fed Treasury program is the attitude of the credit markets. It is relatively simple. If bond purchasers do not demand higher yields for US debt, then whatever the long term effect of the ballooning US debt and inflation the government will not be forced to pay higher rates. If Treasury prices are not falling the Fed will not have to support the market with further Treasury purchases and the currency markets will not be stampeded away from the dollar by monetization.
Foreign central banks have been unusually critical of the US government’s fiscal and debt policy. The Chinese were so again this week. But what matters are not the banker’s words or their musings about a world reserve currency. What matters is action. As long as the Chinese, Russians, Japanese and private investors continue to buy US Treasuries, the Fed will not have to choose between supporting the US economy and supporting the dollar.
It is a delicate balance but so far the Fed has, with the cooperation of the Treasury markets, kept the pointer right in the middle of the scale. The Fed has managed to mitigate the scare it threw into the currency markets in March with its recent statements and actions.
There are still a huge amount of Treasuries to be sold over the next three months and the economic situation is still dangerous. But the Fed view as reflected in the FOMC statement, no more quantitative easing and a slight though significant withdrawal from the credit markets may be the right and artful balance between keeping down US interest rates and avoiding a dollar panic in the currency markets
Last Call for Monetization? – Joseph Trevisani, FX Solutions
n its post-meeting statement, the Fed removed a passage it had used after its three previous meetings to warn of the risk of deflation, meaning a broad-based decline in prices. Deflation is closely linked with another “D” word: depression.
The old statement wording read, “The Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.”
That was code for deflation.
Fed Tries To Turn Conversation Away from Deflation Risk – Money & Co.
Wikipedia lists nearly 600 defunct American automobile manufacturers, many of which boasted the top innovations of their day. How would auto development have occurred if the government had nationalized each one, as they have now done with GM?
Smith Automobile Company, the first automobile made west of the Mississippi river (closed 1912).
Long before the Chevy Volt, Grinnell Electric Car Company manufactured a five-seat electric car that claimed to have a 90-mile range (closed 1913).
Stanley Motor Carriage Company, the world’s fastest car until 1911 (sold 1917).
McFarlan Motor Corporation, known as the “American Rolls Royce”, was a favorite of celebrities such as Fatty Arbuckle, Jack Dempsey and Al Capone, who bought one for his wife (bankrupt 1928).
Brewster & Co., whose cars were immortalized in the Cole Porter song “You’re the Top”: “You’re the top! You’re a Ritz hot toddy. You’re the top! You’re a Brewster body” (sold at auction, 1937).
Uncle Sam’s Heist: Deficits and Inflation – Jonathan Hoenig, SmartMoney
