What Will the Recession Feel Like?
Way back in mid-January, when the Washington policy herd had not yet determined that the economy needed stimulus, The Washington Post ran an editorial in which it held out the prospect that a recession may not be severe. This comment was intended to calm readers and slow the rush to stimulus. (The Post editorial board flipped the following week and joined the rush to stimulus.)
Still, the Post was right. We don’t know how severe this recession will be. My bet is that the loss of $4 trillion to $8 trillion in wealth due to the collapse of the housing bubble will lead to a serious recession. But perhaps the Post's optimism will prove correct; what will the world look like?
My colleague at CEPR, John Schmitt, did some quick calculations to remind people what happens in recessions.
The story is not pretty. He contrasted the economy’s performance in mild and severe recessions, with the last two recessions providing the basis for a “mild” recession and the 1980-82 recession being the model of a severe recession.
In a mild recession, we can anticipate that the unemployment rate will increase by at least two percentage points. This increase will not be evenly distributed. For blacks the unemployment rate will rise by three percentage points, for teens by five percentage points, and for black teens by close to eight percentage points.
In the event that the recession proves to be severe and looks more like the 1980-82 downturn, then we will be looking at an increase in the unemployment rate of almost three percentage points. The rise in the unemployment rate for blacks and teens will be close to five percentage points, and for black teens the increase will be nine percentage points. We still will not have recovered to current unemployment rates by the time of the next presidential election in 2012.
We can look forward to other bad things as well. The number of the uninsured will rise rapidly, wages and family income will fall, and poverty rates will rise. You can go the whole grisly story here.
Since when are grizzlies experts on economics?
January 29, 2008 6:17 AM | Reply | Permalink
Grizzlies are really cool, they know about everything. (correction made)
January 29, 2008 8:18 AM | Reply | Permalink
I think a bigger concern this time round is that bank capital has taken a nasty hit. I'm not a veteran of too many downturns, but for my sins I was at Citigroup during the last credit blow-out (when Enron, Worldcom, Parmalat and others staked their place in the corporate rogues' gallery), and back then there was no great concern that Wall St firms were at financial risk. Their reputations were harmed, but their ability to continue to grow their balance sheets was not.
This Bloomberg article refers to research estimating that if the monoline insurers aren't able to retain their triple-A rating, then the banking sector (globally) will need to raise another 143bn to recapitalize. The rumor is that the banking industry will bail out the monolines, but even assuming they do, that still suggests a significant recapitalization of the industry as a whole is due.
Further, the Basel II is now in effect - it's most persuasive critics argue that a key problem is its pro-cyclical capital adequacy requirements, so that thesis could immediately be tested.
I'll defer to Dean in terms of how this recession might feel like in terms of the employment dynamic, but I think this is also going to be a recession where getting credit is going to be unusually difficult and/or expensive. It's also why Fed policy effectiveness has a big question mark against it... they can dump all the liquidity they want into the system, it doesn't much help when the system is horribly clogged up and there's no great hurry to clean it out.
January 29, 2008 7:09 AM | Reply | Permalink
Just a thought or two in reference to "bank credit":
1. In a recession the extension of bank credit falls; any chart will show it. But where's the chart that shows the number of businesses and consumers who applied for the credit in the first place? Missing in action? It takes two to tango.
2. American corporations are awash in cash -- small businesses not so much. They don't need credit.
3. American business is short-term oriented. Why would they take on credit for new projects when consumption (sales) are falling?
4. The world's awash in dollars. Who needs banks (except as packagers and intermediators) when we've got securitization? This isn't your father's financial system!
5. And finally, there isn't a liquidity problem; there's a credit risk problem. For any business that has a reasonable story to tell there's plenty of credit to be had, but how many businessmen have any interest in telling such stories during a recession -- see, above.
January 29, 2008 7:23 AM | Reply | Permalink
I think you missed my key argument - that "credit is going to be unusually difficult and/or expensive" in this downturn. As in, more difficult than normally would be the case.
None of your five points address this. And to assume "They don't need credit" (whoever "they" are) seems to be a crazy generalization. Those that do need credit will be impacted. And if no-one thinks they need credit (your points 3 and 5) then the economy is in much worse shape than anyone has so far argued.
Anyways, maybe I'm wrong, maybe banks won't find they are capital constrained and credit markets will soon return to some sort of normalcy. God knows plenty of folks are hoping that, I just don't see it like that at the moment.
Ps. This was a joke, right - "we've got securitization".
Yeah, we do. But have you taken a peek at the ABS markets recently? It's a wasteland. Whatever you think of this outcome, a second order effect is that a staple balance sheet management tool for banks has had to be benched.
So there's another reason why banks will be less able to grow their lending books. And it's another pro-cyclical force at work.
January 29, 2008 9:35 AM | Reply | Permalink
I think you missed my key argument.
Recessions are not caused by nor exacerbated by a lack of credit (or its cost -- exception Volcker's forced recession). Recessions are caused by a reduction in consumption or capital goods demand. As Keynes pointed out, you can't induce businessmen to borrow when the demand for their products and services is down. And you can't induce people to borrow money to buy houses that they don't want to buy because they believe that house prices are deflating.
P.S. No; securitization is not a "joke." It all depends on what you're securitizing. There's nothing wrong with the ABS market. Now, the Assetless Backed Securities market is a whole nother thing, entirely.
January 29, 2008 11:38 AM | Reply | Permalink
Well, yeah, precisely my point! I am saying this downturn could be one of your exceptions because of the credit situation.
But heck, who cares what I think. Here's Martin Feldstein:
January 30, 2008 7:26 AM | Reply | Permalink
And Bush and the Republicans will push for more tax cuts for the wealthy while cutting funding to social programs, transferring more money to the people in the top 1%. Y'know, the have-mores.
And the Democrats will let them.
January 29, 2008 8:32 AM | Reply | Permalink
Why should we not believe that the same entities which have infused cash into USA financial institutions (Sovereign Wealth Funds and other cash rich investors, for a piece of the pie, won't do the same for the "monoline insurers"?
With cash infusions won't the ratings for the monolines will be raised to their previous levels?
It seems it shouldn't matter to credit consumers if portions of the financial institutions or insurers are owned by foreign government investment funds of other foreign investors.
Strive for the ideal, but deal with what's real.
January 29, 2008 8:36 AM | Reply | Permalink
~
Why's everbody speaking "Chinese" ... ?
~OGD~
January 29, 2008 9:30 AM | Reply | Permalink
Indeed.
Probably because Chinese leaders figured out some time back that it can hold way more sway over USA policy through amassing USA debt than through a military competition.
Strive for the ideal, but deal with what's real.
January 29, 2008 9:50 AM | Reply | Permalink
I've often wondered the effect of economic downturns on marriage rates. Discord due to financial stress surely results in divorces. However, how many marriages occur with gaining health insurance as a goal? Two persons co-habitating, each with insurance, and one loses his/her job. Marriage has been contemplated (or maybe not) but now the risk of one person going uninsured due to unemployment needs addressed and the result is marriage. Has that ever been studied or quantified?
January 29, 2008 10:18 AM | Reply | Permalink
I don't know if that's been studied or not, but that certainly is an interesting question. I'm a single guy with little interest in marriage. However, I have been considering it solely for economic reasons. It's expensive to be single!
January 29, 2008 6:38 PM | Reply | Permalink
Re: I've often wondered the effect of economic downturns on marriage rates.
During the Great Depression marriage rates were up and divorce rates went down. Different time and different culture, although the expense of divorce is a factor today as well.
January 30, 2008 3:16 AM | Reply | Permalink
The impact of unemployment on many households could be very tough this time around. Fewer companies offer decent severance packages for laid off employees.
Many households are already maxed out on credit (home equity & credit cards), so they won't have much to fall back on in case of job loss.
January 29, 2008 3:04 PM | Reply | Permalink
A few years ago I read a post on a Peak Oil site that struck a chord. (It may not be directly related to the recession, but it seems like appropriate advice to share here.) The author stressed that Americans should transition toward a E.L.P. lifestyle. Here are the three points:
Economize - Imagine that your income is reduced by 50% tomorrow. What would you immediately trim to meet your budget? Your netflix subscription? Eating out? Cable? Consider these things and start reducing your expenses anyway and put some of that money into an Al Gore-type lockbox. In case of emergency, you'll be glad you did.
Localize - Shop local businesses. Is it possible to live closer to your job? Basically do everything you can to reduce the amount of gas you need to live your life. This helps you, local businesses, and reduces gas consumption. Win, win, win.
Produce - How do you earn a living? Do you produce a good or service needed by your community? In the case of a major recession or global petroleum crisis, people will begin trimming the excess from their budgets. Earn a living selling SUVs or lingerie? Are you a Communications Major? If so, your skills (ha!) may not be required in an economic crunch.
I think most people can benefit from considering these points and transitioning toward an ELP lifestyle. If a recession is percolating, you may want to consider this now before you are forced to make tough decisions.
So what will this recession feel like? I'm not a student of economics, but my gut says that even a "mild" recession is going to hit people very hard. Americans have grown accustomed to a lifestyle of expensive coffee, cell phones, high speed internet, cheap food, cheap gas, and cheap travel. Giving up half of these items would be a psychological blow to Americans, and create the impression that our country is regressing. It may not compare to the serious issues people faced during the Depression, but it is going to hit people hard and force serious lifestyle changes. Americans just aren't into that...
My suggestion? Open a well-fortified liquor store. That's guaranteed income in any economy!
January 29, 2008 6:31 PM | Reply | Permalink
Watching the behavior of people over the past thirty years, my bet is on a great awakening for the American people.
When we decided to carry a large amount of debt to satisfy our desire for instant gratification, we sold out our financial souls. If we didn't learn how to live within our means, this recession will be very difficult. However, if we have learned how to live with less, we will survive.
January 29, 2008 7:31 PM | Reply | Permalink
Ray-gun took it over a trillion, and now this chicken's coming home to roost...and I think it's got a bad case of diahhrea....don't chickens ALWAYS have that, though? Hmmm...
buy a good hat before they shut off the VISA!
LOL
January 29, 2008 9:24 PM | Reply | Permalink