Download The DEPRESSION of 2008-09 (The Great Recession)

The DEPRESSION of 2008‐09
(The Great Recession)
Elliott Parker, Ph.D.
Professor of Economics
University of Nevada, Reno
[email protected]
Depression vs. Recession
• A recession is a decline in the nation’s total economic output (measured by Gross Domestic Product) for two or more quarters in a row.
• “It's a recession when your neighbor loses his job,” Harry Truman said, “it's a depression when you lose yours.”
• Minsky defined a depression as a recession caused by a severe financial crisis. Depressions tend to be deeper, longer, and different than other recessions. Recessions/Depressions in the U.S.
• NBER: 21 different recessions in the U.S. from 1854‐1939. Average recession lasted almost two years, recovery the same. • Nine or more qualified as depressions, including the Great Depression. GDP usually declined for about a year longer than other recessions, and the recovery afterwards was typically slow. • After 1945, our recessions became less common, and – except for the severe recession of the early 1980s – they also became shorter and shallower. Recessions/Depressions Abroad
• IMF: postwar recessions caused by banking crises in other countries tend to follow a similar pattern. • After a typical crisis, GDP falls for three straight years, and never fully recovers even after growth returns. • Seven years later, GDP usually remains about 10 percent below its pre‐crisis trend.
In the Great Depression
• A recession led to a stock market crash but more importantly a banking crisis, which turned it into a depression. • This was made much worse by tight monetary policy, which caused severe price deflation.
• It was compounded by states reducing spending in response to falling taxes. • By 1932, the Hoover Administration was raising taxes and cutting spending to balance its budget. Attitudes in 1929
Andrew W. Mellon, Hoover’s Treasury Secretary:
‐ “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.”
‐ “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.”
Comparisons to the Great Depression
• DJIA lost 46% of its value from 10/10/1929 to 10/9/1930.
• In 1929, 1.4% of homeowners lost home to foreclosure.
• In first ten months of decline alone, 744 banks failed. Then it
got worse through Spring 1933. Depositors lost $140 billion, more than all of 1929 GDP.
• GDP declined by 1/3, unemployment rose to 25%.
• Depression spread from here to the rest of the world.
7
What led us here?
„
The U.S. economy reached what Paul Krugman
calls a “Wile E. Coyote” moment.
• The current focus is on unemployment and budget deficits, but we also saw a credit crisis, a dramatic fall in the dollar, rising trade deficits, and a big jump in oil prices, commodity prices, and food prices.
Monthly Housing Prices
250
A Look at Housing Prices from 1987 to 2009
Adjusting for Inflation
USA
Las Vegas
Reno-Sparks
Sacramento
CS-LV
CS-C10
The Pop!
200
Adjustedfor Inflation
The Bubble!
150
100
50
Why did we think that housing prices would
continue to always rise faster than inflation?
0
1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
HPI and Case-Shiller
The “Ownership Society”
Between 1994‐2004:
• Est. 15 million new homes owned,
• 9 million at trend, plus
• 6 million more (5% rise).
• California and Nevada started catching up to rest of the country.
Mortgage debt grew MUCH faster than either income or home ownership
First Wave (1950s)
– commercial banks
Second Wave (1980s)
– GSE‐guaranteed securities
Third Wave (>2002)
– other mortgage‐backed securities
Real estate mortgages seemed like such good investments
Subprime lending had a much higher default rate, but
it was less than ten percent of the mortgage market.
13
14
Inflation-Adjusted
S&P 500 vs. DJIA
2500
2000
The Double Bubble in the U.S. Stock Market
Index
Adjusted
1500
1000
500
0
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Monthly Data
It is hard to believe the market was acting rationally.
2010
A Longer Look at the DJIA – Adjusting for Inflation
(1949‐2009 Monthly Close)
15,000
10,000
Boom through 1968, stagnation
through 1984. Overall, the Dow just
kept up with inflation for 40 years.
5,000
0
19
4
19 9
5
19 1
5
19 3
5
19 5
57
19
5
19 9
6
19 1
6
19 3
6
19 5
6
19 7
6
19 9
7
19 1
7
19 3
7
19 5
7
19 7
7
19 9
8
19 1
83
19
8
19 5
8
19 7
8
19 9
9
19 1
9
19 3
9
19 5
9
19 7
9
20 9
0
20 1
0
20 3
0
20 5
0
20 7
09
DJIA / CPI
By the 1990s, people came to
think rapidly rising stock
prices were normal.
Monthly Close
Remember the Bubble in NASDAQ?
Remember the Enron scandal? How did we become so forgetful?
18
Relative Size of U.S. Financial Markets
Billions of US Dollars, 2007 Data
$0
$3,000
$6,000
$9,000
$12,000
$15,000
$18,000
Gross Domestic Product
Total Mortgage Debt
Single‐Family Mortgages
Commercial Mortgages
Other Commercial Loans
Credit Card Debt
Other Consumer Loans
NYSE Capitalization
Nasdaq Capitalization
Institutional Money Funds
Commercial Paper
October Bailout
US Dollars Per‐Capita:
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
Relative Size of U.S. Financial Markets (2)
Billions of US Dollars, 2007 Data
$0
$3,000
$6,000
$9,000
$20,000
$30,000
$12,000
$15,000
$18,000
Gross Domestic Product
FDIC‐Insured Bank Assets
US Money Supply (M2)
Federal Expenditures
Total Federal Debt
Privately‐Held Federal Debt
Foreign‐Held Federal Debt
October Bailout
US Dollars Per‐Capita:
$10,000
$40,000
$50,000
$60,000
Relative Size of Other Markets
Billions of US Dollars, 2007 Data
$0
$50,000
$100,000
$150,000
$200,000
$250,000
$300,000
U.S. Gross Domestic Product
World Gross Domestic Product
U.S. Single‐Family Mortgages
NYSE Capitalization
World Stock Market Capitalization
Notional Value of OTC Derivatives:
Foreign Exchange Contracts
Interest Rate Swaps
Credit Default Swaps
Gross Market Value:
Foreign Exchange Contracts
Interest Rate Swaps
Credit Default Swaps
What Caused all this Lending?
• New homebuyers, existing homeowners, and speculators.
• Mortgage brokers and predatory lenders.
• Financial market consolidation.
• Firms competing for highest returns.
• Short‐term incentives for financial managers.
• Investment banks, rating agencies, and hedge funds.
$350,000
Let’s not forget Hubris.
• Some risks are not diversifiable.
What are Derivatives?
A derivative is a financial asset whose value is derived from
other financial assets (e.g., futures, options, swaps).
„ A derivative is financial insurance against price changes:
a risk-averse person pays another party to take their risk
from them.
„ The most common type of derivative is an interest rate
swap, but there are more types of derivatives than bets in
a casino.
24
Why are Derivatives a Problem?
„
„
„
„
„
Insurance markets are regulated to make sure the insurer has
adequate capital. Derivative markets are not.
Derivative markets can be complex, and traders on both sides
may not realize what they are doing.
Derivatives are not transparent, often off-book, and huge.
You don’t have to own the asset to buy insurance on it. This
can leads to pyramiding of side bets. There are also often
multiple generations far removed from the asset.
All insurance markets have problems of moral hazard.
25
What Else Caused It?
• Fannie Mae (FNMA) and Freddie Mac (FHLMC)
– Privately‐owned, government‐sponsored enterprises responsible for the mortgage‐backed securities market for conforming loans. These were latecomers to the subprime debacle, but they also may have led many mortgage brokers to believe they would guarantee bad loans.
• Federal Reserve Bank – Monetary policy made cheap credit available, creating incentive for combining short‐run borrowing and long‐term lending. Twelve FRBs
are controlled by member banks, and failed to regulate bank involvement in the derivatives markets.
The Federal Reserve chose not to regulate derivatives or act to prevent bubbles
Alan Greenspan recently testified, – “I made a mistake in presuming that the self‐interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their
equity in the firms.”
‐ Congressional testimony, October 22, 2008
27
22
20
18
16
14
12
10
8
6
4
2
0
30-Year Mortgage Rate
Prime Lending Rate
Federal Funds Rate
Inflation Rate
19
71
19
73
19
75
19
77
19
79
19
81
19
83
19
85
19
87
19
89
19
91
19
93
19
95
19
97
19
99
20
01
20
03
20
05
20
07
20
09
Percentage
Mortgage Rates have been much more Stable than either Prime or the FFR
Monthly Data
Let’s Not Forget the Federal Government
• Encouraged more people to buy homes, and pushed lenders to devote some portion of their lending for those who would normally not get loans.
• Removed regulations on lending practices and on derivative markets, and negligent in enforcing existing regulations. Pressure to turn a blind eye to emerging problems. • Allowed financial mergers that made these firms too big to fail.
The role of campaign contributions from financial sector…
Financial Markets are Prone to Market Failure
• Market economies are most efficient when (1) there is competition, (2) everybody knows what they are buying and selling, and (3) external spillover effects are minimal. • Finance fails on at least two: information and contagion.
• Basic problem: banks are lending somebody else’s money. • Government insurance (FDIC) and private insurance (CDOs) both lead to moral hazard, excessive risk‐taking for short‐run profit. Bailouts are just an extreme form of insurance.
Rising Oil & Gas Prices helped to pop the bubble.
A Major Cause/Effect is Household Spending
Over the last decade:
• a sharp rise in consumption
• A fall in personal domestic savings
The Great Recession
• This recession is estimated to be the biggest worldwide since the Great Depression.
• In 2008‐2009, OECD says GDP fell by:
–
–
–
–
–
2.5% in the United States, 2.1% in Canada
13.7% in Turkey
8.5% in Japan, 8.6% in Mexico, 8.4% in Ireland
3.3% in Iceland, 4.9% in United Kingdom
4.8% in Euro area, including 6.9% in Germany
What are the Global Implications?
• Much of the savings being lent to Americans came from foreign sources. • Housing bubbles occurred in dozens of countries.
• Many foreign banks engaged in the same practices as U.S. firms.
• Markets for derivatives are often offshore.
• Foreign markets rely on exports to American consumers.
20%
U.S. International Transactions
15%
Share of GDP
10%
5%
0%
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
-5%
-10%
Quarterly Data
Exports
Imports
Trade Balance
FCB Purchases
Foreign Exchange Rates
• From 2006‐2008, foreign currencies were becoming more expensive in Dollar terms, and this was starting to rein in the trade deficit.
• Falling demand for imports and troubles in other countries led this to reverse in the last three quarters.
• This is likely to be a temporary depreciation of foreign currency, with effects on the trade deficit.
1.4
Real Direct Exchange Rates
Initial P eriod= 1.0
1.3
1.2
1.1
1.0
0.9
0.8
0.7
0.6
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Monthly Data
RMB
Euro
Pound
6000
Real Dollar Value of
Shanghai Composite Index
5000
4000
3000
2000
1000
0
2000
2001
2002
2003
2004
2005
2006
M ont hl y C l ose t i m e s R e a l Ex c ha nge R a t e
2007
2008
2009
40,000
Japan's Nikkei 225 Index
(adjusted for inflation and exchange rate)
30,000
20,000
10,000
0
1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
R e a l D ol l a r Va l ue of M ont hl y C l ose
Bank Bailouts
• Emergency Economic Stabilization Act:
– $700 billion authorized in October 2008.
– TARP funds began with plan for purchase of troubled MBS, but changed to a preferred stock model, with restrictions over executive pay.
– Many large financial institutions have begun to pay these amounts back. Monetary Intervention
• Federal Reserve authorized:
– Purchase of government bonds, helped drive yield to zero.
– Purchase of private mortgage‐backed securities for the first time.
– Central bank currency swaps.
– Target federal funds rate near zero.
Federal Reserve
Monetary Aggregates
9000
8000
MB
7000
6000
5000
M1
4000
3000
The Fed doubled the monetary base…
M2
2000
1000
0
M ont hl y Fe d D a t a
Worries about Inflation
• Rise in Monetary Base would normally have been inflationary – but deposit expansion multiplier collapsed!
• Primary worry was deflation, as during the Great Depression.
• M2 has not grown much, no sign of inflation yet.
• A Good Sign – worries have switched.
• Bernanke needs an exit strategy, to reduce reserves when banks start lending again.
Fiscal Intervention
• Economic Stimulus Act of Feb. 2008: – Tax rebates for 2008, estimated $150 billion cost (about 1% of GDP) in 2008.
• American Recovery and Reinvestment Act of 2009:
– Estimated $800 billion cost over several years, with less than $200 billion spent in FY 2009, and $400 billion in FY 2010 (about 3% of GDP).
– About 40% in tax credits, 30% in state fiscal support, and 30% in infrastructure investment (education, energy, health care), and some extended benefit support.
Fiscal Skepticism?
• Economists are very skeptical about fiscal policy working when we are close to full‐employment.
– Higher real interest rates crowd out investment.
– Higher dollar crowds out exports.
– Higher debt leads to future deficits.
• But we are NOT near full employment, and monetary policy isn’t enough when banks are scared and interest rates are zero.
• What are our choices? Worries about the Debt
• Recent estimates have raised 2009‐2019 cumulative federal deficit projections from around $7 trillion to $9 trillion.
– Falling revenues due to slower growth, assumption that tax cuts will be extended in 2012.
– Servicing growing federal debt.
– Additional tax cuts and expenditures from ARRA.
The Stimulus made big budget deficit projections even bigger.
120%
Federal Budget
(as a Share GDP)
100%
Federal Expenditures
80%
Federal Revenues
Share of GDP
Federal Savings
60%
Federal Public Debt
40%
20%
0%
1929
1934
1939
1944
1949
1954
1959
1964
1969
1974
1979
1984
-20%
Annual Data (Actuals through 2008)
1989
1994
1999
2004
2009
2014
2019
Is it Worth it?
• The total economic loss from the Great Depression was perhaps 120% to 140% of 1929 GDP (about $20 trillion
now).
• The total loss from the 1980‐1983 recessions was 15% to 17% of 1979 GDP ($2.4 trillion).
• The IMF estimates a typical depression costs more than 50% of GDP cumulatively over 7 years ($7 trillion). The Stimulus added $1 Trillion to the Federal Debt
• If this spending could prevent only a fifth of the effect of a typical depression…
• If GDP would have declined 8% instead of 4%...
• If the recovery would have begun in 2010:1 instead of 2009:3…
… then it would be a very good investment.
• But we don’t KNOW what would have happened without it. • And it probably wasn’t done optimally.
140%
Federal Budget and the U.S. Economy
(as a Share of 1950-2000 Trend GDP)
120%
Share of 1950-2000 Trend GDP
100%
80%
Federal Expenditures
Federal Revenues
Federal Savings
60%
GDP
Federal Public Debt
40%
20%
0%
1929
1934
1939
1944
1949
1954
1959
1964
1969
1974
1979
1984
1989
1994
1999
2004
2009
2014
2019
-20%
Annual Data (Actuals through 2008)
In the Current Depression…
• A severe banking crisis led to a stock market crash, and a fall in GDP for four straight quarters, for a total drop of almost 4%. • In the last two quarters, GDP has begun to grow again, though unemployment still remains high.
• Though states continued to follow their depression‐
era habits, the federal government helped to fill in part of the hole they were digging themselves into, to help prevent the typical downward spiral in spending. Financial Regulation?
• How do we prevent this from happening again?
• The federal government seems afraid to shut the barn door while the horses are gone.
Will Things Return to Normal?
• On one hand – remember 9/11?
• Overconsumption is not sustainable – Households too, not just government.
– Foreign countries did our saving for us.
• Nevada was particularly dependent on gaming, construction.
– Much of this was driven by Californians letting their housing investments do their savings for them.
18
Michigan
Unemployment Rate
Nevada, California, Michigan,
and USA Average
16
14
13.0%
12
10
California
8
6
Nevada
4
Unemployment in Nevada and California is now the highest since the Great Depression!
2
0
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Monthly Data
5%
Personal Income Growth by Quarter
4%
2%
1%
0%
19
90
.1
19
90
.4
19
91
.3
19
92
.2
19
93
.1
19
93
.4
19
94
.3
19
95
.2
19
96
.1
19
96
.4
19
97
.3
19
98
.2
19
99
.1
19
99
.4
20
00
.3
20
01
.2
20
02
.1
20
02
.4
20
03
.3
20
04
.2
20
05
.1
20
05
.4
20
06
.3
20
07
.2
20
08
.1
20
08
.4
20
09
.3
Unadjusted Rate of Change
3%
-1%
-2%
-3%
-4%
Nevada was the fastest‐growing state.
United States
California
Nevada
In 2008‐09 it was the fastest‐shrinking.
We are at a turning point…
• Our government debt is large, and growing, but not yet unsustainable. Will the current deficit be temporary or permanent? • Our economic trajectory is not sustainable. We can’t keep our spending growing faster than our income, and depending on other countries to keep financing that spending.
• Similarly, many countries with high savings rates have seen us as an export market driving their growth AND a place to invest their savings.
How do we escape?
• Time – there is still significant deleveraging that still needs to occur. Housing prices must also stabilize.
• Confidence – consumers and investors no longer are as worried that we are in freefall.
• Restructuring – high consumption with trade deficits/foreign borrowing is not sustainable.
• Policy – difference between short‐term intervention and long‐term growth strategies.
What is the Prognosis Now?
• Housing prices are stabilizing nationwide – but Nevada is still being wagged by California.
• There is still a significant inventory of foreclosures and forced sales which are waiting to go on the market.
• Recession is likely over now, but recovery may take a year or more to get started.
• Unemployment lags growth, and acts as a brake.
This presentation will be available online
http://www.business.unr.edu/faculty/parker
or just Google “Elliott Parker”
Look under “Hot Topics” on the right side.
Thank you!