Happy Birthday, Recession!

The National Bureau for Economic Research has dated the beginning of the current recession at December 2007, meaning we have been in the midst of recession for one year. They did something quite unusual for some economists and tied the start date to the beginning of when the bad economic picture started to actually affect people's lives.

The committee views the payroll employment measure, which is based on a large survey of employers, as the most reliable comprehensive estimate of employment. This series reached a peak in December 2007 and has declined every month since then [...]

Other series considered by the committee—including real personal income less transfer payments, real manufacturing and wholesale-retail trade sales, industrial production, and employment estimates based on the household survey—all reached peaks between November 2007 and June 2008.

The committee determined that the decline in economic activity in 2008 met the standard for a recession, as set forth in the second paragraph of this document. All evidence other than the ambiguous movements of the quarterly product-side measure of domestic production confirmed that conclusion. Many of these indicators, including monthly data on the largest component of GDP, consumption, have declined sharply in recent months.

Semanticists desperate to protect the status quo have clung to the "a recession is only present after two straight quarters of a decline in GDP" but we know better. That is only one statistic in the face of all this other evidence. And when you put it all together, contra Larry Kudlow, we're in a longer recessionary cycle than the last two, in 1990-91 and 2001.

In short, things are really, really bad and the prospects for a quick turnaround are remote. The lies and unsustainable risks of Wall Street have finally caught up with them (that's a sublime piece by Michael Lewis. It'll make you sick. Wall Street traders were making fantasy football bets with our future). They made enormous bets and pressured everybody to stay positive and keep the go-go dancers dancing. Eventually, many saw the obvious pitfalls but those voices were marginalized.

The Bush administration backed off proposed crackdowns on no-money-down, interest-only mortgages years before the economy collapsed, buckling to pressure from some of the same banks that have now failed. It ignored remarkably prescient warnings that foretold the financial meltdown, according to an Associated Press review of regulatory documents.

"Expect fallout, expect foreclosures, expect horror stories," California mortgage lender Paris Welch wrote to U.S. regulators in January 2006, about one year before the housing implosion cost her a job [...]

In 2005, faced with ominous signs the housing market was in jeopardy, bank regulators proposed new guidelines for banks writing risky loans. Today, in the midst of the worst housing recession in a generation, the proposal reads like a list of what-ifs:

• Regulators told bankers exotic mortgages were often inappropriate for buyers with bad credit.
• Banks would have been required to increase efforts to verify that buyers actually had jobs and could afford houses.
• Regulators proposed a cap on risky mortgages so a string of defaults wouldn't be crippling.
• Banks that bundled and sold mortgages were told to be sure investors knew exactly what they were buying.
• Regulators urged banks to help buyers make responsible decisions and clearly advise them that interest rates might skyrocket and huge payments might be due sooner than expected.

Those proposals all were stripped from the final rules. None required congressional approval or the president's signature.

If the investment bankers and the Bush Administration were thinking ahead, they would have detained economists for being gloomy, like this actual case in Latvia.

Wall Street didn't care what it was selling. Their greatest strength lied in making sure nobody else understood it and blocking the regulators from doing anything about it. Eventually, reality caught up. And it has overwhelmed the greater economy.

Now the question turns to what we do about this. The consensus is forming on the left and even in the center and some elements of the right. Joseph Stiglitz is arguing for $600 billion to $1 trillion over two years and an even bigger investment in jobs than the Obama team has suggested. Robert Reich is firmly in the Keynesian camp, while emphasizing how these infrastructure projects must be tightly controlled and not bridges to nowhere. And Paul Krugman lays out the whole thing in the most lucid fashion.

Even if the rescue of the financial system starts to bring credit markets back to life, we'll still face a global slump that's gathering momentum. What should be done about that? The answer, almost surely, is good old Keynesian fiscal stimulus.

Now, the United States tried a fiscal stimulus in early 2008; both the Bush administration and congressional Democrats touted it as a plan to "jump-start" the economy. The actual results were, however, disappointing, for two reasons. First, the stimulus was too small, accounting for only about 1 percent of GDP. The next one should be much bigger, say, as much as 4 percent of GDP. Second, most of the money in the first package took the form of tax rebates, many of which were saved rather than spent. The next plan should focus on sustaining and expanding government spending—sustaining it by providing aid to state and local governments, expanding it with spending on roads, bridges, and other forms of infrastructure.

The usual objection to public spending as a form of economic stimulus is that it takes too long to get going—that by the time the boost to demand arrives, the slump is over. That doesn't seem to be a major worry now, however: it's very hard to see any quick economic recovery, unless some unexpected new bubble arises to replace the housing bubble. (A headline in the satirical newspaper The Onion captured the problem perfectly: "Recession-Plagued Nation Demands New Bubble to Invest In.") As long as public spending is pushed along with reasonable speed, it should arrive in plenty of time to help—and it has two great advantages over tax breaks. On one side, the money would actually be spent; on the other, something of value (e.g., bridges that don't fall down) would be created.

Krugman also stresses financial reform of the kind that the regulators wanted to implement back in 2005, and across all markets globally.

What we're going to have to do, clearly, is relearn the lessons our grandfathers were taught by the Great Depression. I won't try to lay out the details of a new regulatory regime, but the basic principle should be clear: anything that has to be rescued during a financial crisis, because it plays an essential role in the financial mechanism, should be regulated when there isn't a crisis so that it doesn't take excessive risks. Since the 1930s commercial banks have been required to have adequate capital, hold reserves of liquid assets that can be quickly converted into cash, and limit the types of investments they make, all in return for federal guarantees when things go wrong. Now that we've seen a wide range of non-bank institutions create what amounts to a banking crisis, comparable regulation has to be extended to a much larger part of the system.

We're also going to have to think hard about how to deal with financial globalization. In the aftermath of the Asian crisis of the 1990s, there were some calls for long-term restrictions on international capital flows, not just temporary controls in times of crisis. For the most part these calls were rejected in favor of a strategy of building up large foreign exchange reserves that were supposed to stave off future crises. Now it seems that this strategy didn't work. For countries like Brazil and Korea, it must seem like a nightmare: after all that they've done, they're going through the 1990s crisis all over again. Exactly what form the next response should take isn't clear, but financial globalization has definitely turned out to be even more dangerous than we realized.

Krugman concludes by stating that we have to get beyond our doctrinal biases and work the problem instead of fretting about some future concern ("I believe that the only important structural obstacles to world prosperity are the obsolete doctrines that clutter the minds of men"). He takes that up in his column today, arguing that those worried about the deficit are again thinking short-term, and in fact the future of our fiscal balance depends on getting the recovery right.

But the deficit worriers have it all wrong. Under current conditions, there’s no trade-off between what’s good in the short run and what’s good for the long run; strong fiscal expansion would actually enhance the economy’s long-run prospects [...]

Just to be clear, I’m not arguing that trying to reduce the budget deficit is always bad for private investment. You can make a reasonable case that Bill Clinton’s fiscal restraint in the 1990s helped fuel the great U.S. investment boom of that decade, which in turn helped cause a resurgence in productivity growth.

What made fiscal austerity such a bad idea both in Roosevelt’s America and in 1990s Japan were special circumstances: in both cases the government pulled back in the face of a liquidity trap, a situation in which the monetary authority had cut interest rates as far as it could, yet the economy was still operating far below capacity.

And we’re in the same kind of trap today — which is why deficit worries are misplaced.

One more thing: Fiscal expansion will be even better for America’s future if a large part of the expansion takes the form of public investment — of building roads, repairing bridges and developing new technologies, all of which make the nation richer in the long run.

I quote at length because these are concepts which must be ingrained into progressive thinking about the mess we're in, and must be argued over and over to push the Obama Administration in the right direction, and back us off this precipice where we've found ourselves after decades of deregulation and allowing Wall Street to have their way with the economy.