Diane Swonk is a senior managing director and chief economist for Chicago-based Mesirow Financial. She is also a professor at DePaul University's MBA program, a past president of the National Association for Business Economics, and is on advisory committees to the Federal Reserve Board, its regional banks, and the White House Council of Economic Advisers.
H.L.: What do the stock market’s huge swings tell you?
D.S.: Basically they’re telling us that the market is concerned about something Federal Reserve Chairman Ben Bernanke has already let us know, that is, “unusual uncertainty,” the phrase he used to describe the economy. We’re in a very uncertain phase of a recovery, which looks like it started sometime in the summer of last year and has been fading lately. We hope not to lose it entirely, but we’re on very thin ice, and the fear is that we may drop through the ice again if more can’t be done, although we’ve already done a lot.
It’s difficult to get the economy moving again beyond a dead-cat bounce. That’s the trouble we face now. We’ve spent most of our fiscal stimulus, and we’re looking to the Fed as the stimulator of last resort.
The good news is that Ben Bernanke is a good student of the Great Depresssion. He wants to try anything he can to avoid a repeat. It’s just not clear that we have the tools to do it. But I think we will see the Fed step up to the plate again by the end of the year and start to purchase mortgage-backed securities to help the housing market, which is a critical piece of the U.S. economy, to move up slightly rather than moving down again.
H.L.: What’s the risk of a double dip back into recession?
D.S.: The risk of a double dip is possible but not probable, which is unacceptable a year into what should be a recovery. What kind of possibility? 20 percent? That’s a one in five chance. That’s way too high for me.
H.L.: Is that what the risk is?
D.S.: At least. And I wouldn’t have said that two months ago. I would have said 15 percent, but this has gotten much more fragile in the last two months. And we have to be very cognizant of it, because we’ve got people who’ve been unemployed since the fall of 2008. That’s not a good place to be, because too many of those people have given up, and we can’t afford it as a society to have people who stop entirely.
H.L.: Can Congress do anything?
D.S.: Congress is a bit impotent at the moment. That’s a kind word for Congress. We can extend the tax cuts. That will be done. My guess is that even high-income tax payers will have extensions to their tax cuts. While we go through this crisis you have to remember that that’s not additional stimulus. It’s just not invoking pain when the economy can’t take it.
It’s also trying to offset what’s going on at the state and local level. In many states we’re seeing lots of tax increases, particularly income taxes being considered as state and local budgets have to be squared away. They’re making deep and draconian cuts in their budgets, but they’re also raising taxes.
H.L.: Could state and local problems sink the economy?
D.S.: It’s not going to sink the economy, but it’s already proven to be a major headwind for employment growth. Beside the loss of federal census workers, many of the layoffs in July came from state and local government. That’s going to continue and is a headwind we’ve got to get over when the private sector is generating only 50,000 or 100,000 jobs a month. That’s not enough to overcome the headwinds of a state and local sector that are cutting anywhere from 100,000 to 200,000 jobs a month.
This is a very difficult time when the private sector is only hobbling in terms of job generation. We’ve yet to see small business step up to the plate, because they haven’t had financing and strong enough growth to justify additional hires. On top of that, although corporate profits that have come back quite nicely, and in fact, large corporations are hiring faster than they’re firing, they’re only doing it marginally. They’re not willing to make big commitments, because they too are very concerned about where the course of the economy is going.
H.L.: When will job growth match population growth?
D.S.: We might barely be able to eke out enough employment growth as we move into 2011 to start to see the unemployment rate be down slightly. Initially, people who give up often rejoin the labor force if there are jobs out there, so we should actually see the unemployment rate rise a bit, but if it rises because people are more excited about the opportunities, that would be a good thing. My concern is that the reason the unemployment rate isn’t higher today is because of the sheer volume of workers who have just plain given up and are discouraged and are not counted. The long-term unemployed are at a record high. A good portion of the workers unemployed today have been unemployed since the heart of the crisis, the worst of the panic in the fall of 2008 and the beginning of 2009, and in fact long-term extensions to unemployment insurance are up over 60 percent from a year ago. What you really worry about is that as the unemployment rate begins to come down hopefully in 2011, it won’t come down rapidly enough to reemploy these workers.
H.L.: What’s in store for the housing market?
D.S.: We’re expecting to see sales decline now that the homebuyer tax credit has worn off, and in fact that’s despite record-low mortgage rates. Much of the problem is that people can’t qualify under the new tougher standards, and homes aren’t appraising at the right level, because it’s very difficult for banks to underwrite loans in an environment where they don’t know whether you’re going to lose your job or maintain your job or if the house you buy will fall further in value.
This could get to be a vicious cycle. The one thing that could help this out is if the Federal Reserve went back and bought agency debt, the mortgage-backed securities, from Fannie and Freddie. The minute the Fed stopped doing that the mortgage markets tightened up again.
There is a bit of a silver lining, in that in some of the worst-affected markets rents are now exceeding the marginal costs of home ownership, which is one of the tipping points. Investors are stepping up to the plate, and cash sales are now a record percentage of existing home sales, as investors go in and snap up foreclosed properties and turn around and rent them at a profit. The fact that that’s going on is some sign that we may be near a bottom.
H.L.: How long could it take before the economy is robust?
D.S.: In the wake of a financial crisis it can take up to a decade to restore economic conditions to a more robust phase. Hopefully the measures we’ve gone to to mitigate the depth of the recession, to prevent it from becoming another Great Depression, will work. I think there will be additional stimulus out there, but it’s along the margin right now.
What’s really remarkable about where we are is that we could be seeing 30 percent unemployment rates instead of 10 today. As hard as that is a bitter pill to swallow, it does suggest that maybe it won’t take the traditional 10 years to recover from a financial crisis. Maybe it will take five. That’s not much solace from an economy that’s experienced so much pain, but that’s about the best we can hope for. Also in the next five to 10 years we have some major budget deficits to deal with that are additional headwinds for the U.S. economy.
H.L.: What steps are needed to get us going?
D.S.: Anyone who has ever been through any kind of restructuring in a company or who has had to tighten their belts knows that pain has to be shared, spending has to be cut, and taxes have to be raised. To eliminate the healthcare bill will not solve our healthcare problems in our country. We have costs that are running out of control. We have a system that’s broken, and we keep trying to fix a broken system rather than come up with something different.
All these solutions dance around the core problems, and you can put fingers in the dike, but it’s still going to explode. You cannot reduce the deficit just by cutting spending and cutting taxes. It doesn’t work that way. On the other side of it, you can’t reduce the deficit by spending forever. We have to stop electing people who continue to promise us the moon in terms of tax cuts and spending increases and start looking hard at our priorities.
H.L.: You’ve stated what not to do. What should we do?
D.S.: First, you can’t do deficit reduction today, because it would undermine an already fragile economic situation. Frankly, we’ve got a little bit of a window because of the fact that we have a reserve currency, and we’ve got very low interest rates on our deficit. Those things are helping to cushion the blow to us of the fact that we’re financially irresponsible. That said, if you don’t make a plan for reducing the deficit today, you’re never going to get it down.
So you need to put things into place over the next five to 10 years. Taxes on capital gains are more productive for society than income taxes. You want to encourage capital gains taxes. On the other side of it we know that very high income households save a lot, and if you reduce their taxes they don’t necessarily spend a lot more. These are things we know to be true.
Also, we should raise the retirement age for Social Security. The Social Security system was based on a time when most people over 65 were not alive, and that is not the case any more. Most states are raising their retirement age to 67, so this is something that is already occurring. Also, Social Security was never meant to cover everyone in society For the very wealthy, the top 1 percent, they’re not going to get it. You can make Social Security solvent for 90 to 99 percent of the American public by restraining what the very wealthiest households get and by raising the retirement age.
Those kinds of decisions need to be made more thoughtfully rather than the scapegoating that’s gone on, the simplistic decisions, the sound-bite solutions that we hear, because frankly they’re not going to get us where we need to go. And both parties in Congress have been incredibly bad at coming to any kind of a consensus and working with each other and just finding where the common ground is. The partisanship is really undermining our ability to function as an economy going forward. Democracy is such a downer in my view. It’s not even representational any more. It comes from years of gerrymandering districts so you only get extremists elected in certain districts, only a Republican, only a Democrat, and they only represent a fraction of the whole in their area. That’s what’s so sad: We don’t have a government that really represents the whole. We have a government that represents pieces, and it’s certainly not willing to come to any decisions. That’s the worst of all, because indecision at this stage of the game is our enemy.
H.L.: How can we change that?
D.S.: That’s our responsibility. We’re the ones who elect these people. When we go to the polls, it’s not just voting against someone. You need to vote for someone, and you have to think hard about sending a message to Washington about compromise, and compromise isn’t easy. It also means taking responsibility that we all contributed to this crisis.
Disclosure: No positions