At the end of 2009, investors, business press pundits, and government policymakers alike reluctantly began to question whether the economic recovery in GDP terms would continue into 2010. Growing almost daily was talk of declining housing prices, rising home foreclosures and mortgage delinquencies, falling tax revenues, growing deficits for state and local governments, and chronic jobs losses occurring at a 200,000 to 400,000 monthly rate—depending on which of the government’s two surveys is chosen. Even government policymakers at the highest levels, Fed Chair Ben Bernanke, for example, admit that job losses may continue for months, possibly several years, and that it will take another five years minimum—until 2016—to get back to a level of jobs that existed in 2007.
In my critique of Obama’s 2009 recovery programs, I argued that there could be no sustained recovery so long as jobs continue to disappear at historic rates and home foreclosures continue to rise by the millions. My further prediction last March that jobless numbers would exceed 20 million by December 2009 was actually exceeded by October. By December more than 24 million of the private non-farm labor force was out of work, according to the U.S. Labor Department’s U-6 unemployment rate.
A second prediction—that foreclosures would continue to rise sharply—also proved accurate, as foreclosures by year end totaled more than six million with some estimates as high as another seven million forthcoming over the next two years. That’s 13 million, more than one in four homes, now estimated will foreclose. No longer a subprime mortgage issue, one-third of the foreclosures in the third quarter of 2009 were prime loans, which make up 78 percent of all U.S. mortgages. These aren’t buyers who got into homes they couldn’t afford; these are owners who have been in them for years and are now losing their homes due to extended unemployment.
From February 2009, the Obama program declared its primary goal was to get credit flowing again, which meant a focus on first bailing out the banks. We were told the bank bailouts were key to getting them to lend once again. Meanwhile, bank lending to U.S.-based businesses that might create jobs has continued to decline every month throughout 2009. A grandiose three-part plan was developed in March to stimulate bank lending (that never happened) by pumping initially $2 trillion into the banks, with a commitment of another $9 trillion if necessary from the Federal Reserve.
My prediction in March was that this bank bailout program—with proposals called the PPIP (Public-Private Investment Program) and TALF (Term Asset-Backed Lending Facility)—would inevitably fail. And so they have. PPIP has all but been dismantled, proving no more successful in getting banks to disgorge their bad loans and assets than did PPIP’s predecessor, TARP (Troubled Asset Relief Program). TALF—designed to resurrect what was in 2007 a $2 trillion market for securitized assets encompassing consumer auto loans, student loans, credit cards, and mortgage loans—has thus far resulted in less than $90 billion in new issues or less than 5 percent of its previous volume.
But haven’t the banks recovered and stabilized, one might ask? That’s the daily line heard in most of the press. The answer is no. Here’s why: the big 19 banks—most of which were insolvent at the beginning of the year and many of which still are—have been able to recapitalize (i.e. raise cash) only about half of their prior losses. But even that partial recovery, based on bank stock price appreciation, had nothing to do with the Obama PPIP and TALF. What set the partial bank stock price recovery in motion in the spring of 2009 was a decision by Congress to suspend the requirement that banks report their true losses at market prices—i.e., mark to market accounting—in effect allowing banks to lie about the true conditions of their balance sheets. They immediately reported profits and their stock took off. The bank stock turnaround was almost perfectly correlated with the suspension of mark to market accounting, not with PPIP and TALF. But now, that primary means of the recovery, bank stock price appreciation, has clearly leveled off. Bank stocks have had their run and now promise to drift lower once again.
Of course, bank profits have not been a total lie manipulated only by accounting gimmicks and stock price appreciation. Banks have enjoyed a profits surge of sorts in 2009. In fact, banks are sitting on a pile of $1 trillion in cash, about half what they had in 2007, but nonetheless a tidy sum. It’s not that they refuse to lend to anyone. It’s that they are refusing to lend to businesses in the U.S. that could expand and create jobs. Their lending instead has taken the form of trading, a euphemism for speculation.
Here’s how it’s been working since the spring: banks borrow real money from the Federal Reserve at less than 0 percent interest rates. Nominally, the rates are 0 percent to 0.25 percent. But that 0 percent is further subsidized by the Fed, which pays the banks interest on their deposits with the Fed. So the Fed is actually paying the banks to take its free money. The banks then loan the money out to global speculators at rates above zero for a quick, short-term return. The investors take the Fed’s dollars and invest in the latest emerging financial bubbles around the globe—Asian stock markets, properties in China, speculation involving the Brazilian real and other currencies, emerging market funds, exchanged traded funds, gold and other select commodities, and, of course, the banks’ own stock as well. It’s what is called the "dollar carry trade"—i.e., get paid by the Fed to borrow dollars, pay nothing for those dollars, and lend it out at interest in speculative projects that hopefully quickly turn a profit. The banks not only lend it out, but use the free money to speculate as well. In short, bank profits are once again being driven largely by profits from speculative investing—i.e., the root source of the original financial instability that exploded in 2007. Banks make profit, bank managers get bonuses again, and bank lending continues to decline to real businesses that might otherwise create real jobs. That, plus the suspension of mark to market accounting, is what lies behind the banks’ recent profit gains and stock price rise.
However, this short-term gaming of the system may be over. As future losses begin to materialize once again in 2010-11, all that is needed is an unpredictable yet probable further financial shock to occur, much as the implosion of investment giant Dubai World now threatens to become. (Dubai World is the state-owned conglomerate that in November sent shockwaves through financial markets by reporting that it was looking to restructure $26 billion in debt.)
Meanwhile, in addition to possible future financial shocks, the potential for further bank losses due to bad assets still on bank balance sheets continues to rise. New losses loom on the horizon as commercial property markets begin to collapse—a $3.2 trillion basket of deteriorating debt about 3 times the size of the subprime mortgage market—and as homeowners default on prime residential mortgages. Apart from the big 19 banks, the situation is even more unstable for the 8,200 small and medium banks in the U.S. that are now failing at an accelerating rate and have exhausted the FDIC’s rescue fund, which will soon have to be replenished with hundreds of billions of dollars.
The only recovery measures of the past year that have provided any indication of a positive impact were added subsequent to the original Obama stimulus and bank bailout plans of February-March 2009. These were the cash for clunkers program to purchase new autos and the first time homebuyers program intended to move part of the growing unsold inventory of homes. In both programs, the government is, in effect, providing consumers and auto and home builders-lenders a subsidy for the purchase of cars and homes.
In the second quarter, of the Obama original stimulus bill of February 2009, the one-time $250 rebate to social security recipients reduced the decline in GDP. The rest of the Obama stimulus had little cumulative effect, at best cushioning the collapse of consumption and fiscal spending by states and local government. GDP was, therefore, still negative in this quarter, though less than the record 5-6 percent declines of late 2008 and first quarter 2009.
The effects of the two third-quarter programs for auto and housing accounted for half the GDP recovery of 2.8 percent. These programs were pushed through Congress, however, despite the resistance and even opposition of Secretary of the Treasury Geithner, Fed Chair Bernanke, and National Economic Council Director Summers. Introduced initially as temporary emergency measures, as soon as it appeared both programs might be suspended or discontinued in September, sales of new autos and homes retreated again. Both were quickly reinstated as measures apparently having more impact than Obama’s original $787 billion stimulus.
It is now becoming clear that government spending in the form of such targeted programs might be required for a much longer term—given today’s stagnating consumption, growing job loss and foreclosures, and declining incomes for the 100 million-plus working and middle class Americans. What the two programs represent is a reluctant shift in fiscal policy, from Obama’s original intention to simply place a temporary floor under the consumption collapse with aid measures to consumers and states, to a policy of more direct subsidizing of consumption. However, neither aid nor subsidizing consumption is an effective substitute for a more aggressive government direct intervention in the markets to create jobs and stop foreclosures.
Corporate sources recognize the implications of direct subsidization of consumption and where it may lead. They have begun a vigorous counter-offensive to prevent any significant extension of fiscal spending on jobs and housing. Their tools and weapons are fears about the budget deficit and the stability of the U.S. dollar. In the early summer, the Obama administration made a policy turn. That shift was in favor of containing trillion dollar annual deficits, due largely to the bank and other bailout costs and an expected long and slow recovery of the economy. Holding the line on further deficits means only token additional future spending on jobs and housing. Deficit containment, the Administration is convinced, is necessary to ensure the dollar does not collapse in value and that, consequently, China, the petro-economies, and other countries will continue to recycle their dollars and buy U.S. bonds. That was the significance of Geithner’s visit to China in June and the simultaneous announcements by both Geithner and Bernanke that deficit containment (and by implication the dollar) were now the primary policy objectives—not further stimulus to generate jobs or rescue homeowners. This policy was reaffirmed by President Obama’s own visit to China and simultaneous signals to the market by Bernanke. In spite of efforts of the more liberal elements in Congress to do more about jobs and housing, it is unlikely much will be forthcoming, apart from token measures in 2010.
The fundamental problems of financial and consumption fragility have not been resolved. Both continue to deteriorate. Bad assets on the big 19 bank balance sheets have not been removed or reduced significantly and have been only moderately offset by a strategy of recapitalization based on speculative profit seeking and stock price appreciation, which has now largely run its course. Huge debt refinancing is looming. The potential for a U.S. version of November’s Dubai World bank crisis may occur, causing hundreds of billions more dollars in additional bank losses. The possibility of a second banking crisis and panic in 2011-14 is high.
The secondary tier of U.S. banks, the more than 8,200 community and regional banks, will fail in increasing numbers in 2010—my prediction is more than 500. The FDIC will have to borrow $200 billion from the Treasury. Meanwhile, Fannie Mae-Freddie Mac will cost another $200 billion and the FHA and other agencies more than $50 billion.
Bank lending to U.S. domestic businesses will continue to decline and remain stagnant. Commercial property markets’ deflation will deepen. Fed rescues will prove necessary to prevent commercial property defaults. Meanwhile, the big 19 banks will continue their trading binge, feeding credit to speculators in global currency markets, select offshore property markets in Asia and elsewhere, commodities, emerging markets, and exchange traded funds.
Business defaults will rise in 2010 as smaller non-financial companies continue to be denied access to credit. Larger companies that accessed junk bond markets in greater numbers in 2008-09, to finance daily operations, will find this credit alternative increasingly expensive. Should the Fed raise interest rates early, before 2011, the recent bubble in junk bonds will likely burst, as will the market in U.S. Treasuries.
Consumption fragility will also continue to deteriorate in 2010. The vast majority of working and middle class consumers have not been able to recover lost income. Their disposable incomes will continue to weaken and their debt-to-income ratios decline, resulting in historic levels of debt to income, around 130 percent (compared to 2007 peak levels of 140 percent). Working class debt ratios are undoubtedly even higher than 140 percent. Comprising more than 70 percent of the economy, consumption will not recover appreciably in 2010.
Job losses in 2010 will continue to rise, notwithstanding the recently reported, but highly questionable data for November jobs, which is based almost totally on hiring temporary workers. Should a jobs stimulus bill fail to be enacted in 2010, jobless ranks will rise to 27 million (from the current 24 million) and the government’s truer U-6 unemployment rate will approach 19 percent by year end 2010. Hiring that does occur will increasingly include temporary and part time labor.
There will probably be no major second stimulus bill proposed or enacted by the Obama administration and Congress in 2010, despite a continuing rise in joblessness. Isolated, targeted proposals like cash for clunkers and the first time homebuyer credit will be enacted, with little permanent or significant impact on jobs. Congress and the president will in effect repeat the fiscal policy errors of 1937-38.
Remaining TARP funds will be used in 2010 to pay for business tax cuts, as a pretext that more tax cuts (already 48 percent of the Obama stimulus bill of 2009) will create jobs. Less than half of the tax cuts to business will be spent for investment; the rest pocketed to bolster corporate cash flow. As economists would say, the tax multiplier will be less than 0.5.
Home foreclosures will rise past 7 million, on their way to a possible 10 million. Home asset prices, temporarily stabilized in major housing markets in late 2009, will resume a decline. Between 33 percent to 50 percent of homes will be under water, with home values less than mortgage balances, by the end of 2010.
State and local government tax revenues will fall and deficits rise, leading to more layoffs and wage cutting in 2010, unless the federal government provides additional aid to the states.
The Federal Reserve will continue its long-run shift in policy priority to protecting the dollar’s value in world markets, thus repeating its policy errors of 1932, in effect protecting the currency at the expense of domestic recovery. However, throughout most of 2010, the Fed will try to maintain a middle course. It will keep interest rates at or near zero until the November elections, unless there is an emergency and the dollar falls more than 30 percent to the euro. The Fed’s strategy will focus on withdrawing money supply from the banking system by paying them to temporarily deposit their excess funds with the Fed. That fiction of money supply contraction without having to raise rates will enable the Fed to claim it is reducing the money supply, inhibiting inflation and reducing the deficit on its balance sheet, while subsidizing the banks even further in the process. The fiction will end in 2011 as the Fed raises rates.
There will be no meaningful financial regulatory reform in 2010. The Fed will successfully beat back attempts to regulate and oversee its operations by Congress. The Fed will expand its role as chief regulatory agency, as the banks themselves prefer. The U.S. dollar will drift lower slowly so long as financial instability remains in global markets. An alternative global currency option will not displace the dollar, but wealthier countries like the BRICs (Brazil-Russia-India-China) will increasingly trade directly with each other’s currencies. Japan will begin negotiations toward forming a common market with China and other Asian economies, including possibly Australia. Japan will experience increasing deflation and a deeper recession.
Notwithstanding the IMF’s $1 trillion rescue fund and primary commitment to rescue the banks of greater Europe as necessary, the euro financial system will be shaken in 2010 by one or more debt defaults on its periphery (Latvia, Ukraine, Greece, Italy). Austrian and Swedish banks will be seriously impacted. The Dubai-World default event of December 2009 will seriously impact UK banks.
Jack Rasmus is a professor of economics at St. Mary’s College and Santa Clara University. He is a member of the national steering committee of the Workers Emergency Recovery Campaign. He is the author of Epic Recession: Prelude to Global Depression (forthcoming from Pluto Books, London, UK and distributed by Palgrave-Macmillan in the U.S.).
Predictions for 2010 and Beyond
A Review of 2009