by Frank James
Former Clinton Administration Treasury Secretary Lawrence Summers had a recent column in the Financial Times that has gotten much attention. The New York Times’ David Brooks, for instance, cited it in his column today.
Summers’s essential point is that the downside risk to the economy is so great, the likelihood of a recession so large, that the Federal Reserve needs to cut short-term interest rates and Congress and President Bush need to engage in some good old-fashioned pump priming by engaging in deficit spending. But even that may not stop the economy from going to hell in a handbasket, he says.
Summers clearly is sounding Keynesian notes here, embracing the notion that the federal government at times when the economic engine shows signs of seizing up, can give the economy a boost through its spending, deficits be damned.In this regard, Summers would agree with Vice President Cheney who once told a Bush Treasury Secretary, Paul O’Neill, “You know, Paul, Reagan proved that deficits don’t matter.” Of course, Cheney and Summers were coming to the same conclusion for different macroeconomic reasons, but that’s another story.
In any event, Summers’ column is well worth reading because it is an alarm from someone with a unique perspective of being one of the premier economists of his generation and a senior Treasury official during the Clinton Administration when there were financial crises in Asia and Mexico.
Summers issues such hair-raising warnings as:
Even if necessary changes in policy are implemented, the odds now favour (British spelling since this appeared in a British newspaper) a US recession that slows growth significantly on a global basis. Without stronger policy responses than have been observed to date, moreover, there is the risk that the adverse impacts will be felt for the rest of this decade and beyond.
Several streams of data indicate how much more serious the situation is than was clear a few months ago. First, forward-looking indicators suggest that the housing sector may be in free-fall from what felt like the basement levels of a few months ago. Single family home construction may be down over the next year by as much as half from previous peak levels. There are forecasts implied by at least one property derivatives market indicating that nationwide house prices could fall from their previous peaks by as much as 25 per cent over the next several years.
That’s a scary forecast; econonomic damage that lasts for years with a crash in housing prices to boot.
Some might be inclined to dismiss Summers as being too alarmist. They probably wouldn’t hold jobs in the real estate industry which got some fairy devastating news today.
According to the Associated Press story, housing prices sustained drops in the third quarter that haven’t been seen in the two decades since these data have been kept, a period which included at least two recessions.
NEW YORK — U.S. home prices fell 4.5% in the third quarter from a year earlier, the sharpest drop since Standard & Poor’s began its nationwide Case-Shiller housing index in 1987, the research group said Tuesday.
S&P also reported that prices fell 1.7% from the previous quarter, the largest consecutive quarterly decline in the index’s history.
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The S&P/Case-Shiller quarterly index tracks prices of existing single-family homes across the nation compared with a year earlier.
A separate index that covers 20 U.S. metropolitan areas dropped 4.9% in September from a year earlier. A 10-area index decreased 5.5% from the previous year.
S&P said there is no real positive news in the home price data.
Here’s what Summers says should be done:
What concrete steps are necessary? First, maintaining demand must be the over-arching macro-economic priority. That means the Fed has to get ahead of the curve and recognise – as the market already has – that levels of the Fed Funds rate that were neutral when the financial system was working normally are quite contractionary today. As important as long-run deficit reduction is, fiscal policy needs to be on stand-by to provide immediate temporary stimulus through spending or tax benefits for low- and middle-income families if the situation worsens.
Second, policymakers need to articulate a clear strategy addressing the various pressures leading to contractions in credit. Very likely this will involve measures that are non-traditional, given how much of the problem lies outside bank balance sheets. The time for worrying about imprudent lending is past. The priority now has to be maintaining the flow of credit. The current main policy thrust – the so-called “super conduit”, in which banks co-operate to take on the assets of troubled investment vehicles – has never been publicly explained in any detail by the US Treasury. On the information available, the “super conduit” has worrying similarities with Japanese banking practices of the 1990s that aroused criticism from American authorities for their lack of transparency, suppression of genuine market pricing of bad credits, and inhibiting effect on new lending. Perhaps there is a strong case for it, but that case has yet to be made.
Third, there needs to be a comprehensive approach taken to maintaining demand in the housing market to the maximum extent possible. The government operating through the Federal Housing Administration, through Fannie Mae and Freddie Mac, or through some kind of direct lending, needs to assure that there is a continuing flow of reasonably priced loans to credit worthy home purchasers. At the same time there need to be templates established for the restructuring of mortgages to homeowners who cannot afford their resets, so every case does not have to be managed individually.
All of this may not be enough to avert a recession. But it is much more than is under way right now.
Summers analysis of the current economic problems as well as his recommendations for addressing them could open up an interesting new debate for the presidential candidates, both Republicans and Democrats.
First, what do they think of his assessment? Second, if they agree that he is right and that the measures taken so far are too little and too late, what do they think of his advice, especially regarding deficit-spending to get the economy through what, according to Summers is likely to be a long and hard rut?