The Downturn: Cyclical or Structural?

Last month the National Bureau of Economic Research declared that the economy has been in recession since December 2007, officially confirming what we all knew to be true. This has prompted a new parlor game, speculation on when the economy will return to "normal." Although there seems to be consensus that the recession will be L-shaped, there is hope, if not optimism, that with proper "stimulus" we will see the tepid beginnings of recovery sometime in 2010. Even the notoriously bearish Nouriel Roubini subscribes to this view.

If our policy reaction is appropriate, by 2010 there will be some recovery of growth. The only risk is that the recovery of growth could be so weak that it feels like a recession even though we are technically out of it.

As uninspiring as Roubini's comments are, they reflect the hope and expectation that the downturn, although severe, is still merely cyclical. There is a darker view that the problem is not cyclical, but structural, and that the age of "growth" as we have known it has come to a permanent end. James Howard Kunstler elaborates on the differences in these perspectives:

There are two realities "out there" now competing for verification among those who think about national affairs and make things happen. The dominant one (let's call it the Status Quo) is that our problems of finance and economy will self-correct and allow the project of a "consumer" economy to resume in "growth" mode. This view includes the idea that technology will rescue us from our fossil fuel predicament -- through "innovation," through the discovery of new techno rescue remedy fuels, and via "drill, baby, drill" policy. This view assumes an orderly transition through the current "rough patch" into a vibrant re-energized era of "green" Happy Motoring and resumed Blue Light Special shopping.

The minority reality (let's call it The Long Emergency) says that it is necessary to make radically new arrangements for daily life and rather soon. It says that a campaign to sustain the unsustainable will amount to a tragic squandering of our dwindling resources. It says that the "consumer" era of economics is over, that suburbia will lose its value, that the automobile will be a diminishing presence in daily life, that the major systems we've come to rely on will founder, and that the transition between where we are now and where we are going is apt to be tumultuous.

Go ahead and read the rest of Kunstler's weekly post - if you have the stomach for it, as his predictions for the new year are shocking and disturbing. You might be inclined to dismiss him as a crank, so with the familiar caveat that "past results are not predictive of future performance," here's an excerpt from his 2005 book, The Long Emergency.

By the time you read this, it is very likely that the housing bubble will have come to grief. With interest rates at rock bottom into the first half of 2004, practically everyone who could have refinanced has now done so. There cannot be another round of re-fi unless interest rates go to zero, which is unlikely to happen and, of course, re-fi doesn't make much sense when interest rates rise, which is what they did in the second half of 2004. In fact, re-fi lending tapered off smartly by late 2004. Housing prices will probably remain inflated for a period of time beyond the end of the re-fi spree because of the end-cycle hangover phenemenon, the persisitence of delusional thinking on the part of wishful sellers who refuse to believe that the boom is over and they might have missed out.

In February 2004, Fed Chairman Greenspan made the bizarre suggestion in a public statement that house buyers might consider adjustable-rate mortgages, but the idea seemed insane in a financial climate in which interest rates had nowhere to be adjusted but upward, which would leave many such a house buyer in a terrible predicament of having the mortgage payment go up just when the value of the house had reached its absolute peak and was very likely to fall, as other house owners (especially those with poor credit records, those living marginal lives, those who had lost their jobs since re-fi) lost control of their finances, were forced to sell, or stumbled into default and repossession. Why Greenspan made that suggestion has never been adequately explained. The only possibility is that there was no other way to keep the economy levitated.

The economic wreckage is liable to be impressive. If large numbers of house owners cannot make their mortgage payments, Fannie Mae and Freddie Mac, and by extension the federal government, would be the big losers. The failure of the GSEs would make the S&L fiasco of the 1980s look like a bad night of poker. The failure of the GSEs would pose a far graver situation than the LTCM [Long Term Capital Management] flameout. It could easily bring on cascading failures that might jeopardize global finance.
[The Long Emergency, 2005, Grove Press, New York, pp 232-233]