Remembering that a market economy will tend to recover from recession in around 18 months on its own, recovery strategies by government need to affect the general economy within that first year and a half, or it is wasted. Realizing that we need two or three quarters to confirm that we are in a recession, effective action is pretty much limited to a year after the administration discovers that the economy is in trouble. There are no “out years” to a responsible recovery plan.
This recession was set-off by the collapse of a housing bubble, whereby prices were artificially high (and climbing) due to decades of questionable federal housing policy. Because mortgages are a large part of banking holdings, and both housing and banking are largely backed by the federal government, when the bubble popped, its effect was pandemic and immediate. The credit markets froze as banks found their portfolios were upside down, and because of that, Fannie Mae and Freddie Mac were technically insolvent. As credit is the cardiovascular system of business, this had the earmarks of systemic breakdown that could threaten depression, rather than just recession. Something had to be done to revive the capital markets, and it was. Businesses are now experiencing recovering levels of activity.
But natural reactions to the cause of the recession, and Washington’s response, are still exerting downward pressure on nearly all non-business, and some business, activity. And this gets into why this recovery is acting like a recession.
The Toxic Asset Relief Program (TARP) was supposed to buy up the ill-advised loans government foisted on banks, but they had been hopelessly bundled in with other securities and sold as big-ticket derivatives to institutional investors both here and abroad, making the finding and procuring of them by government nearly impossible. Much of the allocation was used merely as grants to many banks (others were allowed to fail), and some of the funds are still unspent. Banks largely used the funds to shore up balance sheets – which is fine, as they needed to get rightside up again so they could serve their function in capital markets. This period saw the discussion of businesses that were “too big to fail,” a fiction that was not resolved by those discussions. General Motors, Chrysler and Ford also turned out to be “too big to fail,” but Ford, after looking at the strings attached to federal bailout, decided it could recover on its own. GM was given to the West Wing and Chrysler was given to the UAW (Fiat has since bought majority interest). But the reaction of banks has been to overreact and tighten up lending criteria to the point that it is stifling small business and many individuals from entering into economic activity that they otherwise would.
Since World War II, construction has been a major component driving economic recoveries. Not only does construction of new buildings and factories help make companies become more productive, but it (and new housing) also creates jobs for the overall economy as each order of concrete, for instance, demands workers to do everything from taking the order to delivering it from the warehouse to the building site, necessitating the ordering of more concrete for the warehouse, and so on. This has been stifled by the glut of overpriced foreclosures sitting on the market and high unemployment keeping many potential buyers off the market.
Given that S&P 500’s non-financial companies altogether hold more than $1.1 trillion in cash and short-term investments, it’s not as if America’s biggest companies don’t have the money to invest. So what’s to blame for the pullback in spending? “It’s a question of why is it that we no longer in a recovery can fund long-term assets – basically 20 years or more – and the answer essentially is that there’s a huge element of uncertainty in this economy,” former Federal Reserve Chairman Alan Greenspan said in a recent interview with The Financial Times [London]. You’re not anxious to play Blackjack if the casino is apt to change the rules after the cards are dealt. This is on top of the slow unfolding of ObamaCare, which will only increasingly make employees more expensive to have. There is no incentive for business to invest or hire right now, and every incentive to hold cash for whatever emerges next.
So banks, construction and investment haven’t come out of recession-mode yet, leaving great swaths of the overall economy underserved by key recovery engines.
Consumer spending hasn’t recovered for much the same reason that banks lending hasn’t recovered – they’re gun-shy after having been burnt by over-extension, and the abnormally high unemployment has taken a bite out of discretionary consumer spending. As our economy is 70% consumer-driven, this is not a trivial impediment to recovery.
All of this is happening on top of a generalized realization that government at all levels have reached the natural consequences of over-promising and under-funding, resulting in nationwide layoffs of government employees, keeping unemployment high and concealing whatever private employment is taking place.
Those are the primary factors feeding a jobless and anemic recovery, so any policy aimed at accelerating the recovery must deal with these factors. I have some ideas, but will hold off until next time.
 The moral hazard of assuming that those who could not afford a house were entitled to one anyway was set in motion by the Community Reinvestment Act of 1977, and artificially inflated housing prices until the bubble burst, deflating housing prices and rendering millions of mortgages worth more than the homes they underwrote.
 Cited in Nin-Hai Tseng, Four ways this economic recovery is different, in Fortune, August 30 2011, p. 31.