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Are We In (Or Headed For) a Recession?

Thursday, March 13, 2008

The evidence is mixed. But it’s certainly possible that America will face only one quarter of negative economic growth.

This week’s news that the Federal Reserve will set up a $200 billion Term Securities Facility to provide liquidity to the troubled banking sector adds another variable to an economy potentially teetering on the brink of recession. Earlier this month it was announced that the United States lost 63,000 payroll jobs in February and 22,000 in January. Not surprisingly, most economic forecasters are predicting that America’s GDP will decline in the first quarter of 2008.

But we still don’t have conclusive evidence that we’re in a recession, which the National Bureau of Economic Research defines as two consecutive quarters of negative growth. We might avoid one altogether. In late July, the Commerce Department will issue the advance estimate of second quarter GDP, but we won’t get definitive data for months (or possibly even years) afterward.

Initial calls of recessions can turn out to be erroneous. For instance, numerous revisions to GDP data revealed that we weren’t even in a recession in 2001, as was initially thought, because we never had two consecutive quarters of negative growth. Growth was only negative in the third quarter of 2000 and in the first and third quarters of 2001.

Today, the evidence of a recession is compelling. Since 1952, we’ve never had two consecutive months of declining payroll jobs without a recession (although that happened several times in the 1940s). In February, not only did industries in the service sector lose more jobs than they created (with the exception of the low-paying leisure and hospitality industry), but the index of total weekly hours worked by production employees in the entire economy declined by one-tenth of 1 percent from January.

The argument for a recession, however, is not only based on present economic conditions, but on the possibility that weak conditions in the banking and housing sectors will spill over into the rest of the economy. As American Enterprise Institute resident fellow Desmond Lachman told me, “I am super concerned about the viability of the American banking system, with international loan losses now estimated in the $750 billion to $1 trillion range, of which the American banks must have at least a half. It would seem to me that we are in for a prolonged period of loan contraction on the part of the banks that will deepen the recession.”

In addition, Lachman believes that there is an accident waiting to happen in the credit derivatives market. That market has risen to a face value of $45 trillion, more than three times U.S. GDP, and the hedge funds’ share of that market has grown to 30 percent. Problems in one or two large hedge funds could cause major problems in the banking system. This means we could be facing a financial meltdown akin to those experienced during the Asian crisis of the late 1990s.

House prices are continuing to decline as payments on adjustable rate mortgages rise, reducing equity in American homes. As prices decline, homeowners with only a small amount of equity in their homes might find it worthwhile to walk away from the homes, increasing the number of foreclosures.

Although the economy shed jobs in the first two months of 2008, average wages have grown by 3.7 percent over the past year.

All of this sounds like a convincing argument for a recession. Yet an equally credible case could be made that we’re facing just one quarter of negative growth, and that GDP growth will be back in positive territory during the remaining three quarters of 2008.

One major reason is that $107 billion will be mailed out to U.S. households in early May, as part of the economic stimulus package passed by Congress and signed into law by President Bush. In addition, over the calendar year, businesses will be able to deduct $51 billion for accelerated depreciation and expensing of equipment. 

One can quibble over whether this package is the most effective way of stimulating the economy. But it will encourage businesses to move equipment purchases into 2008, and it will raise household spending by $40 billion in 2008 and 2009, according to the Joint Tax Committee, which might help to prevent a recession.

Although the economy shed jobs in the first two months of the year, average wages are growing—by three-tenths of a percent last month and by 3.7 percent over the past year, above the rate of the GDP price index. Unemployment declined to 4.8 percent last month, and the number and percentage of those who qualify as “long-term unemployed” (unemployed for 27 weeks or more) actually fell. 

The banking crisis is getting all the headlines, but by some measures the nonfinancial business sector continues to perform well. Federal Reserve data show that commercial and industrial loans continued to increase in volume through 2007 (one might have expected them to contract due to the credit crunch). Such loans increased from $1.19 trillion in December 2006 to $1.44 trillion in December 2007.

My colleague at the Hudson Institute, John Weicher, reports that housing prices aren’t doing as badly as we might think. The broadest price index, the Office of Federal Housing Enterprise Oversight (OFHEO) Home Price Index, shows that median house prices declined by 0.3 percent from December 2006 to December 2007. This differs from the Case-Shiller index, which reports that prices declined by 9 percent in 2007.

What’s the difference between OFHEO and Case-Shiller? The OFHEO index represents the entire country, whereas Case-Shiller covers all of eight states (including the District of Columbia), parts of an additional 30 states, and has no representation in the remaining 12 states. However, Case-Shiller has the advantage of including both jumbo loans and mortgages on lower-priced houses, whereas the OFHEO index is based only on loans purchased by Fannie Mae and Freddie Mac.

Although Federal Reserve Chairman Ben Bernanke believes he can stimulate the economy through interest rate cuts without increasing inflation, Allan Meltzer, an economist at Carnegie Mellon University and a visiting scholar at AEI, disagrees. Writing in The Wall Street Journal on February 28, Meltzer argued that “The Fed should insist on its obligation to prevent inflation and sustain growth, not sacrificing inflation to lower unemployment before the election.”

It will take many months before we know whether the economy has sustained two quarters of consecutive contraction. By that time, we will probably be on a positive growth path once again. Yet we do not need the certainty of a recession in order to give our economy proactive assistance.

We could make the Bush tax cuts permanent, instead of waiting for taxes to rise after 2010.

We could increase transparency in credit markets, penalize ratings agencies when they fail to evaluate credit risk correctly, and require mortgage originators to keep a percentage of what they sell.

We could develop a sensible energy policy: one that is focused on increased domestic production of oil and natural gas, additional refinery capacity, and nuclear power, rather than the mirage of renewable fuels. 

We could remove the corrupting link between employers and health insurance, and develop ways for consumers to shop around to get their own portable healthcare plans.

In short, there is much we could be doing right now to improve our economic performance. We shouldn’t wait for the National Bureau of Economic Research to declare an official recession.

Diana Furchtgott-Roth,, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute and a weekly columnist for The New York Sun.

Image by Corbis/Darren Wamboldt.

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