The sluggish recovery, as GOP candidate Mitt Romney repeatedly notes, pales in comparison to previous comebacks in the U.S. economy since World War II, but studies show that recessions resulting from major financial collapses such as the one in October 2008 usually have slow and difficult recoveries.
“A severe financial crisis chills economic performance for a very long time,” said Vincent R. Reinhart, chief economist at Morgan Stanley and co-author of a study covering the 15 worst financial crises in the second half of the 20th century.
He found that the U.S. economy, while experiencing a “little ice age” as a result of the monumental housing bust and banking crisis in October 2008, is actually doing somewhat better than most crisis-struck countries.
“The financial crisis wiped out the equivalent of almost two years’ worth of income from household balance sheets in 2008 and 2009” because of the collapse by more than a third in housing prices and the loss of nearly half the stock market’s value at that time, he said.
Beyond the unprecedented loss of wealth for the middle class, nearly a third of U.S. homeowners got stuck with houses worth less than they paid and ended up over their heads in debt with mortgages that borrowers often could not refinance because they had no equity.
That led to an unprecedented wave of defaults and millions of foreclosures that hurtled the housing market into depression territory and continues to hold it back.
Banks, hobbled by breathtaking losses, cut back drastically on credit to consumers and businesses, while consumers sharply cut spending as they braced for layoffs and scrambled to recover from their loss of wealth. The legacy of such heavy debts and losses continues to weigh on banks and consumer spending to this day, Mr. Reinhart noted.
Moreover, the federal government also went deeply into debt in a bid to limit the damage to banks and consumers and coax the economy back from recession. Efforts to stem the hemorrhaging of federal debt are likely to further hold back growth for years to come, he said.
“This harsher climate is a familiar feature after a severe financial crisis,” he said. In fact, the tepid 2.2 percent average growth rate that the U.S. has eked out since the recession ended in July 2009 is actually better than what most countries experienced.
The study Mr. Reinhart co-wrote with his wife, Carmen Reinhart of Harvard University, found that economies struck by a major financial crisis typically went into deep and long recessions, followed by shallow recoveries.
It took on average about five years from the onset of the crisis for the economy to achieve the healthier pace of growth experienced before the crisis. In 10 of 15 cases, the unemployment rate never fell to its pre-crisis levels. A stunning half of the countries studied experienced two recessions within a decade.
Studies by the International Monetary Fund have also found a pattern of anemic and difficult recovery in nations suffering from major financial crises.
President Obama, under constant assault from Mr. Romney for the poor economic performance during his term, has defended himself by citing these studies.
“Keep in mind that some of this is us just working through a very, very deep worldwide financial-based recession,” he said recently on the campaign trail. “You guys are probably familiar with some of the work that’s been done on this.
“Recessions that follow a financial crash of some sort, including the popping of the housing bubble, are not regular recessions. They’re not your typical business cycle recession.”
Many economists agree that despite some missteps, the measures the Federal Reserve and White House took early in Mr. Obama’s term to re-capitalize and stabilize failing banks, prevent the failure of two of Detroit’s three car companies, and stimulate growth with $800 billion in tax cuts and spending increases, helped to prop up the economy and prevent an even worse economic debacle.
The studies of private and public debts by Mr. Reinhart and his colleagues are widely respected within the economics profession and often cited by analysts and politicians alike. Many GOP candidates, while apparently shunning his conclusions about the depressing effects of the housing bust on U.S. growth, have cited his conclusion that mammoth government debts such as the ones the U.S. is accumulating threaten to hold back growth for years to come.
Russ Koesterich, analyst with iShares, cites the Reinhart studies in saying he expects the U.S. economy to be “stuck in the slow lane” for years.
“In the aftermath of credit bubbles, both housing and labor markets take a very long time to recover, and government debt typically skyrockets,” he said. “It could take five to 10 years for the housing market to recover — yet another sign of how the current economic recovery is likely to be anemic and uneven.”
Prominent economists on Mr. Romney’s team point to studies by economic gurus John F. Cogan and John B. Taylor of Stanford University that concluded Mr. Obama’s stimulus program failed to jump-start a more robust recovery because it did not address structural problems in the tax code, regulations and entitlement programs.
“We are stuck in a low-growth trap,” said Mr. Taylor in a paper co-written by R. Glenn Hubbard of Columbia University and N. Gregory Mankiw of Harvard University, because of “the administration’s economic errors and poor choices … [the] Obama administration chose to emphasize short-term fixes — ineffective stimulus, cash for clunkers, myriad housing programs that went nowhere, and a rush to invest in ‘green’ companies irrespective of cost — rather than restoring long-term growth and productive private-sector job creation.”
The Romney economists contend that, if the economy had been handled correctly by the White House, it would have surged back to life like it did after a deep, two-year recession during President Reagan’s first term.
But other economists point out that the 1981-82 recession was induced by the Federal Reserve, which hiked interest rates to double-digit level to fight raging inflation at the time. It did not result from a financial crisis like the Great Recession.
Harm Bandholz, economist at Unicredit Research, accuses the Romney economists of “ignoring economic reality — and the facts” while “playing politics” in a heated effort to clinch a victory in the close-fought race.
“Blame the president for many things — but not for the weak economy,” he said. “To be sure, there are a lot of things that the Obama administration could have done better over the last four years,” such as including fewer welfare payments for the unemployed in his stimulus bill and more traditional road-building projects that could have put to work millions of construction workers idled by the housing bust.
Mr. Obama has been pushing for an additional round of spending on infrastructure in his latest stimulus legislation, which has gone nowhere in Congress.
“There is probably not much that the administration could have done” beyond that, Mr. Bandholz said. “Many economists predicted an anemic recovery right from the start,” he said, citing the studies by the IMF, the Reinharts and Nomura Bank’s Richard Koo.
U.S. consumers, saddled with more debt than assets after the financial crisis, had to reduce their debts and rein in spending for a long period to regain financial health, he said. Since consumers are the main engine of growth driving the economy, that inevitably led to slower growth.
“The only way for the government to cushion the impact on total demand is deficit spending,” he said.
Now that consumers have reduced their debt loads significantly and home prices are starting to rise again, the economy is poised to start posting stronger growth next year — regardless of who is president, Mr. Bandholz said.
“The incoming President, be he Barack Obama or Mitt Romney, will therefore inherit an economy that looks much healthier than it did four years ago and that needs less government support,” he said.
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