Game Over. Hit Reset.
The economics lesson of the last four years, says Keivan Deravi, is that “the whole heart and soul of capitalism collapsed.”
“We’ve never been under such distress.” —Keivan Deravi
Keivan Deravi is a professor of economics at Auburn University Montgomery’s School of Business. He designed the Alabama Economic Forecasting Model, which is used to generate forecasts for the state’s major economic variables. This model has been used by every governor’s administration in the last 15 years to develop the General Fund and Education Trust Fund budgets.
I don’t call it a Great Recession. I call it a reset. A typical recession is either caused by consumers adjusting their spending or investors adjusting their investments. Or it can be induced by monetary or fiscal policy. From the peak of the last cycle to the middle of 2012, there was growth of only 1.7 percent. This compares to previous recessions that for the same period of time had 12 percent growth after moderate recessions, to 16 percent after severe recessions.
What we had here was none of those but, rather, that the whole financial market just collapsed. What we had was something we’ve never had before, which was a capital market where all the savings and money goes through intermediation and is loaned out and there is collapse. No bond market, no stock market, the whole heart and soul of capitalism collapsed.
When that happened, corporations went into an extremely harsh trajectory. They did what they had to do to protect the bottom line. They laid off an enormous amount of people, unmatched by any other period in our history. There were 750,000 to 800,000 jobs lost every month. With the peak coming in the last quarter of 2007, the recession was declared over in the second quarter of 2008, with 5.2 million people who had lost their jobs. Amazing. This was a complete reset.
Only in two other cases have financial systems collapsed as badly: Sweden and Japan. Japan has not been able to control the collapse of their financial system to this day. The Swedish economy nationalized all the banks, cleaned everything, took over all the bad assets, so they were able to recover. But Sweden is a small economy relative to the U.S., and with a small economy you can do a lot of things.
China is heading into recession, and Europe is already in recession. This is a contagious disease that big economies can’t get rid of. It’s a plight not just of Greece and Spain, but France and Italy will be in the same boat.
It will take about five more years to correct itself. It will be a restart with a different direction, acceleration and momentum. The housing market hasn’t yet recovered. It will take many years for it to get to where it was before. There is $8.2 trillion of housing in place with about $8 trillion in mortgages against that. Twenty-two percent of all homeowners owe more to the bank than their homes are worth. In 2011, the average U.S. household wealth was less than it was in 1999. Inflation-adjusted wages in 2011 were less than in 2000. The employment figures just released in September — even after the big push to count everyone — barely passed the employment in 2007. Universities in Alabama all collectively raised tuition about 35 percent since 2009, because of budget cuts of 30 percent. Who has to pay this? Middle income people, the same people who aren’t able to find jobs. The value of housing is down, wages are lower, collective income is shrinking along with government tax collections. All these adjustments mean that as a nation we are poorer. We’ve never been under such distress.
There is a glut of workers in the market, and wages are going down. GM, just like Chrysler and Ford, is beginning to pay a two-tier wage, with new hires getting only $13.63 an hour. If you work full time, your income is below the median income. The wealth base is tremendously impacted, and it has a ripple effect everywhere else. In state after state, they have promised to save the village, but the only way they have to save the village is to burn the village. The Sept. 16 amendment in Alabama, this plan of borrowing for three years just kicked the can down the road. Unless there is a constitutional reversal allowing deficit spending, we are going to have to put cuts in Medicaid on the table and cuts on collections for everything else.
It’s not going to turn around. There will be a new growth trajectory. Growth will have a different makeup. It will be on average 3.5 percent. Right now it’s at 2.5 percent. We will live in smaller houses, drive smaller cars and hold onto them later and later. It will be a different type of demographic for consumers. They will not buy on impulse. They will buy something to replace something that is broken — less conspicuous consumption. Not everyone will go to college. And businesses will have to minimize cost and adjust their expectations of markup. Generally, they will have to act like Walmart.
It will put a damper on U.S. consumption, and businesses will have to go overseas to make money — investments in China, India and South America. If you cannot make a profit here, it will cause investment to change, the growth trajectory will change. About 42 percent of all S&P 500 company earnings are from overseas now, and they will become more globally oriented.
Our financial system is the most efficient in the world. They lick their wounds and go on. They lick their wounds with the money the government gives them. There is a moral hazard with not fixing the system. It means the banks will come back in five or six years and do it again. A lot of money is sitting in the banks now; banks are not making loans. Eventually they are going to go back into the marketplace, and they will repeat this behavior. With risk-taking, there is a tremendous amount of reward, and — with the compensations Wall Street has paid on profits they made in recent years — that drives you to take a risk with somebody else’s money.
No, there is not going to be any outrage over this type of behavior by banks. Many people are not at the level to be able to follow all of this. They pay their bills and try to stay afloat. It’s very complicated. The CEO of J.P. Morgan Chase didn’t understand the investment by one guy that exposed his bank to a $5 billion loss. These are the kind of guys you’re dealing with. Money moves. Money hires smart people, and these smart people do the damage.
Chris McFadyen is the editorial director of Business Alabama.