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It Will Take Years Before the Current Recession Will End

Many are predicting that the current recession will end soon, by this summer, later this year, or at most next year. I don't believe this prediction, which I see as largely politically motivated or self-serving. Instead, I believe that it will take years for the recession to end unless major reforms are initiated that go well beyond current policy initiatives. Here are some of the many reasons:

• The failed attempt to remedy the situation by TARP and its successor, the US Treasury's private-public partnership plan, that mistakenly tried to fix the economy from the top down, by putting enormous federal funds into major banks and non-bank financial institutions, rather than from the bottom up, through funding homeowners and small businesses

• President Obama's economic stimulation plan, the American Recovery and Reinvestment Act (ARRA), while doing many useful things on infrastructure, the environment, housing, health, etc. has been and will continue to be insufficient to stop the downward economic spiral

• There is still a lack of short-term credit in the U.S. economy, making financing for businesses, individuals, and even governments difficult. Credit markets remain paralyzed, with everything on hold and with many major corporations having failed or at the brink of failing. At the same time, hedge funds and private equity funds, that have provided some small amount of lending, are unwinding, accelerating the economic decline. Until bank and non-bank financial institutions resume lending, there will be a continuing downward economic spiral

• From the viewpoint of potential borrowers, whether businesses, financial institutions, governments, or individuals, risk premiums are so high that they are reluctant to borrow

• There are continuing defaults on mortgages, with many homes going into foreclosure, while Fannie Mae and Freddie Mac are in deep trouble with no way out and no means to help people obtain mortgages or emerge from foreclosure

• GM is closing most of its plants and Chrysler has gone into bankruptcy, closing most of their plans and throwing huge numbers of their workers out of their jobs with repercussions on their employees, suppliers, dealers, and local communities

• States, counties, and cities throughout the country are facing enormous deficits and downsizing with furloughs, layoffs, and reductions in expenditures, with substantial secondary effects

• As unemployment increases more people are losing their health insurance that will lead to more personal bankruptcies since health costs for the uninsured are a major cause of personal bankruptcies

• The collapse of Lehman Brothers, in September 2008, and the change in status of J.P. Morgan Chase to a commercial bank means that we have lost our major investment banks that play a key role in capital formation

• The lax regulatory framework that resulted from the deregulation that took place at the end of the Clinton Administration continues. It paved the way for the excesses of the financial system leading to the astronomical growth of new and risky financial products, such as credit default swaps. They continue, creating huge instabilities for those on both sides of these private deals and are totally unregulated. In addition, highly leveraged financial institutions with unworthy debtors are still a major source of potential instability

• Lax reviews by credit rating agencies exacerbated the situation, while regulatory bodies were ill equipped to render sound judgment on the health of these financial institutions and apply necessary actions. The result was a vicious circle of losses leading to a financial meltdown, that continues

• Other nations worldwide are also in recession and in many cases deeper ones than that in the U.S. so there are no international "locomotives of growth" unlike previous recessions. Indeed, several nations of Eastern and Southern Europe are at or near bankruptcy and will not be able to repay their debts to banks in Germany and other European nations, with secondary effects on the U.S. economy. The agreement at the recent London G-20 meeting on increasing the resources available to the IMF will not be adequate to stop the worldwide downward spiral.

As a result of these and other considerations, this recession will not be V-shaped with a quick turnaround, as many public and private economists have been forecasting. Instead, it will be "U-shaped," with a long economic malaise comparable to the "lost decade" in Japan in the 1990s (and not to the Great Depression). The recession in Japan followed equity and real estate bubbles, as in the U.S., and it lasted years. Similarly, the current worldwide recession could take 6 to 8 years to recover from its official start in December 2007.

Michael D. Intriligator, Professor of Economics, Political Science, and Public Policy, UCLA and Senior Fellow, the Milken Institute