A World Transformed: Panelists Look Beyond the CrisisPublished: March 04, 2009 in Knowledge@Wharton
Most Americans don't need a university professor to tell them that the economy is in trouble. Hard luck stories are everywhere, linked to the country's rising unemployment, snowballing foreclosures, skidding stock prices and billion-dollar bank bailouts.
But many still wonder when the tide will turn. Could the United States be on the cusp of another Great Depression? Will the most recent government stimulus get us out of this hole or dig us in further? And what should we do to make sure an economic crisis like this never happens again? These were some of the questions a panel of University of Pennsylvania professors tackled last month at the inaugural David and Lyn Silfen University Forum, organized by Penn president Amy Gutmann and titled, "After the Fall: A World Transformed?"
Drawn from Wharton, the University's law school, and Penn's political science and economics departments, the professors debated the severity of the crisis and how long it would endure. While there was not a lot of consensus, the panel did agree on a few things. First, this crisis is big, it's bad and it probably won't be short-lived. According to corporate law professor David Skeel, nobody really knows when the economy will bottom out, "but a consensus answer is that nobody thinks it's going to be over soon. It's not going to be two or three months. It's going to be a year, two years, three years, four years."
When the recession began is a bit more certain. Although official numbers say it started in December 2008, the real drop in the economy began in September 2008, according to Wharton finance professor Richard Marston. "In September, it got terrible and, as a result, consumer confidence fell, business confidence fell. In my view, that was the beginning of the recession." The numbers bear that out. The bulk of the 3.5 million jobs lost since the beginning of 2008 came in the last five months, Marston said, adding that 600,000 jobs were lost in January 2009 alone. "You're going to want to hope that you're a sophomore," Marston commented to the students in the audience, "because as far as jobs are concerned, I think it's going to be a bad job market through 2010.... Next year is going to be a very tough year for jobs."
Most of the panelists agreed that job growth would probably not turn around before 2010. Penn political science professor Donald Kettl predicted the economy might not regain its footing for another two years. When the economy does turn around, it's not clear how quickly the recovery will take hold. "Is it a V?" which, because of its shape, is often used to describe a period of short and sharp decline followed by a strong recovery. "Or is it a U with a long bottom?" Kettl asked. "Nobody knows."
Nevertheless, comparisons of the current economic crisis with the Great Depression were classified as "ridiculous" by Penn economics professor Harold Cole. "The standard of comparison should be post-war recessions," Cole said. "There are post-war recessions which look substantially worse." A comparison of today's "real side" numbers -- such as economic output, employment and productivity -- reflect an economic downturn that is mild compared with the 1930s. For example, output per hour (GDP per adult) was down 42% in 1933 relative to 1929, Cole said. Today, output has dropped only about 0.2% from its peak.
One of the biggest differences between now and the Great Depression is the breadth of the economic crisis, the panel agreed. Today's crisis spread quickly around the world, Kettl pointed out. "The perception is that this is big and broad and global. There's the sense of the news cycle out there which tells everybody whether things are better or worse.... The anxiety spreads around very quickly, and because [the downturn] is rooted in housing, it's unclear where people are going to go. It's not clear what is safe anymore."
Relying on 'the Kindness of Strangers'
The current crisis also differs in some ways from previous banking crises such as Japan's in the 1990s, said panelist Jennifer Amyx, a Penn political science professor who focuses on the economy of East Asia and has written extensively about Japan. "The U.S. crisis is much larger in scope because it had securitized assets," noted Amyx, referring to the process of bundling mortgages and selling them to investors who have no relationship to the borrower.
"One thing the U.S. has done well is recognize the problem quickly," Amyx said, "but the U.S. is not as well positioned going into this crisis. Japan had high savings rates. The debt was to Japanese households, not spread around the rest of the globe. The U.S. has zero household savings.... We're relying on the kindness of strangers and foreign investors to finance the stimulus that we need to get us out of this crisis."
The interconnectedness of the world's economy and financial systems has also made today's crisis more global than in the past. Problems caused by mortgage-backed securities spread like a virus through world financial systems. Other countries, especially those dependent on exports to the U.S., are struggling to cope with a problem they didn't create. "This is something that has hit every country around the globe regardless of their history," Amyx said. "Many people [in the U.S.] are thinking about jobs and their pensions, but there are a lot of other people in countries out there who have just been dropped below the poverty line."
The degree and depth "of resentment and frustration that this crisis is going to generate -- has already generated -- around the globe is under-appreciated here in the United States," added Amyx. And yet the U.S. is more likely to come out of this recession more quickly than countries such as Japan or China. "Many other countries are going to be feeling this for years."
Because the crisis has spread worldwide, the United States needs to consider the global impact of the steps it takes to alleviate the crisis, panel members suggested. "Never assume you can't make a bad situation worse," Kettl stated. "We have in our power the ability to really make this one worse if we engage in massive protectionism." For example, "we could put in anti-competitive efforts in the attempt to restructure the auto industry."
According to Cole, too much government intervention could hurt the U.S. as well. "You can do very negative things in terms of intervening and interfering with the markets. There are some things we can learn from the Great Depression and some fairly negative things we can learn about the New Deal.... They put in place a very anti-competitive ... set of policies that are commonly called the National Recovery Act. My own research argues that these were important factors in dragging out the Great Depression after 1933."
Amyx noted that during Japan's financial crisis in the 1990s, many government measures didn't work. "Japan had five injections of capital into banks. So one clear lesson is that, in terms of re-capitalization, the government needs to do its due diligence." Japan also spent massive amounts of money on fiscal stimulus. "It didn't work; it didn't get Japan out of the recession." One reason: Japan's political battles at the time. "The fiscal stimulus was directed in very political ways. It had nothing to do with where the economy was going. So I think one of the lessons is that [fiscal stimulus] needs to be done judiciously."
The U.S. can also learn from the fact that Japan's turnaround took hold when the government was finally able to stop propping up the market, according to Amyx. So as the Obama Administration considers its stimulus programs, it should keep an exit strategy in mind. "It's very common for governments to come in and create institutions to jumpstart markets," said Amyx. "The difficulty is to withdraw that support."
But even the government's focus on stimulating the economy may be misdirected, Kettl suggested. "The real problem is that we have been playing the wrong kind of politics so far. We have allowed this debate over the stimulus to dominate everything else -- and have spent a lot of money that we probably didn't need to spend to get a stimulus that's not going to help very soon -- instead of working on trying to fix the banking system. The stimulus is not going to matter unless the banks get fixed. So ultimately, none of this is going to matter without focusing on the central problem -- which nobody really knows for sure how to attack right now."
Marston advised the Treasury to be as innovative in its approach to the bank bailout as the Federal Reserve has been about the commercial paper markets. "The Fed has been heroic," Marston said. "The Fed has basically re-written its rulebook in the last five months."
When the commercial paper markets seized up in October, the Fed "realized that the only way short-term security markets could start working again is if they took things into their own hands," Marston noted. "The Fed said there has to be a commercial paper market in this country, so we're going to invest in commercial paper to the tune of $200 billion. By doing this, they restarted the commercial paper market. So today, the Fed is withdrawing from the commercial paper market. It's now on its own.... And as a result, the short-term securities market has come back."
Stuck Paying the Bill
Meanwhile, there is no shortage of grass-roots support for slapping new rules on the banking system. "Many ordinary American citizens are concerned to the point of being angry about the bailout of the banking industry," said Gutmann, who acted as the panel's moderator. "They suspect the government is taking failing banks out to dinner and leaving ordinary taxpayers with the check."
Indeed, the crisis may present an opportunity to rethink the way the government regulates banks.
"I think one of the most important things we can do right now is to restore and create new, more effective regulations," said Skeel. "One place I think this crisis does look a lot like the New Deal is that in the New Deal, our financial services and securities regulation got a stress test. And they failed that stress test. It was clear that in the 1930s our banking and securities regulations were not up to the task of overseeing the problems at the time. We're in exactly the same kind of position now. Our financial services regulation is not prepared to deal with this kind of crisis. One of the questions we need to be asking is, are we going to have another crisis like this in 10 or 15 years? And if we don't want one, what are we going to do to try to prevent it?"
One of the few "silver linings of a crisis is that you get popular attention on issues like fixing our banking system," Skeel noted. "You can make changes that are good for a generation. That's what happened in the New Deal. Roosevelt passed securities regulation that was good for 50 years." Added Cole: "A lot of what we need to do is roll back our regulatory structure to what it was in 1980. We want to go back to trying to put in place a fairly stark regulatory structure for our financial markets."
But turning the clock back 30 years could prove difficult, Kettl said, given how the world has changed. "American autonomy in this might not be quite what it was before. We may not be able to roll back to 1980. There may be a lot of other countries that are going to have real concerns about how we allowed [ourselves] to get them into all this trouble. There's going to be a lot of real international pushback."
The U.S. also has "to recognize that we've had an abnormal situation in our country with consumer finance," Amyx said. "There's no society around the globe, no country where you could talk about the sub prime mortgage issue -- about the way Americans could get mortgages -- and have any empathy for what's happening right now in the United States. It's abnormal, and we need to change expectations."
"A lot of what's going on is about how much risk an individual can take," added Kettl. "We are increasingly looking to government to protect us from the risk.... In case after case, we are looking to government to provide these protections, but at the same time we talk about the need to assume more responsibility. There's a fundamental conflict here. And at some point we're going to have to come to terms with what the implications for that might be."
Skeel boiled the issue down to a single query. "I think we really need to re-think all the subsidies we give to people who are buying houses and all the pressure we put on lenders to lend into the housing market, and ask the question: 'Can everybody genuinely afford to have a house?'"