A Precarious Balance:Outlook for the U.S. Economy

Dr. John CaldwellDirector of Economics

Edison Electric Institute

What Constitutes a Recession?

Source: Federal Reserve Board

Interruptions in Long-Run

Growth

The Business Cycle Since WWII

Note: Average annual real GDP growth during this period has been 3.4%.

Causes of RecessionsWhich Was Responsible for This One?

___ Speculative “Bubble”

___ Sudden and/or Extreme Rise in Energy Prices

___ Failure of Regulators/Auditors to Identify Systemic Problems in Business/Accounting Practices

___ Tightening of Money Supply by Central Bank

___ Credit Crisis – Insolvency of Financial Institutions

___ Excessive Reliance on Foreign Sources of Funding

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The Economic Crisis: Timeline

2000 20051995

1990’s U.S. Stock Market Boom

Asian Financial Crisis

Start of Housing Bubble

“Dot-Com” Recession; Collapse of

Stock Bubble

Energy/Commodity Prices Soar

Start of Current

Recession

Housing Prices Peak

The Financial Meltdown: Timeline of Events

Oil tops $100/bbl

S&P’s/Moody’s downgrade

several hundred subprime bonds &

securities

Fitch downgrades Countrywide to

BBB+Bank of America

buys Countrywide

Bush signs Economic Stimulus

Act of 2008

Northern Rock nationalized

Housing and Economic Recovery

Act of 2008

• Fannie May / Freddie Mack seized by government

• Lehman Brothers files bankruptcy• House rejects bailout plan

Congress approves bailout plan – Bush signs

Barack Obama elected President

Obama signs

stimulus bill

Subprime lender New Century files for bankruptcy

Diminished liquidity in interbank lending markets

JP Morgan buys Bear Stearns

Causes of the Financial Crisis• Abundance of Low-Cost Sources of Money

• Housing Boom Encouraged Consumers to Over-Extend in Borrowing

• Faulty Lending Practices

– Government policy aggressively encouraged expansion of homeownership

– Reward structure in lending based on fees rather than interest income

– Risky loans repackaged into complex investments

– “Capture theory” – Ratings agencies had incentive to give these investments positive evaluations

America’s Growing Reliance Upon Debt

Source: Federal Reserve Board

Recent Trends Indicate A Rise in Both Poverty and Debt

State of the EconomySome Disturbing “Vital Signs”

How Serious is This One? Comparison with Past Recessions

Length (Months)

05101520

Loss of Output

-4%

-3%

-2%

-1%

0%

1%

1929 = 42 months 1929 = 25%

1929 = 27% 1929 = 89%

The National Debt• Currently at $10.8 trillion (78% of GDP, $35,000 per person)

• Why is the National Debt a Problem?– Leads to inflationary pressures / high interest rates

– 25% of it is owed to foreign countries

– Interest expense on debt becomes significant share of government budget

Social Security / MedicareA Huge Bill Looming Ahead

• “Pay as you go” entitlement programs are underfunded:

• Social Security needs an additional $13.6 trillion to meet future needs . . .

• But Medicare needs an additional $85.6 trillion!!!

• How bad is this? Consider some alternative “fixes”:• Bill every American today $330,000 (or $840,000 per household).

• Raise income taxes by 68%.

• Cut government discretionary spending (e.g., national defense, education, the environment) by 97%.

National Debt Will Continue to Grow

Source: Congressional Budget Office

Will reach 85% of GDP in 2010

“Follow the Money”Why Government Spending Is

Not a Long-Term Solution

Private Sector Investment

Government Spending

Private Savings

Taxes

Foreign Investment(from Trade Deficit)

$

$

$

$

$$

$

$

$

$

Prognosis for the EconomyWhen Can We Expect a Recovery?

• Necessary Preconditions for Recovery:• Housing Prices Bottom Out• Borrowing / Spending Resumed• Consumer Confidence Restored• Banks’ “Toxic” Assets Eliminated/Managed

• Potential Roadblocks to Recovery:• Second Banking Crisis • Stimulus Program Has No Effect

• Too Little, Too Late, or Channeled into Wrong Areas• Trade Wars Due to Protectionist Elements in Plan(s)

• Financial Sector Restructuring Ineffective

The Road to RecoveryThe Long View

• Borrowing and Lending

• Consumer Spending

• Full Employment

• Remove “Toxic Assets”

• New Regulation of Financial System

• Rein in Deficit Spending

• Reduce National Debt

Businesses / Consumers Banking / Financial Sector Federal Government

Thank You!