The American Economy - More Pain to Come For Now

| Fri Oct. 17, 2008 9:30 PM EDT

Below is a guest blog entry by economist and MoJo author Nomi Prins:

There are no bright spots on the immediate horizon for the US economy, mired in a debt-led recession that has yet to reach its trough. Indeed, on Wednesday, Federal Reserve Chairman, Ben Bernanke relayed his most somber opinion about the US economy to date. Focusing on the ongoing liquidity crisis, he told a roomful of people at the Economic Club in New York that there was a "significant threat" to the US economy emanating from the credit markets, indicating that as bad as it seems, the worst is still ahead.

Though Bernanke appeared to be giving the Fed room for more rate cuts in the near future, especially since inflationary pressures from things such as high oil prices have fallen dramatically over the past few weeks, that won't be enough to do more than put some short-lived cheer in the markets.

Even if Bernanke were to cut rates to the levels that Greenspan reached to spur the US economy out of its recession in 2001, he and the US are facing a more widespread problem given the extent of credit issues. He can do little to control the massive over-leverage that still exists in the US (and global) banking industry, but wait, and hope that at some point, the pressures of the tightened credit will ease.

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Meanwhile, they are seeping through the rest of the US economy. And, there are other growing problems. The most obvious is that the housing sector is still weak, and foreclosures are still rising. Second, unemployment is rising. The national unemployment level reached 6.1 percent last month, or 9.5 million people, an increase of nearly 30 percent over the prior year. New jobless claims are at their highest level since the milder recession in 2001. Wall Street will have laid off 30 percent of its workforce by the end of year, due to a combination of bankruptcies, mergers, and general cost cutting measures, which affect not just former bankers, but everyone whose livelihood is related.

The speed of the rise has even caught some state unemployment funds off guard. At this pace, the funds of at least 10 states in the US will go bankrupt by spring of 2009, including California, New York, Michigan, and Ohio. An average of almost half a million new Americans are claiming unemployment benefits on a weekly basis, since August.

Aside from the unemployed, there are a growing number of underemployed workers (part-time workers who want full-time jobs, and jobless workers who aren't actively seeking employment, but do want a job). At 11 percent of the population, or 17 million people, that underemployment rate is at its highest level in more than 14 years.

According to the Economic Policy Institute in Washington DC, "The fact that one out of every nine US workers is now either unemployed or underemployed is clear evidence of the need for a second stimulus package targeted at job creation."

Yet, so far, Congressional discourse about helping and protecting taxpayers aside, all that has been implemented by Washington to fix the financial meltdown are various means of government guarantees to back agencies like Fannie, Freddie and bank-to-bank lending, as well as cash and equity injections. AIG, reaching the end of its $85 billion helping of government money, is already back for more. Citigroup and Merrill Lynch posted new ominous losses this week.

Treasury Sec. Hank Paulson's $700 billion purchase plan still concentrates mainly on preferred stock purchases at the most influential banks, as their leaders hold out for the toxic waste purchase phase. It was the CEOs of the top 5 banks that met with Paulson in Washington to discuss the plan's steps, not leaders representing American citizens, many of whom would love an equity injection of their own to help balance their debts.

Meanwhile, the plan's execution will at best provide temporary relief to massively overleveraged financial institutions, but will neither fix their problems, nor those of the greater economy. And, it is not just the banking system that is overleveraged: Federal debt has shot through the $10 trillion mark, and will rise to accommodate the latest bailout plan. The budget deficit is expected to triple in size to almost half a trillion dollars for 2007-2008, up from $162 billion dollars during the prior year, from 2006-2007.

"This year's budget results reflect the ongoing housing correction, and the manifestations of that in strained capital markets and slower growth," said Paulson in a statement on Tuesday. This dogmatic attachment to the idea that the underlying financial problems in the US, that have weakened the entire economy, are merely a 'correction,' is a willful denial that the current situation is the result of years of deregulation, lack of oversight, rampant repackaging, and leverage.

It is important to understand this reality to work towards solutions. Effective legislation and immediate action is required to keep people from default and foreclosure on their homes, in order to contain the hemorrhaging at the bottom of the mortgage loan market that has proliferated entire neighborhoods as well as the global financial markets. That won't solve the problem either, but it will go a longer way to securing the foundation on which all the leverage and toxic assets sit, plus help citizens who need it. Plans to create more jobs to keep up with rising unemployment figures are required.

On an interview on the Fox Business Network, Paulson projected optimism that the measures that he and the Bush administration will work, "We will mitigate the impact on the real economy and we'll get this financial system working again," he said.

Polls of ordinary Americans weren't quite so sure. Results of an online CNN Money poll that asked, "How gloomy are you about the nation's economy?" taken one day after the last presidential debate between Barack Obama and John McCain summed up the country's sentiment. 71 percent of respondents said, "It was the worst I've seen", 16 percent said, "this is bad, but I've seen worse", and just 13 percent said, "This isn't so bad."

Unfortunately, it will take a few years to get the US economy moving forward. Getting through the crisis in the banking sector is one step, particularly since the banking sector's problems are keeping ordinary Americans from getting credit on everything from student to small business loans, and causing unaffordable fee hikes on credit cards, another looming disaster. Helping Americans keep their homes and find good jobs will be necessary to bolster the economy. Forget cutting taxes and bloating the budget further, that's something that the next president of the United States will have to work on, fast.

—Nomi Prins

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