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No bottom in sight yet: a conversation with Doug Henwood

Doug Henwood
Doug Henwood

For the past 20 years plus, journalist/author Doug Henwood’s Left Business Observer newsletter has been an essential source for economics news and analysis from a left-progressive viewpoint. Likewise his books, which include After the New Economy, a critique of the tech bubble years and “new economy” hoohah, and Wall Street: How It Works and for Whom, which is available for free download at the LBO website. He's currently working on a book about the American ruling class.

I spoke to Henwood (who also hosts a weekly radio show at WBAI in New York that’s archived at LBO) yesterday afternoon, just a couple of hours after Barack Obama took the oath of office, to see what he makes of the tea leaves and of Obama’s likely course.  

SP: A great many economists--including Nouriel Roubini, who famously predicted the credit crisis back in 2006--now say that the likeliest scenario is a very steep recession that lasts through this year and part of next year. What's the most compelling case about the length of this downturn that you’ve encountered?

Doug Henwood: It’s hard to say. There are really no signs of it approaching a bottom yet. None of the leading indexes seem to have approached a bottom. If we were going to see some kind of stabilization by mid-year, that would start showing up in some of the leading indexes now or soon. So we’ll be looking for that, but there’s no reason to believe we’re anywhere near that point.

If you look at the history of financial crises--and there’s a good paper by a couple of economists, Kenneth Rogoff and Carmen Reinhart, that looks at some of the major financial crises of the past several decades and looks at what happens to real economies after them--the average increase in unemployment rates was about 7 points. We started at 4.5, which means we’d end at 11.5, which would be a post-1930s record. The authors also saw very, very steep declines in GDP, on the order of 9 or 10 percent. We’ve only seen a fraction of a percent so far. [You can buy the paper for $5 from the National Bureau of Economic Research, here.]

So judging on the basis of past financial crises, we are not even halfway through this.

SP: Let’s talk more about that. To the average person, the idea of the recession ending suggests a return to markedly better economic times in fairly short order. Here, though, you’re saying that’s unlikely because of the huge level of private and public debt in the system and so much overvaluing of assets as a hangover from years of easy credit. Correct?

Henwood: Yeah, that’s the proximate cause of all our problems, as the lawyers would say. Just too much debt. And it’s going to take a long time to work that off. On the basis of past financial crises--Sweden in the early 1990s, for example--it takes about three years to work through that. The Japanese financial crisis, depending when you date the start of it, took anywhere from five to 15 years to work through. It’s going to take us a long time.

The classic business cycle pattern through much of American history has a V-shape. You have a sharp recession and then the economy turns around rather quickly and grows rather quickly. For the last two, in the early 1990s and early 2000s, it was more like an L-shaped pattern. We had what appeared to be a mild recession by historical standards, but the recovery was very, very slow, especially in the job market. In both those cases, 15 years ago and five years ago, we had the official recession ending, yet employment declining for a year or two after the official end of the recession.

I think something happened in the labor market that produced that, and also produced a very weak recovery in 2002. It does look like, for example, Wall Street pressures for corporations to preserve profitability and produce profit growth means tremendous pressure [on corporations] not to hire or invest. I think that’s one of the things that happened in the early 2000s recession: In order to see profits go up under pressure from stockholders, companies were very slow to invest or expand operations or hire new people. I think that habit is going to persist, probably even more [intensely], when this recession is finally over.

There is an economist whose name escapes me now who used a fancy mathematical technique called auto-regression--which basically uses statistical analysis of the past to project the future--to project that the economy will bottom out sometime in late summer or early fall, but the job market will continue to be really crummy for another year or more. That seems like a reasonable forecast. What gives me pause about that is that a lot of people seem to think that’s a reasonable forecast, and it just doesn’t seem to me that things are likely to work out the way people expect.

SP: One of the themes we hear about regularly is the notion of keeping the economy moving to give markets time to "wind down" their overleveraging. Broadly speaking, what does "winding down" bad debt mean in a situation like this, and what is the collateral impact on the real economy as it occurs?

Henwood: Well, in some sense, the debts and assets on balance sheets aren’t really what makes an economy move. What makes an economy move is what’s happening in the present. Goods and services that are made and made available and bought in the present, incomes earned in the present. The way unwinding bad debt has an effect on the economy is through what it does to present behavior.

We’ve seen for the last 30 years or so that debt was used by a lot of people to compensate for very weak income growth. The real value of the hourly wage in the US peaked in 1973, declined into the mid-90s, picked up a bit in the late ‘90s, and now has been flat to declining ever since. In the face of stagnant incomes, people worked harder. More people from families went to work. They worked longer hours. But they also borrowed very aggressively. So one reason we saw this tremendous growth in debt over the last couple of decades was to compensate for those deficiencies in the real economy--the weakness of real wages for most people.

What are we going to do about that? We can work off all the debt we want, and the banks can do all the write-offs they want, but if we still have very weak income growth--and, as we’ve seen through the 2001-2007 expansion, very weak employment growth (the weakest labor market income growth we’ve ever seen in a post-WWII expansion)--then you still have a fundamental problem. And I don’t think going through this financial exercise of restructuring the banks is going to do anything to solve that underlying fundamental problem.

SP: Is the financial collapse still relatively contained to securities stemming from home mortgages, or has it started creeping into other sectors like credit card debt and commercial mortgages?

Henwood: The major problems are still tied to the mortgage market and the weakness in the housing sector. A footnote to what I said earlier: A lot of the juice for the 2001-2007 expansion came from people borrowing against the value of their houses. That kind of mortgage equity withdrawal, as it’s called, was a compensation for very weak job market growth and income growth.

And now that that’s gone, it’s really worsening the situation. We have incomes contracting but also the lack of a housing bubble to borrow against is causing the economy real problems. So all that is still the centerpiece of our difficulties, but we are seeing signs of it spreading to commercial mortgages--office buildings, shopping malls, that sort of thing--and to credit cards. A lot of banks are cutting back on credit card lines, and so for a lot of borrowers it’s going to be harder to get a credit card. And credit cards were another way people compensated for weak income growth. It almost became a private welfare state if people lost their jobs. Since we have no public support to speak of, they used their credit cards. It’s going to be harder to do that in the coming months and years.

It also looks like a lot of credit card debt is going bad as the economy weakens and unemployment rises. So we’re going to see a lot of banks having trouble with their credit card portfolios as well.

So yeah, it started in housing, but it does seem to be spreading beyond that.

SP: You mentioned that the housing bubble became a way for people to buttress their standard of living by drawing down on home equity. I believe the ballpark number for 2004 was $600 billion, which was 6 or 7 percent of consumer spending. Am I remembering the ballpark figures correctly?

Henwood: Yes. The amount withdrawn during the housing bubble years from 2001-2006 was $4-$5 trillion in borrowing against home equity. Some of that was from people spending the cash proceeds when they sold a house, some of it was just borrowing. In any case, turning the paper value of a house into cash was a big deal. It financed about a third of the growth in consumption during the five years or so at the heart of the bubble.

SP: It’s a staggering figure. The sum of $600 billion in one year’s time is way more than Barack Obama is proposing to spend on direct consumer stimulus in 2009.

Henwood: Oh, yeah. He’s talking about $800 billion or so spread over a couple of years. That’s considerably less than we saw in mortgage equity withdrawals.

Now that [withdrawal figure] has gone into reverse. There are no official figures, but there’s a guy at the Fed, James Kennedy, who does compute unofficial estimates of mortgage equity withdrawal. That’s gone negative. Now people are paying back more than they’re drawing out. So that’s gone from being a big stimulus to being a big drag on the economy.

SP: I still occasionally hear the line that the bulk of the credit crisis only involves a relative handful of the very biggest banks and financial institutions. But I've also read that the banking system in general, including the banks on Main Street, have come to hold a lot of dubious financial instruments--like CDOs and other "securitized" instruments--in their own portfolios. And that suggests that the poison has permeated the system all the way down to your bank on Main Street. Which is the more accurate view, do you think?

Henwood: This stuff is all over the place. First of all, the idea that if it’s just the big banks, then it doesn’t matter as much, is kind of strange. The big banks are very big, and if they go down, they’ll take everyone down with them.

But the other thing is, this really is all over the place. There are a few banks that avoided it. There’s one, Hudson City Bank in New Jersey, that did no subprime lending at all, and they’re a darling of Wall Street now because they’ve got something like $500,000 in total mortgage losses on their books. But those are very, very rare. Almost everyone got involved in this, from the smallest to the biggest. And because of the way the securities were structured, no one really even knows the extent of the problem. No one knows who holds what, how bad these things are. That’s part of the problem: There’s such a high degree of uncertainty that banks are very reluctant to do business with each other. They really don’t know whether the other guy is going to go bust if they do a trade.

Everyone’s being very cautious, and that’s part of the logic of getting the government involved so heavily. They hope that somehow they can knock heads together and buy off some of the bad debt and create some kind of reversal of the psychology of fear even as they’re trying to increase the solvency of the system.

We’re going to spend a lot of money, and it’s not quite clear what the public is going to get in return.

So far the banks are getting a blank check. The management is still in place, the shareholders have not been wiped out. We could have a lot more constructive approach to this bailout than we’ve seen from the Bush administration or we’re likely to see from the Obama administration.

SP: A couple of hours ago, Barack Obama was sworn in as president and assumed responsibility for some of the policy decisions about the economy going forward. His economic appointments, as many commented, have seemed quite conservative and conventional. Can you see any populist or progressive silver lining for working stiffs in the signals Obama has sent about the policies he'll pursue going forward?

Henwood: Not yet. Not at all. There’s a very interesting quote from Barney Frank in the Financial Times today. He says Obama shows too much of a desire to be liked by everybody. He should be more like Franklin Roosevelt and welcome their hatred, referring to the Republicans. That is not at all the approach that Obama is taking. He’s tried to make friends with the Republicans. He’s tried to win a lot of them over. People were surprised by the invitation to Rick Warren to deliver the invocation, but as it’s emerged in the last couple of weeks, Obama’s been making a lot of overtures to the right.

It’s a bit of a mystery why he’s so eager to make friends with the right. I always thought the guy was kind of a centrist. But to see all his overtures to the right has surprised me, and I didn’t expect much out of the guy. He’s not at all embracing populism. He’s embracing a very orthodox elite agenda. It struck me recently, since I’m working on a book about the American ruling class, that one of the reasons Roosevelt--and not just Franklin, but to a lesser extent Teddy--was able to act as a kind of perceived traitor to his class is that it takes someone who comes from that class to have the nerve to betray it. Someone like Obama, who comes from modest origins and believes in meritocracy, is usually more eager to please the powerful and the orthodox. As the German philosopher Adorno put it, you have to have tradition in one[self] to hate it properly. I don’t think he quite has it in him, and doesn’t hate it properly.

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Comments (1)

Henwood's good, iconoclastic and pragmatic. Thanks for the interview.

We did pump a tremendous amount of money into the economy, both as home equity withdrawals and deficits, after the recession of 2000. That's a lot of the reason we got the "L shaped" curve described - there was not the restructuring necessary to create the next uptick. I have a graph on my blog, the piece "Keynes to Success" showing how GDP growth less deficits has been negative since 2001 - and much more so without the equity withdrawals.

Let's hope this massive Keynesian stimulus is a bit more productive, which is to say that the Feds better be asking for more restructuring for the money. I think we're going to get this done, but ... we have to watch it. The appearance of free money is hypnotic.