Call me a dreamer, but I keep looking for glimmers of light in the economic darkness, small signs that we’re approaching a corner we could turn and see hope for jobs bounding back, investments rising and home prices stabilizing.
I can’t say I was dazzled by such a light at the “First Tuesday” luncheon sponsored by the University of Minnesota’s Carlson School of Management. But the economic experts who spoke did offer some comfort.
Not surprisingly, a good share of it came from Arthur Rolnick, a self-professed optimist, who depicts recessions as painful but necessary economic corrections. He is senior vice president and director of research at the Federal Reserve Bank of Minneapolis.
Financial crises are a time-honored routine in the U.S. economy, going back at least to the Civil War and rearing up at least every decade since then, Rolnick told the luncheon crowd at the University’s McNamara Alumni Center in Minneapolis.
This is the 11th recession since 1948, he said, and in terms of lost jobs it is by no means the worst. Instead, we are right at the median, meaning about half of the other 10 recessions have been tougher in the workplace. (You can see charts supporting Rolnick’s claim here.)
“I know when you are going through a recession it always feels like the worst,” Rolnick said. “But if you look at the data, we are right about at the average recession since 1948.”
Where most of us see a crisis, Rolnick and many economists see the business cycle’s “creative destruction” in process.
“Some firms have to fail and reinvent themselves, some people have to find new jobs,” Rolnick said. “That’s how market economies work. They have business cycles. There are going to be ups and downs.”
Unlike some other experts who warn of prolonged hard times, Rolnick predicted “there is a very good chance that we will be out of this recession by the end of this year.”
Further reassurance, albeit slim, came from Andrew Winton, chairman of the Carlson School’s finance department.
Banking crises on the scale of what we’re suffering today hit the Nordic countries and Japan in the late 1980s and early 1990s. They survived and eventually recovered. Almost all of those countries tried some sort of government intervention, as the United States now contemplates.
The sobering truth is that no one knows for sure this time how to resolve the crux of the problem, which is “billions of dollars of toxic securities and loans on the balance sheets of the banks,” said John Beuerlein, president and chief investment officer of Marquette Asset Management, Inc.
Indeed, no one knows how to sort the bad loans from the good. As mortgages were bundled into securities, they were mixed and matched under a theory that the risk in the bad loans would be sufficiently diluted if they could be mixed with enough good ones.
“They figured that if they mixed and matched them well enough, the overall quality of that security was going to be OK,” Beuerlein said.
Now, those toxic tidbits are embedded in securities that were sold to all kinds of investors all over the world.
“We tried to spread the risk, but when the risk starts to hit, then it hits everybody and that’s where we are,” Beuerlein said.
Meanwhile, the federal government is headed for a deficit of at least $1.7 trillion this year, or 12 percent of GDP, and “we are likely looking at trillion-dollar deficits for a couple of years,” Beuerlein said.
“Yet failure to act could trap the economy in a protracted slump,” he said.
Still, does the government know what to do? That’s one of the questions keeping me awake at night.
Rolnick said Japan made some costly mistakes in its bid to breathe life into its economy, especially by providing loans to inefficient “zombie companies” that should have been left to fail.
“In a market economy, that’s a mistake,” he said. “Firms are going to have to change. Some firms have to go out of business.”
The U.S. government’s guiding principle should be the medical imperative to do no harm, Rolnick said. Where it does intervene, it should be with “high-return investments” such as education, roads and bridges.
“The notion that we can stimulate the economy and just have people spend more and get out of this recession is a flawed view,” he said. “We have little evidence that simply spending more money gets you out of a recession. What keeps an economy growing is innovation, building human capital and letting the market prices adjust.”
One of many risks the government faces as it takes on the massive challenge is that its increased debt could jeopardize its credit worthiness and set off an erosion in the value of the U.S. dollar, Beuerlein said.
World’s largest scam?
Q&A time brought some questions that have reverberated across America since September.
Where were the federal and state regulators during the period leading up to the crisis, and why did they act as they did?
Rolnick: The regulators did fail in this case, but we put a major burden on them by allowing financial institutions to become too big to fail. They had become so large and complex that it was very difficult to know where they stood on any given day in terms of their solvency.
A questioner from Rochester, Minn., drew applause when he asked how — with all of our sophisticated computer software and IT savvy — we were not able to foresee the crisis coming, to ward it off and to sort out the assets after it hit. “Are we not in the midst in one of the world’s largest scams for the lack of good ethical leadership?” he asked.
Winton: The economy is a very complex thing. We are just starting to model one human brain on a computer, but to model what’s going to happen in the economy you’ve got to know what billions of people around the world are going to do and that is just orders of magnitude more difficult.