Economic cold comfort: Recessions are necessary economic corrections

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.

Toxic waste
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.

Zombie companies
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.

Comments (7)

  1. Submitted by Paul Udstrand on 02/04/2009 - 09:56 am.

    “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,…”

    What do you mean “we”? There were economist who saw this coming, but the consensus media wasn’t talking to them… they were talking to guys like Rolnick. The question is why are you still talking to guys like Rolnick? How wrong does someone have to be before you question their credibility?

    Recessions are not part of any “cycles”. If they were everyone would see them coming. Economies and markets fluctuate, they don’t “cycle”. Economist like Rolnick talk about cycles because it make them look like they have predictive authority when if fact they don’t.

    Markets fluctuate for a variety of reasons some predictable some not, but recessions like this are completely avoidable if you favor a stable economy over a bubble economy. While guys like Rolnick were predicting perpetual prosperity driven by diluted derivatives, others looked at this economy and saw it for what it was, a mosaic of domino’s created by 20 years of really really stupid public policy based on neo-liberal free market ideology. This isn’t a “cycle” and you shouldn’t be listening to anyone tells you it is, they are either lying, or don’t know what they’re talking about.

  2. Submitted by John Reinan on 02/04/2009 - 10:53 am.

    I agree with Paul — there were credible economists, not cranks, who were warning about a meltdown as far back as 2005 and 2006.

    Nouriel Roubini, for one — the NYU professor who was sarcastically nicknamed “Dr. Doom” for his apocalyptic writings. Well, he turned out to be right.

    Dean Baker, who was recently interviewed by MinnPost’s Steve Perry, was another.

    There were also any number of bloggers who accurately foresaw the housing market collapse.

    But as Paul points out, the mainstream media weren’t paying attention to these people until it was too late.

    And now we’re handing hundreds of billions of dollars of taxpayer money to the very same people who got us into this mess. Yeah, that’ll work.

  3. Submitted by Paul Udstrand on 02/04/2009 - 12:30 pm.

    “I agree with Paul — there were credible economists, not cranks, who were warning about a meltdown as far back as 2005 and 2006.”

    Just to add to the list:

    Kevin Phillips (Steve Perry has note about him on his blog), Paul Craig Roberts,David Cay Johntson.

    There’s a nice interview with Johnston at Democracy Now!:
    http://www.democracynow.org/2009//2/david_cay_johnston_more_corporate_tax

  4. Submitted by Lance Groth on 02/04/2009 - 03:24 pm.

    I agree with the first three posters. Peter Schiff and Gerald Celente (a trends forecaster, not an economist) are two more who called the ball at least a couple of years ago. Celente in particular has been uncannily accurate – I heard him talking about the “Panic of ’08” on the radio, in 2007.

    When even the mainstream talks about this crisis as being “once in a century”, with conditions “not seen since the Great Depression”, it’s ludicrous for guys like Rolnick to claim it’s just an average recession. As to unemployment being in line with other recessions – Rolnick ought to consider that the national layoff festival is not over. We’re just getting started. Not to mention that this mess is global, not regional as were the nordic and japanese situations of the 80’s and 90’s.

    Here’s a test as to who is credible, the results of which will play out during this year. Celente is calling for total unemployment (including those who have given up looking, and those who are underemployed – unlike the official rate that ignores these categories) to reach 22-27%. He also says the next domino to fall will be commercial real estate, the collapse of which will exceed in severity the subprime loan collapse. Given his track record, I’m betting (so to speak) on Celente. I hope he’s wrong, but I’m preparing as if he’s right. Hope for the best and prepare for the worst – that’s good advice regardless.

  5. Submitted by Paul Udstrand on 02/05/2009 - 09:19 am.

    Another fallacy that needs to be revealed is the idea that recessions are part of some kind of natural ebb and flow. Keep in mind the fact that most recessions are caused by corporate crime waves of some kind or another, whether it be savings and loans, technology, accounting firms, or banks, behind every recession is a corporate crime wave of some kind.

    One reason guys like Rolnick promote the “cycles” narrative is that it casts recessions in the light of some kind of natural rather than man-made phenomena. He prefers that narrative because it doesn’t logically lead to more regulation. Remember, just weeks before the housing crises hit it’s stride Wall Street bankers were in D.C. complaining about all the onerous post Enron regulations and arguing that they needed less oversight. On the other hand, once you acknowledge the role that of corporate crime waves in creating recessions, the logical policy is to regulate and criminalize bad behavior. The “cycle’s” narrative let’s neo-liberal free market economists pretend that nothing really causes recessions, they just happen because they have to, and no one is really accountable. Obviously this narrative has it’s advantages for those who tend to create recessions.

  6. Submitted by Daniel Tinklenberg on 02/06/2009 - 10:22 am.

    Thank you, Ms. Schmickle, for your consise recap of the “The Growing Economic Crisis: Why, Who and You” First Tuesday event. Similarly to you, I did not walk away from the event with any one nugget; rather a confirmation that it took awhile to create the current economic situation and it will take a time to climb out of it. I found Mr. Winton, Mr. Beuerlein & Mr. Rolnick’s comments on the crisis and possible solutions interesting as they individually delivered monologues rather than an ongoing discussion. This format helped them as speakers to complete their train of thought and me as a listener to separate out their individual viewpoints on the current situation. Their educated and insightful presentations were the most informative that I, as a layperson, have heard. Yes, more businesses will falter or fail and people will lose their jobs, but opportunities will shake out from this current crisis as they always have.

  7. Submitted by Beryl John-Knudson on 02/08/2009 - 07:53 am.

    A belief in cyclical determinism may have got us here as proclaimed by some/one economist who thinks we are merely completing a circle of sorts? But such simple, ‘positive’ acceptance is an inescapable fallacy and is demonstrated only by the circle-theory he pedals.

    Think of him kindly however, for he is but a furry-tailed rodent, judging the economy by the squirrel cage he inhabits…round and round and round…

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