Recession is a given. Can we avoid depression?
When economist Robert Parks predicted early last week that there was more than a 60 percent probability the current financial meltdown in the United States would lead to the "Bush depression," his phone began ringing like crazy with calls from the media.
Only last fall, most economists were forecasting a modest slowdown. Now, a good majority of them see a slump big enough to qualify as a recession.
But a depression?
Nah! Most number crunchers are counting on the Federal Reserve to stop any failure on Wall Street from cascading to other financial institutions and leaving them falling down like dominoes.
The Fed, under Chairman Ben Bernanke, has taken several orthodox and unorthodox monetary actions to prevent the credit freeze-up from spreading and damaging further the basic economy.
Last Tuesday, for instance, the Fed dropped short-term interest rates another 0.75 percentage points to 2.25 percent, hoping to revive financially squeezed banks and encourage consumers to borrow and spend.
Mr. Parks, however, doubts the cuts will do much to boost the economy. Rather, he sees a further steep fall in housing prices, continued major deficits in the federal budget and in the international trade balance, a tumbling dollar, and a weak stock market leading to a genuine depression with 30 to 35 percent unemployment, greater poverty, more loss of homes, plunging bond and stock prices, even some starvation. Parks, now a Pace University finance professor (for years he was chief economist at three Wall Street firms), says he has never predicted a depression before. His e-mail to press acquaintances sparked a lot of interest, as Parks was daring to express publicly the financial community's worst nightmare.
What prompted Parks's pessimism is his assumption that the "right-wing ideology" prevalent in the White House will keep Washington from acting to ward off a major depression. A fan of famed British economist John Maynard Keynes, who called for major government spending programs to remedy the Great Depression of the 1930s, Parks would like the federal government to step up outlays to fix rickety bridges, repair pot-holed roads, improve schools, and more to provide more jobs, more income, and thus more spending to cure any economic downturn.
As Parks sees it, Washington and Wall Street are mostly counting on Fed additions to the money supply to revive the free market and right the economy.
"Automatic recovery is in no way a reliable concept," he warns, especially if deflation (falling prices) has begun. He recalls warning of the economic damage that the bursting real estate and stock market bubbles would wreak in Japan: That nation suffered stagnation from 1990 to 2001. Today's financial crisis has revived the debate over the role of government in stopping a slump.
If the economy doesn't improve soon, says Ed Yardeni, president of Yardeni Research in Great Neck, N.Y., the United States might want to consider doing what Sweden did in 1991: Inject government capital into a troubled financial market. The Swedish economy bounced back quickly.
"This is the worst credit crisis we have ever had" in the postwar US, Mr. Yardeni reckons. He praises the Fed for breaking historical precedents and being creative in its steps to prevent a credit meltdown. But actions by Treasury Secretary Henry Paulson to stem the troubles are "pretty lame," he holds.
So far, Yardeni expects only a "modest recession" in the US, with the "basic capitalism and materialistic instincts" of Americans coming back soon.
Economist Dean Baker figures that more of Wall Street's "big boys" – financial firms like Bear Stearns – will be pushed to the edge, "victims of excessive greed and really bad judgment." The co-director of the Center for Economic Policy and Research in Washington sees the financial system as biased toward pushing income to the already wealthy. So he wants any necessary federal intervention to keep troubled banks alive in a way that doesn't rescue managers or shareholders but merely keeps the institutions running under new management.
Economist A. Gary Shilling, like Parks, is also pessimistic. He predicts a 25 percent drop in house prices by 2010 from their 2005 peak. The result: All homeowners with mortgages will see, on average, nearly all their personal equity in their houses disappear – a $2 trillion drop in total wealth.
Mr. Shilling, a consulting economist in Springfield, N.J., also sees a major retrenchment in consumer spending. And he worries about a "wild card" – the financial crisis spreading as those in the investment community try to unwind their leveraged investments. Many hedge funds and investment banks have borrowed as much as 40 times their own capital to invest, seeking a high return.
Unlike Parks, Shilling expects a deep slump to urge Congress, regardless of party, to respond with rescue measures – say, Federal Housing Administration guarantees of mortgages and a moratorium on foreclosures. He's not sure if it will happen this year or wait for a new administration.
