The Great Recession could have done some good for America. It did help normalize the housing bubble, although with severe economic pain. The housing bubble was a rocket ride and it is unrealistic to expect a rocket ride to end with a soft landing. However, it appears we failed to learn the most critical lesson – if the economy relies on excessive debt and risk, then painful recessions, and perhaps even depressions, are inevitable in the future.
Technically, the Great Recession ran a year and a half from late 2007 to mid-2009. The fact it officially ended more than four years ago will surprise many who are still dealing with the economic hangover, but we are unlikely to know the complete impact for a very long time.
Could the recession have been avoided given where it started? Probably not – there was no other way to get the nation to face the situation where real estate, and especially housing, were grossly overvalued. It is almost impossible to preach caution when the average person believes, although wrongly, that they are getting wealthier daily. That is why the so-called bubbles are actually manias – people’s eyes get big at the thought of easy money and their reasoning shrinks as their greed grows.
History is rife with economic manias from investments in tulip bulbs in the early 1600s to the dot-com bubble of the late 1990s. Prior to the Great Depression of 1929, the average prices of stocks rose 40 percent in only 16 months. Many of the conditions that led to the Great Recession were similar to those causing Great Depression. And in my opinion, they still exist. This will lead to the next recession because our economic behavior indicates we have not learned our lesson.
The basic conditions and psychology were outlined neatly in a 2003, pre-recession, paper; “The Great Depression as a Credit Boom Gone Wrong” by Barry Eichengreen, University of California, Berkeley, and Kris Michener, Santa Clara University. This extensive quote from the introduction sounds all too familiar:
“Higher property and securities prices encourage investment activity, especially in interest-sensitive activities like construction. But, as lending expands, increasingly risky investments are underwritten. The demand for risky investments rises with the supply since, in the prevailing environment of stable prices, nominal interest rates and therefore yields on safe assets are low. In search of yield, investors dabble increasingly in risky investments. Their appetite for risk is stronger still to the extent that these trends coincide with the development of new technologies, in particular network technologies of promising but uncertain commercial potential.”
The authors went on to note that eventually this type of investment activity and the “wealth effect” produces inflation, which causes the central bank to tighten interest rates. Then the financial bubble bursts as asset prices decline and “the economy is left with an overhang of ill-designed, non-viable investment projects, distressed banks, and heavily indebted households and firms, aggravating the subsequent downturn.”
Isn’t that were we are going now? When you factor in inflation and taxes, the safest investments have a negative yield. Yet the stock market is buoyed because investors seek more return in equities while excessive borrowing by the Federal Reserve is nothing but cheap credit – albeit, mostly to fund government spending.
If you did not like this recession, you’re really going to hate the next one when you finally have to pay for them both.
(Note, Monday’s New York Times contains an article on the same subject, this column was written before that was published – Marty)
