Remember the Recession?

THE BE YOUR OWN ECONOMIST ® BLOG

Yesterday the stock market retreated because General Electric reported disappointing earnings as well as disappointing prospects for the remainder of the year. Investors thought GE’s diversification had insulated it from the business cycle and guaranteed strong profit growth regardless of the economy’s ups and downs. GE’s poor results brought them back to earth. If GE can’t make it, maybe this recession is worth our attention.

Good point. We have focused so heavily on the financial crisis that we seem to have forgotten about the real-economy contraction that continues to threaten us. That’s a mistake. The Fed and the Treasury may have prevented the financial markets’ disintegration, but the glut of homes and the attendant collapse of home prices – the root cause of our problems – is still with us. And that glut of homes and price-slide continues to dissipate household wealth and reduce aggregate demand.

A number of home-rescue packages are in the works. If the one that is implemented can stop the foreclosures and stabilize the housing market, that might help halt home values’ downward spiral. But partisan politics and a presidential-election season give pause. We may end up with too little, too late.

Meanwhile, the optimists have directed their attention to the economic-stimulus package’s tax rebates and the Fed’s interest-rate reductions. “After all,” they say, “Didn’t these work well in pulling us out of the 2001 recession?” That’s true. Once again, however, there was no housing glut and home-price collapse in 2001. “Yes,” they respond, “But wasn’t the dot.com bust just as bad, and we have nothing like that now.”

Good point. But keep this in mind. The 2001 tax cut and interest-rate cut contributed to the 2002/2003 recovery. They did not prevent the 2001 recession. Some investors seem to think that the recent tax rebates and lower interest rates can forestall recession today. We’ll see, but maybe not. And if recession does grip the economy, corporate earnings will contract and the stock market will fall. Then we’ll have a stock-market slump and a housing contraction, exacerbating the reduction in household wealth.

The economy will eventually recover, but it’s difficult to have confidence in any recovery until the glut of homes is removed from the market and housing prices stabilize. And that will take time.

© 2008 Michael B. Lehmann