Though little-remembered now, the 1932 Democratic Party platform called for a balanced federal budget. A frequent campaign theme of the party's presidential candidate, Franklin Roosevelt, was that Herbert Hoover was running unconscionable deficits and spending recklessly. Although once in office, Roosevelt's domestic economic policies dwarfed the spending and deficits of the Hoover years, FDR was keenly in touch with public opinion and knew what it took to get elected. He understood the moral underpinning of America's predominant Presbyterian Scotch-Irish heritage: Thrift is good. Debt is bad.
The same moral antithesis had been played out before in American history. Andrew Jackson's populist crusade in the 1830s against banks in general and the Second Bank of the United States in particular had a moral much more than an economic basis. And, it's being played out again today. Thrift is the underlying message of those economists and elected officials who believe that reining in federal spending is the nation's most critical and immediate task. These are the people The New York Times recently suggested were suffering from "whip-deficit-now fever," a not-subtle reference to Gerald Ford's futile "Whip Inflation Now" rhetoric in the '70s. The Times and liberal, Nobel Prize winning economists like Paul Krugman and Joseph Stiglitz counter that government stimulus has, if anything, been insufficient. To reduce spending now, they argue, will be counterproductive, choking off the very growth needed to bring the economy back to health. To quantify this point, Krugman noted in a June 7 column that "a rough estimate right now is that cutting spending by 1.00% of Gross Domestic Product (GDP) raises the unemployment rate by 0.75% compared with what it would otherwise be, yet reduces future debt by less than 0.50% of GDP."
Of course, no one believes that the government can borrow and spend indefinitely. The question is, "When to address the deficits?", now, or when the economy is sufficiently strong to bear harsh medicine. The right answer depends on how firmly the recovery has taken hold. Persistently high levels of uncollectable debt, ongoing threats to job creation, and the widening wealth gap incline me to the liberal camp. Persistently low interest rates for US Treasury debt suggest that the markets are there too.
The conservative's case for immediate deficit reduction begins with the fact that, in a technical sense, the recession is over. Gross Domestic Product—the total value of all goods and services produced in the United States—has expanded for three consecutive quarters. More persuasively, consumer confidence has been steadily increasing. Last week, the University of Michigan survey registered its highest reading since January 2008. And indeed, anyone can read the signs of the times: restaurants are more crowded, highways and airports are more congested, and so on. How can this be when, depending on whether you prefer the headline number or the number that includes those who've stopped looking, somewhere between 9.7% and 16.6% of the workforce is unemployed? Well, it's the other 83.4% to 90.3% who have become more confident. In 2008 and 2009, these folks were worried about losing their jobs. Finding themselves still employed after all, they have become accustomed to the new reality. But, the 2010 version of reality does not seem to include the same urge to spend as its pre-crisis predecessor. Households that can are paying down their debts and saving money into the bargain. The amount of revolving consumer credit outstanding has fallen for 16 consecutive months and is down $160 billion from its peak. The savings rate has been consistently in the 3-4% range each month, after hovering around zero for several years. Retail sales unexpectedly fell in May.
The new reality also includes a very ugly problem: Far from being over, the mortgage crisis is getting worse. According to the Mortgage Bankers Association, 10% of all mortgages were delinquent at the end of the first quarter, and delinquency rates are growing in all segments, but particularly in mortgages made to the best borrowers. The chart shows the trend in prime mortgages. From the first quarter of 1998, when the MBA began keeping records, to the second quarter of 2007, prime delinquency averaged 2.45% and never got as high as 3.00%. Since then, it has gone straight up to 7.32%. The delinquency rate for fixed-rate prime mortgages, the cream of the crop, has tripled in the last four years to 6.17%.
Home equity lines of credit (HELOCs) have also become more problematic, since 24% of mortgaged homes have negative equity. When it comes to non-payment, HELOCs are similar to credit cards. People pay until they stop; that is, HELOCs are all but incurable once they go delinquent. According to the most recent FDIC data, charge-off rates for HELOCs are the third highest of all loan categories, at 3.12%, but unlike credit cards, HELOCs have not traditionally been priced for this level of default. Not that credit card issuers can sustain the near 10% charge-off rates they have endured for the last year.
The continuing failure to repay debt has many serious repercussions. Some are glaringly obvious—tightened credit standards, depressed real estate prices, eviscerated equity—but some less so. Of especial concern are the indirect effects of the mortgage crisis on employment. For instance, the Congressional Budget Office noted in a recent report that "when a significant share of homeowners owe more on their mortgages than their house is worth, many people may not be able to sell their house for enough money to enable them to relocate" and take new jobs elsewhere. Reduced home sales and higher mortgage delinquency also translates into less tax revenues for states and municipalities. The Center on Budget and Policy Priorities, a Washington think tank, estimates that combined state budget shortfalls will reach $180 billion in fiscal 2011 and $120 billion in fiscal 2012. In a May 25 report, the Center concluded that federal stimulus funds have saved 347,000 jobs, mostly in education, while the elimination of stimulus funds could cost 900,000 public and related private-sector jobs.
The problems in nonresidential real estate are, if anything, worse. Even before the word "subprime" was in their vocabulary, banking regulators were worried about commercial real estate loans. Commercial real estate projects take a long time to complete. The pipeline of unfinished projects is winding down, with two unpleasant consequences. First, many of the still-unfinished projects were started at the tail of the boom, when prices were highest and expectations most unrealistic. I mentioned earlier that charge-off rates for credit cards and HELOCs were the first and third highest of all loan types. Construction and development loans are number two, at 5.32%, and their delinquency rate of 16.82% is number one by a huge margin. There's a lot more pain for banks ahead as these deals go down. The second consequence is the effect on employment, which may already have begun. The Bureau of Labor Statistics reported a surprising drop of 35,000 construction jobs last month. The largest declines came in non-residential construction trades. There will be an oversupply of retail, office, and hotel space for years, which will affect not only jobs in the construction industry, but all the industries that make, deliver, and service the goods used in commercial properties.
Another reason for caution is the growing disparity in wealth between white and African-American households. The chart shows the results of a longitudinal study conducted between 1984 and 2007 by Brandeis University's Institute on Assets and Social Policy. During the period of the study, which was concluded before the crash, the median difference in wealth between white and African-American households grew from $20,000 to $95,000. A quarter of African-American households, in each year of the study, had no assets at all, but, as time passed, they were increasingly able to get credit. This is precisely the segment of the population that can no longer get credit and whose prospects of finding a job are the poorest. One reason, again to quote the Congressional Budget Office report cited above, is that, "temporary layoffs, from which a person can reasonably expect to be called back to work, were more common in the recessions of the 1970s and 1980s—when union membership and manufacturing jobs were more prevalent—than in the recessions of the 1990s and 2000s." These, of course, were the very jobs that attracted African-Americans to northern cities in the first place.
I have, so far, focused on statistics and reports that emphasize the weaknesses remaining in the economy in order to bolster the need for continuing federal stimulus. I could as easily have chosen data that supports the contrary argument that deficit spending has gone too far. Had I written that commentary, I would have begun with the already massive increases in federal debt as reported in the Fed's most recent Flow of Funds statement:
Period | Percentage Increase in US Treasury Debt |
Q1 2009 | 22.6% |
Q2 2009 | 28.2% |
Q3 2009 | 20.6% |
Q4 2009 | 12.6% |
Q1 2010 | 18.5% |
But then, I would have had to explain why the Treasury can still borrow so cheaply. The longest maturities of Treasury debt are 30 years and 10 years. Since the beginning of 2009, the Treasury has borrowed $213 billion for 30 years at a weighted average cost of 4.36% and $588 billion for 10 years at a weighted average cost of 3.46%. Any government that can raise more than half a trillion dollars of long-term debt at a cost of less than 4% clearly retains the confidence of the world's financial markets. All the evidence is that additional borrowings will be easily absorbed.
Yes, thrift is good, and debt is bad, but 15 million people out of work is worse. To sum up, I can do no better than quote Paul Krugman's advice: "The right thing, overwhelmingly is to do things that will reduce spending and/or raise revenue after the economy has recovered—specifically, wait until after the economy is strong enough that monetary policy can offset the contractionary effects of fiscal policy. But no: the deficit hawks want their cuts while unemployment rates are still at near-record high levels…Utter folly posing as wisdom. Incredible."