Reflections on the Economic Downturn

[1] I have ambivalent thoughts about the current efforts to address the economic recession in the United States, and, by extension, the world, since it is abundantly clear that economic contractions in the United States dramatically affect the rest of the world. On the one hand, I certainly would like to see my pension accumulations quit shrinking. I don’t even look at them because when I do the diminishing totals lead me into a funk the rest of the day. I do hope the economy gets going again, not only for my sake but for the sake of many millions of people.

[2] On the other hand, I am pretty skeptical about whether the so-called stimulus package will in fact bring us genuine economic recovery in the short- and mid-term. Moreover, if the package is successful in jump-starting the economy, that very success may be damaging to our prosperity and freedom in the long term. But before I address those issues, let me outline my understanding of the current crisis.

[3] First, I have to admit that my mind boggles at the amount of money involved in both bad debt and in the recovery package. We are far beyond the day when Everett Dirksen could say: “A million here and a million there; pretty soon we are talking about real money.” In this case we are talking about billions and trillions, staggering sums. How in the world did we get into this mess? After reading fairly widely about the problem, this is my layman’s analysis.

[4] As I understand it, there are at least three facets. Fannie Mae and Freddie Mac, quasi-governmental agencies, were pressured by congress to make more loans available to marginally qualified buyers, as were private banks. When it was discovered that the government would cover bad loans and mortgages, well, why not make as many loans as possible? More money could be made without risking your own. And many financial agencies did just that, with over half the American mortgages winding up in Fannie Mae and Freddie Mac’s possession. On top of that, the Fed kept interest rates very low, prompting many people to buy second and third homes, which in the long run they could not afford.

[5] Enter bright financiers on Wall Street who invented various sorts of “financial instruments” that disguised the bad loans and mortgages in those instruments. They sold bundles that contained both good and bad loans at a goodly profit to other buyers, who in turn sold to others, in one gigantic Ponzi scheme. Lots of money was made until it was discovered how toxic many of these instruments were. Further, investors couldn’t tell the good from the bad and therefore refused to buy. No one would buy them, and a credit crunch ensued.

[6] What brought the whole scheme to a screeching halt was that the price of housing began to fall, countering the stupid but widespread expectation that housing prices would always rise. This made more and more mortgages dubious; debt on the mortgaged property was more than the house was worth so people bailed out, causing yet more trouble.

[7] Evidently these sorts of practices were not exclusively American. Other economies were built on dangerous financial practices. One of my favorite countries, Iceland, is basically bankrupt because of the reckless behavior of both private banks and the government.

[8] I believe that the financial markets are in the process of sorting these things out. Hard lessons have been learned on each of the facets above. Private banks have learned to be more cautious about lending to marginally qualified borrowers. (I am worried that the government-controlled Fannie Mae and Freddie Mac have not yet learned that lesson. Indeed, the government seems intent on pressuring banks to make dubious loans even now.) Financial instruments are now far more transparent. And we now know that the price of housing can fall as well as rise.

[9] Perhaps it was important to get more money into the banking and financial system so that credit could be obtained more easily. Perhaps it is important to get the toxic debts off the backs of the banks. Perhaps more regulation of Wall Street is warranted. I do not purport to have any simple answers to these complex questions. From what I have observed not too many of the experts have those answers either. But there had to be something done to loosen up a system that seemed to be frozen.

[10] Beyond that, I believe the economy would have self-corrected and gotten going again, though the recession may have been longer and deeper than the ones in the early 80s and 90s. The economy will be stimulated by continuing the across-the-board tax breaks enacted during the Bush administration, including those to the wealthy who provide a good deal of investment as well as tax money. Taxing the rich prohibitively almost always has negative results on the whole economy. But continuing tax breaks to the middle class is even more important in order to increase consumption.

[11] Further, a major jolt to the economy can be effected by lowering the corporate income tax, though I do not think the Obama administration will do this. But if small and large businesses were given a tax break they would begin to expand their enterprises, thus hiring many more people. Getting the private economy to grow again should be the highest priority.

[12] Instead, the Obama administration is hastily enacting a huge stimulus bill that throws money in every direction, many projects having little to do with economic stimulus but much to do with rewarding political supporters. (President Obama has tried to stampede congress by constantly telling us that things are getting worse. He warns of another Depression. Who is practicing the “politics of fear” now?) There are welcome tax breaks for middle class people in his proposals, as well as needed infrastructure grants and some provision for the poorest among us. But much of the money will be wasted on expensive projects that will be drags on the economy rather than stimuli. There could well be huge subsidies for expensive forms of energy—wind and solar, for example—that will cost far more than less expensive forms such as nuclear. Further, it is folly to believe we can free ourselves from reliance on fossil fuels. I am all for lessening that dependence in market-based ways, but government could do silly things like increasing the requirement for ethanol in fuel, the production of which is not only expensive but which also raises the prices of foodstuffs all over the world.

[13] These huge government outlays—which will fire up inflationary tendencies and exponentially increase the debt to be paid for by the next generation—will also increase the government reach into all sectors of American life. The stimulus proposal increases federal money to and therefore reaches further into the educational system, the financial affairs of the states, the health system, the banking system, the financial system, the welfare system, energy production, and even the decisions people make about whether to pay their mortgages or not. (If the government will bail you out, why try so hard to pay for that mortgage with your own money?) Public investment will diminish private investment and the stock market will duly note that.

[14] Perhaps the government will prudently back out of these systems once they are “juiced up,” but such reticence is unlikely. I fear that governmental choice and initiative will begin to crowd out private choice and initiative, and we will have a long decline in creativity and productivity among our citizenry. Once people become increasingly dependent on the government, governmental actions become more and more important—and therefore politicized—while private responsibility wanes. And mediating institutions—churches, private schools, voluntary associations, charities—become less and less important. The short-term success of the Obama initiative could bring long-term effects that are not so attractive. My pension funds could start increasing but my grandchildren might live under a far more statist regime. Of course, a horrendous possibility is that the stimulus won’t work but we will get a statist regime anyway.

[15] An unscientific postscript on three topics that didn’t fit well into the body of the essay above:

1. The bubble giveth and the breaking of the bubble taketh away. It is a bit comforting to know that the big run-up in our pension funds in the 90s and early 2000s was partly due to the bubble produced by the three causes I mentioned above. We enjoyed the bubble’s fake prosperity which was then forfeited when the bubble broke. This means that my gains and losses were both a bit illusory.

2. We lament the deleterious effects of economic growth only when the economy is growing. When it stops growing everyone suffers—especially the last and the least—and we want to do anything to get it going again. Criticism of growth is a luxury good produced by growth itself.

3. We crunchy liberals and conservatives ought to lay off our criticisms of Wal-Mart. When times are hard Wal-Mart does well because the middle classes join the blue collar folk in shopping there. Only the well-off can then afford small stores, be they delis or upscale markets. The working class knows that they can save up to 20% of their cost of living by shopping there. Is that not something to appreciate?

Robert Benne

Robert Benne is the Jordan-Trexler Professor of Religion Emeritus and Research Associate in the Religion and Philosophy Department, Roanoke College, Salem, Virginia and Professor of Christian Ethics, The Institute of Lutheran Theology.