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Assessing the Policy Response to the Great Recession: Past, Present and Future

Summary of remarks by
Mark Zandi
Chief Economist, Moody’s Economy.com
January 20, 2010

At a National Economic Club luncheon on Wednesday, 20 January 2010, Mark Zandi, Chief Economist with Moody’s Economy.com (see www.economy.com) gave a presentation on the topic “Assessing the policy Response to the Great Recession: Past, Present and Future.”   His more detailed research and views can be found in his book, “Financial Shock: Global Panic and Government Bailouts – How We Got Here and What Must Be Done to Fix It.”  It is available on Kindle.  He has another book coming out 24 September 2010 and the title is “Paying the Price:  The New Economic Mess We Have Created and How to Get Out of It.”

We suffered a recession primarily for three reasons.  Aggressive monetary policy with the tech bubble led to the “fodder” for bad lending.  The process of securitization was broken; no one knew the totality of what was happening and thus, good dollars were placed toward bad dollars.  There was lack of regulatory oversight.

Panic began with the receivership of Fannie Mae and Freddie Mac, one week before the Lehman failure.  In investors’ minds, no financial institution was safe.  Both the common shares and preferred shares were wiped-out.  There were policy errors related to monetary and regulatory decisions.  The policy mistakes initiated the panic.

TARP was vital to economic recovery and necessary to do without putting equity in institutions.  As for a TARP tax, he believes financial institutions should pay a tax and that the tax should be made permanent.  These institutions borrowed at unusually low rates.  Customers of these institutions are attracted to the too-big-to-fail idea.  Shareholders and debtholders get some of the subsidy back.  These institutions would be kept from growing too large.

The Bank Stress Test restored and re-established confidence, which can be also seen in the TED spread, which is the difference between the 3 month LIBOR and Treasury Bills.  Dr. Zandi told an FDR story.  After the closing of all banks on a Friday and opening only a few hundred on Monday, FDR believed that investors would have confidence in the fewer numbers that re-opened and believed that the remaining banks would be in good shape.  His assumption turned-out to be correct.  Banks capitalized to the Great Depression levels to sustain the loss forecast percentage.  Big banks knew they had to raise that amount of capital.

Dr. Zandi stated that we would have been still in recession had it not been for the stimulus.  The maximum contribution was in 3Q2009 and spent-out (negative) in 4Q2010.  The spent-out was due the drag on economic growth.  While we are no longer in a recession, we are not yet in a recovery.  While layoffs have slowed, businesses are not convinced to begin hiring again.  The financial system is stable, but not normal.  The securitization bubble height was in 2006 at $2 trillion and was only $150 billion in 2009.  In 2009, only structured finance issuance has been in ABS products.  Big banks cannot offload.  In 2011, it may be difficult to lend-out.

HAMP and HARP need to be changed.  He expects to see more foreclosures during the winter and spring of 2010.  House prices will decrease again in the summer of 2010.  All the monetary and fiscal policies have not yet evolved to expansion.  There will not be any more buying of mortgage securities after that.  “The coast is not clear.”  $4.5 million first mortgage loans are 90 days in arrears or in the process of foreclosure and 52 million mortgage loans are outstanding.  Expect more foreclosures and then, a decline in housing prices.  Policymakers need to do more.  If his analysis is accurate, the interest rate would be raised after a year.  The current desired Fed Funds rate is -2%.  The Federal Reserve should increase their commitment to credit easing.

Fiscal policymakers are not finished yet.  “Recently passed:  $45 billion in more aid to unemployed workers, extension and expansion of homebuyer tax credit, extended higher conforming loan limits, and NOL.  High odds of passage: $50 billion in aid for workers losing jobs in 2010. (Depends on job reports; there are 45 billion unemployed workers.)  Better than even odds of passage:  $50 billion in more SBA lending, job tax credit, weatherization program. (Depends on job reports.)  Even odds of passage:  $50 billion in another round of help to financially stressed state and local government for FMAP. (Exhaustible with another $500 million job cut.)  Less than even odds of passage:  expansion of loan modification plan including incentives for principal writedown. (May make substantive changes to writedowns.)”

He continued by saying that policymakers need to have “aggressive collective action in this period.”  Globalization would not be able to shoulder the burden.  The levers for healthcare reform will take effect in the long run, not in the near term; they may include a “Cadillac” tax and a Commission addressing Medicare (versus Congress).  The Bush tax cuts for 2011 will be most likely delayed and perhaps a financial transaction tax or a VAT tax will be incorporated.  Changing the process as a more unified Congress, Democrats and Republicans working together with the Administration.

Points brought-up during Q&A, follow.

Mark Zandi is chief economist of Moody's Analytics, where he directs research and consulting.  Moody's Analytics, a subsidiary of Moody's Corporation, is a leading provider of economic research, data and analytical tools.  Mark's research interests include macroeconomics, financial markets and public policy.  His recent research has focused on the determinants of mortgage foreclosure and personal bankruptcy, analyzed the economic impact of various tax and government spending policies, and assessed the appropriate policy response to bubbles in asset markets.  Mark also conducts regular briefings on the economy.  He is often quoted in national and global publications and interviewed by major news media outlets and is the author of ‘Financial Shock,” an exposé of the financial crisis.  “Paying the Price,” provides a roadmap for meeting the nation's daunting fiscal challenges.  A trusted adviser to policymakers and an influential source of economic analysis for businesses, journalists and the public, Mark has frequently testified before Congress and has advised the Obama administration as well as Senator John McCain's presidential campaign.   Dr. Zandi received his PhD at the University of Pennsylvania, where he did his research with Gerard Adams and Nobel laureate Lawrence Klein, and received his B.S. from the Wharton School at the University of Pennsylvania.

Rapporteur:  Renee DeFore

 

 

 

 

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