“Plagued by a housing bubble, the collapse of the subprime lending market, high energy costs, record national debt, a record trade deficit, two war fronts and now rising unemployment and maybe inflation, the U.S. economy is teetering on the brink of recession, and 2008 will be a year of contraction.”
— Written last January, that was the opening sentence in the overview story of the annual BizTimes Economic Trends report for 2008.
Of course, we did not foresee $4 gasoline or the collapse of the nation’s financial and automotive sectors, much less the bailouts that followed. But we were bold enough to declare on the cover: “Teetering on the brink: Economy may be on verge of recession.”
Fast forward now to January 2009. Speaking of recession, we are so there. Nearly 2.6 million American jobs were lost in 2008, including 1.9 million in just the past four months. The job losses are the most in any calendar year since 1945.
What’s done is done. It is time to hit the reset button. Hit the reset button on the subprime mortgage mess. Hit the reset button on the credit crunch. Hit the reset button on the housing bubble. Hit the reset button on the automobile industry collapse. Hit the reset button on the depleted stock market.
Hit the reset button on the notion of a deregulated Wall Street. Hit the reset button on Ponzi schemes.
Let’s just start anew at home and abroad. At this point, it’s all we can do.
True, we’ve lost half of our retirement savings, and many of these problems will linger for years, but we need a fresh start. We need to reset our collective American spirit and get back to business.
“Hit the reset button. That’s a great way to describe what we’ve got to do. One, the change in (presidential) administrations is a chance to reset, you know, who the leadership is. There is certainly going to be a reset on a number of major policies,” said Michael Knetter, Ph.D., the Albert O. Nicholas dean of the University of Wisconsin School of Business in Madison.
Knetter, a former economic advisor to Presidents George H.W. Bush and Bill Clinton, provides a macroeconomic overview every year at the Northern Trust Economic Trends Breakfast presented by BizTimes Milwaukee.
“Because so much has happened with asset prices, many people will have to hit the reset button in terms of their thinking about retirement and how they’re going to repair their own balance sheets,” Knetter said. “So, households, firms, government – everyone is reassessing their situation and developing a new course of action.”
Knetter is hopeful for a recovery, but he says it won’t be quick, and it won’t be easy. Brick by brick, the working elements of the economy must be rebuilt. Knetter expects the credit market to be the first pillar that will be restored, followed in order by the stock market, the Gross Domestic Product (GDP), consumer spending, the housing market and finally the job market.
In other words, the unemployment rate will continue to deepen and will be the final wound to heal.
The following are excerpts from BizTimes Milwaukee executive editor Steve Jagler’s annual interview with Knetter.
BizTimes: Well, let’s get right at it. We’re in a recession. The key questions now are how deep and how long will it last?
Knetter: “We already know it is deep (at least in Q4 2008) and it is long – one year and counting, according to National Bureau of Economic Research Business Cycle Dating Committee. I expect when the books are closed on this case, it will be a recession comparable to the long and deep recession of the early 1980s, but that the recovery will be a slower one.”
BizTimes: Last year, you answered one of my questions with the following: “Many parties entered into financial contracts that weren’t good contracts, and bailing those people out is not the right thing to do.” That’s almost eerie as we look back on 2008 now. What do you think of the bailouts, starting first with the bailouts of AIG and the financial services sector? The automotive sector?
Knetter: “When I made that statement, I had no idea just how many bad contracts had been written. Like many others, I underestimated the extent of bad lending, repackaging and speculation that had gone on in the MBS and CDO markets and failed to appreciate the full implications of the highly leveraged positions that many institutions had taken. The ripple effects of the housing bust proved to be an asset price tsunami.
“In the face of that tsunami, many decisions were made that are likely to be judged harshly by history. There seems to be little rhyme or reason to who was helped, how and how much they were helped, or why they were helped. When we look back, we have more information than decision-makers had at the time, and it seems obvious that we should have entered the tsunami with a consistent policy on bailouts. It appears we had no policy, and it also appears that the authorities were overly optimistic, thinking each bailout would be the last. Now we know each one is just the next…”
BizTimes: OK, looking forward. What do you make of President Barack Obama?
Knetter: “He has a very impressive command of policy issues and has made very impressive choices of people for his economic policy team. He went well beyond his own inner circle in choosing members of his team, and I commend him for that.”
BizTimes: What do you think about his economic team? Do you know any of those folks?
Knetter: “I know many of them, especially those with academic backgrounds, and this is a group that is widely respected by the economics profession. But they have a very difficult job in front of them.”
BizTimes: What do you think of the Obama economic stimulus plan? Is it the right prescription?
Knetter: “The December jobs report certainly confirmed that the economy is losing traction fast and major action is needed to boost demand and consumer confidence. Whether the Obama stimulus plan is the ‘right’ prescription will depend not only on what is actually done, but how it is communicated and received by households and firms who are making decisions.
“We will likely need a heavy dose of direct spending by government if we want to ensure that some of the slack in demand is taken up. The administration seems sensitive to the fact that any spending plans need to be expedited, and so I think they are on the right track there.
“The biggest threat to the economy remains a continued downward adjustment in consumer spending that will continue to destroy more jobs and income. Part of what is driving that reduction in household spending is fear about the future and attempts to adjust savings quickly to restore wealth positions. If people can be persuaded to make those adjustments over five or ten years and not immediately, then there is a better chance any tax cut actually goes toward consumption. This will require a good long-term plan that is effectively communicated by the Obama administration. I think his team will be up to the task, but it is a daunting challenge right now.”
BizTimes: What’s the lesson to be learned from this recession?
Knetter: “What goes up can come down and usually does. And when everybody starts believing that the price of a particular asset, say housing, can only go up, that it is a good time to start thinking about hedging or betting against that asset.”
BizTimes: Wisconsin has lost thousands of manufacturing jobs in the past year. What lies ahead … more layoffs and downsizing, or is the worst of the pain behind us?
Knetter: “Well the Department of Revenue is predicting 65,000 more lost jobs in 2009. In terms of job losses, there is more pain ahead. I expect the unemployment rate will peak one year from now. Output will rebound sooner, but in the early part of the recovery that will come through increased productivity rather than additional employment.”
BizTimes: Our manufacturers are impacted by the value of the U.S. dollar as a currency. Which direction do you see the dollar going in 2009?
Knetter: “The dollar will remain relatively weak in 2009. By that I mean, if you live in the Eurozone or Japan, U.S. prices will look like bargains after currency conversion. That will help U.S. exports and hold imports back a little, which is what our economy needs right now.”
BizTimes: How high will the unemployment rate climb?
Knetter: “Given the negative momentum in the recent employment report, I fear it could reach as high as 9 percent unless we can inject significant direct stimulus and restore consumer confidence.”
BizTimes: Which direction will the stock market go in 2009?
Knetter: “It will move up this year, but moderately, provided the new administration can present a coherent plan for sustained recovery and make progress on implementing that plan.”
BizTimes: Relative to the rest of the country, what do you view as the strengths of the Wisconsin economy?
Knetter: “Wisconsin is a bit heavy on manufacturing, agriculture and tourism relative to the U.S. average. We tend to be lighter on knowledge-based companies and certain service industries. The weaker dollar will help manufacturing and agriculture. The general economic headwinds will hurt manufacturing, especially the auto production sector. Auto parts may not be so bad since people may try to squeeze more years and miles out of the cars they currently own. Since our tourism industry is not ‘high end,’ like say Disney World, I think it will hold up well. The ‘staycation’ is in.
“The boom was never as big here and the bust will not be nearly as bad. Most companies in the state have stronger-than-average balance sheets. So, at the moment, the fiscally conservative nature of our companies will be a source of potential advantage in the marketplace. I hope that we can find ways to capitalize on that.”
BizTimes: I’m at once hopeful and frightened. You’re saying the key to climbing out of this hole is … us. Our own confidence. And yet, us consumers are getting conflicting messages. We’re being scolded for taking on too much debt. And we’re being told that the only way to climb out of this is to spend. How can those conflicting messages be reconciled?
Knetter: “That is the paradox I have been talking about with people: Now that we have been persuaded over spending is our problem, we are being told that more spending is the solution. That is why we need a marriage of short-term stimulus with a responsible long-term plan.”
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