US in deepest recession since 1982

• Tailspin. The US is in a full-blown recession, even though the NBER has still to make the official call. The only question now is how far the economy will plummet, and how many billions in federal funds will be needed to stop the free fall.
  

• Plight. Our analysis of the US labor market data reveals that they are already worse than at the low point of the 2001 recession – and they will soon also leave the 1990/91 crisis readings in their wake. The US economy is thus heading for a recession comparable to that in 1982, to date the most serious of the post-war era (pages 4-6 & chart below).
  

• Billions. This illustrates that the funds provided so far will not be enough to halt the tailspin. Consequently, the Fed has pledged USD 800 bn to facilitate access to mortgage and consumer loans, and thereby soften the impact of the deep consumer recession. Moreover, Obama favors an additional stimulus program of at least USD 700 bn.
  

• Europe. Stimulus programs launched by the EU and the continental European governments pale in comparison. Furthermore, the ECB appears to be adhering to its tentative interest rate policy and will ease “only” 50 basis points next Thursday. The pressure for more aggressive fiscal and monetary policy measures will, however, increase.
  

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Where angels fear to tread

This week's announcement of new unprecedented steps by the Fed in coordination with the US Treasury underscore that efforts to limit the depth and length of the recession will live or die by their ability to revive private consumption. Where angels fear to tread, the Fed is de facto stepping in as lender to consumers and small businesses and as buyer of mortgage- backed securities to improve mortgage financing. The two steps in combination should prove effective in cushioning the collapse in private consumption and help a gradual recovery later next year. The UK’s stimulus package, centered around a significant temporary cut in VAT rates, is also clearly focused on consumption and in this respect welltargeted. Signals from European policymakers have been more mixed. The European Commission has announced a coordinated EU-wide fiscal stimulus this Wednesday, but official statements so far raise the fear that the fiscal policy response could be insufficiently bold and coordinated. European governments are very aware of the importance to signal a commitment to fiscal responsibility. They should however be mindful that a sharp and prolonged recession would also put pressure on budget deficits and debt to GDP ratios. The global economy needs fiscal stimulus, as coordinated as possible and focused on measures that can give an immediate boost to growth and can more easily be reversed.

With the launch of yet a new facility, the Term Asset-Backed Securities Loan Facility (TALF), the New York Fed will extend 1-year non-recourse loans against new or recently originated ABS backed by auto loans, student loans, credit card loans or small business loans guaranteed by the US Small Business Administration (with collateral haircuts to be determined for each eligible class of assets). The total amount in play is USD 200 bn, with the first USD 20 bn provided by the Treasury through the TARP. The range of ABS targeted could later be expanded to include other asset classes, including commercial mortgage-backed securities and non-Agency residential mortgage backed securities.

Where angels increasingly fear to tread, the Fed has no choice but to rush in, to halt and reverse a contraction of credit to households and small businesses that threatens to make the recession even deeper. The main target of the new facility is the US consumer, with ABS accounting for about one quarter of total consumer credit outstanding (nearly 50% for credit card loans and about 13-14% for car loans). My colleague Harm Bandholz has highlighted the recent sharp rise in credit card delinquencies, and the concomitant collapse in related ABS, leading to a plunge in the rate of growth of revolving consumer loans. With the housing market still contracting and the labor market facing a further deterioration (during previous recessions, unemployment peaked at 7.8% in 1992 and 10.4% in 1983), US consumption needs all the help it can get. Lower commodity prices are clearly not enough yet, and as we wait for a new bold fiscal package it had become imperative to prevent a further deterioration in credit conditions.

A sustained stabilization of consumption also needs at least a bottoming out of the housing sector, and the here again the Fed stepped in, this week announcing it will purchase up to USD 600 bn in mortgage backed securities of Government Sponsored Enterprises (GSEs). Purchase of the first USD 100 bn will begin next week, through competitive auctions; the remaining USD 500 bn will be purchased through asset managers still to be selected, and the goal is to have those purchases begin before year-end. The fact that the first purchases will begin next week underlines the urgency of the situation. The purchase program should help reduce the stillelevated spreads on GSE MBS, thereby reducing financing costs for mortgages and helping stabilize the housing market. The government had taken the GSEs into conservatorship exactly to ensure financing to the mortgage market, but as spreads remained elevated the cost of mortgage financing has remained too high.

With global demand weakening, domestic consumption is even more pivotal than usual for the growth outlook. This week’s revision to the Q3 GDP figures was another alarm bell in this regard, with a downward adjustment to consumer spending underlying the GDP revision to -0.5% from a preliminary -0.3%.

The focus on consumption was also clear in the UK’s prebudget report, where the GBP 20 bn stimulus package will get most of its traction from a temporary cut in the VAT rate to 15% from 17.5%. This is indeed probably the best way to maximize the effectiveness of the fiscal stimulus: as the tax cut is temporary, it creates an incentive to bring consumption forward; moreover, as it acts directly through consumption, it does not risk being absorbed by higher savings, as tax rebates might. The package should therefore prove quite effective in limiting the downside to the gloomy UK growth outlook. Eurozone policymakers, by contrast, have given a very lukewarm reception so far to proposals for a coordinated reduction in VAT rates like the one advanced by Bruegel’s Jean Pisani-Ferry, Andre Sapir and Jakob von Weizsaecker. The European Commission has proposed a USD 200 bn coordinated EU-wide fiscal stimulus, and it has indicated it will allow member states to reduce their VAT rates – a permission that would clearly sound like a suggestion. France’s Sarkozy and Germany’s Merkel, however, have so far been united in rejecting the idea. I see a significant risk that Europe’s fiscal policy response to the crisis might be too slow and insufficiently ambitious, mirroring the cautious monetary policy response – especially as some of the official rhetoric raises the fear that there might still be an element of denial in assessing the seriousness of the crisis. Given Europe’s structural rigidities, a timid policy response would heighten the risks of a prolonged slump.

The need for a decisive fiscal stimulus of course clashes in part with concerns over longer-term fiscal prudence and public debt dynamics. In this regard, several governments now pay the price for not having been more virtuous when times were good. The launch of the UK plan made this obvious, as the pre-announced fiscal tightening to start in 2011 dominated the news headlines to the point that it sounded like the government was in fact announcing an austerity package rather than a fiscal stimulus package. In the eurozone, the ECB has emphasized the importance to uphold the Stability and Growth Pact, and the widening in sovereign bond spreads within the eurozone has showed that the market pays renewed attention to public debt ratios (even though triggered by a generalized rise in risk aversion and flight to quality). Governments should be mindful, though, that a sharp and prolonged recession would also put pressure on budget deficits and debt to GDP ratios. The global economy needs fiscal stimulus, as coordinated as possible and focused on measures that can give an immediate boost to growth and can more easily be reversed, rather than measures that risk translating into a more durable expansion of the government’s role in the economy.

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