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The Dichotomy of the US Economic Downturn

Economics / US Economy Feb 07, 2008 - 07:55 PM GMT

By: Paul_Petillo


Best Financial Markets Analysis ArticleWe crave transparency but once we have it we tend to no longer want it. We seek information, but once we get the news we react poorly. We look for some signs from a time past hoping that what once happened could possibly shed light on what is. But this time it is different.

At no time in recent history have we been confronted by so much conflicting information, cloaked appraisals of where we are and where we are headed, veiled attempts at regaining normalcy or risk with as little risk as possible and all this while we have two economies running side-by-side. One economy, that according to Mr. Bush is doing just fine and the other one, the rest of us live with each day.

Are we in or headed for a recession - or not? Do we need stimulus - or not? Do we have any reason to hope that the next piece of economic or political news will show us the way - or not?

Let's begin with President Bush's last and final budget.

First off, as it was with previous budgets, the outlays (this time projected at $3.107 trillion) far exceed the receipts (also this time: $2.700 trillion). Many of the budget proposal' spending projections now come with deep domestic cuts that suggest to the American people that our leader in Washington is much farther out of touch with what is going on down on Main Street than any of us previously realized.

The cost of operating entitlement programs such as Medicare and Medicaid are growing. Health and Human Services Secretary Michael Leavitt projects that in forty years, outlays for these programs could consume 9% of the gross domestic product. Currently, it commands 4%. As the first wave of baby boomers begins heading towards retirement or some reasonable facsimile, Mr. Bush wants to cut payments to hospitals and skilled-nursing facilities.

Current outlays for Social Security, Medicare, Medicaid, and miscellaneous other benefits that the poor and elderly desperately need amount $1.635 billion. To meet that expense, the budget would need to redirect several known receipts. Payroll taxes cover almost two-thirds of the needed cost of all of those programs. As a stand-alone receipt, those taxes pay 32% more than Social Security needs to operate. Redirecting that excess, adding in what is collected from corporate income and excise taxes and killing the ill-conceived Medicare Advantage program would cover the shortfall nicely. But that idea may not satisfy either side of the aisle.

The mess in Iraq and Afghanistan is not about to go away anytime soon and the cost of running those two wars without end is not even in the budget. That's right, the $515.4 billion that is included in his proposal does not include the cost of the war(s) or his pursuit of nuclear defense. This portion of the proposed budget gives more to Homeland Security, the Pentagon and for the eventual preparation for a military that faces serious shortfalls in readiness when and if we ever get out of the Middle East.

This kind of defense spending has increased almost 30% during Mr. Bush's tenure, the most since World War II. Now some would argue that these are dangerous times, and they would be right. But these war(s) have not had the same economically stimulating effect that other conflicts have had which makes them, from a strictly economical point-of-view, a waste of money.

The snake in the economy's backyard is still the AMT. This is, truth be told, Mr. Bush's only possibly way of keeping the deficit from deepening further; something he projects will disappear by 2012.

Instead of focusing on the real tax problem about to engulf 23 million taxpayers (up from the 10 million who paid prior to 2001 to which the administration has offered $50 billion patches), Mr. Bush hopes he can force the hand of the lawmakers in Washington to make his misdirected tax cuts permanent.

The Alternative Minimum Tax consequence was well known when the tax cuts of 2001 and 2003 were enacted. In fact, had it not been for this sort of gimmickry, the tax cuts would never have flown through Congress, GOP controlled or not. The cost to fix this problem permanently has risen somewhat since then. Projected cost of fixing the AMT now stands at $1.3 trillion over the next ten years, which is deducted from projected revenues.

Making the tax cuts permanent is not a tax hike. It will not bring the American middle class to its collective knees nor would it take the small business owner down. The tax cuts did little to lift the prosperity of this country, increase the amount of jobs needed to meet parity, or keep us from drifting from one recession to another in the short span of six years. We need to fix the AMT problem and soon.

The main attraction of an investment is, even when it is considered long-term, its liquidity. There are numerous places to put our money to work. Some are easier to divest on a moments notice (stocks for example), some come with penalties for early withdrawal (retirement savings or CD's for example), some are much more difficult to sell quickly (land, jewelry and art come to mind). Appreciation in value is a byproduct of wise choices but it is the market that dictates the price and ultimately determines an investment's liquidity.

But a house does not qualify as something liquid or an investment. It is shelter, whose price growth is determined by comparable real estate sale and the potential receipt if you would choose to sell. Key to that last sentence is: if you sell.

Many of us fail to be good risk takers, which is why, I suppose, only half of us are invested in the equity markets. We do not have time to follow the nuances, the day-to-day activities of a marketplace that has become more global and populated by investors far more savvy than we could ever hope of becoming. Calling our home an investment means we have embraced all of those nuances and, as good risk takers know, you have to sell when the “investment” is no longer worth keeping.

Housing was bound to adjust just as the stock market did. The current equity and bond market adjustments since the first of the year are all byproducts of the housing debacle.

What makes this time wholly different is the fact that most of the consumerism of the last five years was driven not by investments but by the roof over our head. We live in our houses. And even when we erroneously think of them as investments, they are not -never have been, never will be.

So there you have it. Mr. Bush's perfidious handling of our trust, his failed economic policies and the inability of the American people to understand the risk of using their homes to finance their spending got us to this point. What now? Bad as it might seem, there are solutions.

We should strive to keep what little regulations that are currently protecting investors in place. Take any discussion of further deregulation off the table. It is the only thing keeping us in a recession and not in a Depression. While making them better is just not possible under the current leadership, seeking to further dismantle them to be a better competitor on the world stage is not acceptable either.

And while we are on the subject of regulations, James B. Lockhart III, Director of the Office of Federal Housing Enterprise Oversight, visited the Senate on Thursday and suggested that “ Fannie Mae and Freddie Mac face growing pressures to expand their mission and risk levels, especially into the jumbo market.” And because housing is such a strong component of the economy and one that is in serious trouble, Mr. Lockhart urged the Banking Oversight Committee “to create a much stronger, unified regulator to support the U.S. housing finance system.” Good for him but quite a few months late to the game.

Another option and perhaps less costly to the taxpayer might be to redeploy the Home Owner's Loan Corporation. This defunct agency helped numerous homeowners keep their homes in the Depression by buying bad loans, refinancing them and stretching the limits for those loans to make them affordable. Sure the mortgage market is a tangled mess of bundled securities but it is not beyond the scope of repair. This could be done without the proposed budget increase Mr. Bush has planned for the Department of Housing and Urban Development.

The last solution is probably the least pleasant. Washington will need to adopt the same pay-go strategy that Middle America is reluctantly embracing. Understanding trade-offs will be much more difficult for an administration that, even with this latest budget submission, has felt no need to be fiscally responsible. But the sooner it does, the sooner we will get back on track. Wait too long, and we will become a nation that shuns credit – not because we don't want it, but because we can't afford it.

I plan on taking a short break to work on my fourth book. It is relatively easy to predict, that by the time I resume writing this column the economy will be at its weakest point in decades. But by the end of March, we will also have a clear contest between Clinton and McCain to speculate on complete with more specific campaign proposals - which is always good fodder for writers like me.

By Paul Petillo
Managing Editor

Paul Petillo is the Managing Editor of the and the author of several books on personal finance including "Building Wealth in a Paycheck-to-Paycheck World" (McGraw-Hill 2004) and "Investing for the Utterly Confused (McGraw-Hill 2007). He can be reached for comment via:

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