The 3 Forces Behind The Miserable Recovery

Pretty good macro commentary here from John Williams of the SF Fed (no, not John Williams of hyperinflation fame!).  He pinpoints 3 causes of the slow recovery – tight credit, uncertainty, and contraction in government spending.   I’d only add that there are two sides to that credit coin.  Demand for debt has been extremely weak due to the effects of the balance sheet recession.   Other than that small clarification, these are good thoughts:

“Powerful forces have kept us stuck in a slow-growth pattern. Some of those forces reflect the direct effects of the housing collapse on household finances. The connection with housing is less direct for other forces holding back the economy. I’ll highlight three of those forces: tight credit, uncertainty, and government contraction.

Tight credit was clearly a product of the housing bust. But it took on a life of its own when fallout from housing almost brought down the global financial system in 2008. The repercussions of those dramatic events still affect markets today. Let me explain how this played out.

When home prices crashed, mortgage delinquencies and foreclosures surged. Exposure to risky U.S. subprime mortgages was spread globally through investments held by financial institutions. Those mortgages had been repackaged to create financial instruments of mind-bending complexity. When the music stopped, it was hard to tell who was left with all those toxic assets. Financial institutions became afraid to lend money to anybody, including other financial institutions. The result was a massive credit crunch that choked off the flow of funds financial institutions and nonfinancial businesses depend on for their day-to-day operations. Many financial institutions that had placed big bets on housing posted massive losses. Some of them failed.

Thankfully, central banks and governments around the world stepped in to provide emergency loans and other support. Those interventions prevented complete financial collapse. In the United States, the financial system has healed to a very considerable extent. The Fed recently conducted a series of tests on the largest U.S. banks. We found that most of them would have adequate capital even if the economy went through another extreme downturn.

As financial institutions have regained their footing, access to credit has improved. Nevertheless, we haven’t returned to normal. Many small businesses and consumers still struggle to get loans. For example, to get a mortgage, a borrower must have a top-notch credit rating and the cash to make a substantial down payment.

Uncertainty is a second factor holding back the recovery. Businesses, investors, and households remain skittish, even in the face of better economic news. Many of my business contacts say they remain cautious about expanding because they’re unsure about future conditions. Ordinary Americans worry about job prospects and future income. Everybody is unsettled by the highly charged political environment.

Financial turmoil in Europe has added another dimension to the unease here. The imminent threat of European financial meltdown has diminished. But the underlying problem of countries with unsustainable debt has not been resolved. Over the next few years, the total debt load among countries that use the euro will grow larger. I’ve heard Europe’s policy described as kicking the can down the road. But the risk is that Europe might be rolling an ever-growing snowball down a hill.

Government cutbacks are a third obstacle to growth. Typically, government spending rises when the economy turns down. That’s because the cost of safety net programs, such as unemployment insurance, go up. And sometimes governments deliberately boost spending to stimulate the economy. But the federal government’s long-term budget problems loom large. And state and local government finances are reeling from the economic downturn. As a result, government stimulus has been unusually limited.”

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