From the August 15, 2009 Weekly Standard Online
August 15, 2009
by Irwin Stelzer
Almost exactly two years ago economists discovered that the problems in the housing and mortgage markets had spread to the financial sector. Subprime mortgages proved highly infectious, a couple of Bear Stearns funds collapsed, banks suddenly looked at their neighbors with such suspicion that they refused to lend to them, and economists dusted off their copies of histories of the Great Depression, looking for a guide to the future.
One year later they returned those books to the shelves as the "real economy" seemed to prove itself resistant to the diseases afflicting those greedy, over-bonused bankers. But summer's lease on a recovery proved all too short, and in a few months there was a run on the essays of one Ben Bernanke, in an effort to learn what the Federal Reserve Board chairman had in mind to stop the rush to economic collapse. We discovered that he was indeed in the great tradition of Walter Bagehot, who wisely advised in 1873 that "whatever bank or banks keep the ultimate banking reserve of the country must lend that reserve more freely in time of apprehension." The Fed not only pumped money into a frozen credit system to thaw it out, but joined the federal government in inventing new ways to cope with what was clearly a panic.
And now, two years after subprime mortgages became the domino that toppled or almost toppled many institutions, one year after the mother of all recessions scared consumers into zipping their wallets, corporate executives into cutting investment and letting inventories run down, it is glad, confident morning again in America.
Of 47 economists responding to a survey by the Wall Street Journal, 27 say the recession has ended, and 11 say the trough has been reached or will be by next month. They expect the economy to grow at an annual rate of 2.4 percent in the current quarter, and many are looking forward to a 2.75 percent to 3 percent growth rate by year end. The housing market is showing signs of life. Toll Brothers, one of the nation's largest builders of up-scale homes, reports that lower prices, reasonable mortgage rates, a rebounding stock market and special incentives have combined to produce an increase in orders, and D.R. Horton, the country's largest builder, reports a 22 percent rise in sales from the past quarter.
Still, the housing industry has a long way to go before it returns to health. Even with the recent improvement, Robert Toll, the company's CEO says "Traffic still stinks" -- a statement of such blinding concision and clarity as to put economists to shame. Repossessed homes continue to flood and depress the market; high unemployment has consumers wary of taking on new commitments; and about one-quarter of all homes are now worth less than the mortgages owed on them.
The real question now is not only when will house prices and new construction show real zip, but when will consumers feel confident enough to start spending, and when the draw-down of inventories will leave retailers' shelves so bare that they have to place significant new orders.
Bernanke and his Fed colleagues pored over these tea leaves last week and decided that economic activity is "leveling out" but that the economy "is likely to remain weak for some time." Which calls for the sort of measured response by the central bank that has won Bernanke the plaudits of economists and demands from a vast majority of them that he be reappointed when his term as chairman ends on January 31 of next year, perhaps derailing Obama's plan to name his economic adviser, former Harvard president Larry Summers to that post.
In recognition of the headwinds the economy still faces, the Fed will continue its program of buying as much as $1.25 trillion in agency mortgage-backed securities so as to keep mortgage rates from rising. It will also keep its near-zero target for short-term interest rates for the foreseeable future. But in recognition of the improvement in the economy the Fed will complete its $300 billion program of purchases of Treasury IOUs in October -- it has already bought some $240 billion. That might push long-term interest rates up, making it more expensive for businessmen to invest, and more costly for consumers to take their already-decreasingly deployed credit cards out of their purses and wallets, perhaps aborting the recovery. The rise in interest rates would, under those circumstances, undoubtedly be accompanied by a rise in the presidential blood pressure.
And thereby hangs a tale. There is a war within the Fed concerning this program. Some of Bernanke's colleagues are unhappy and restive. They don't think the Fed should be complicit in Obama's decision to run eye-watering deficits that will drive Treasury borrowing higher this quarter, and higher still in the next. Which is what they are doing by buying Treasury IOUs and thereby holding down rates. By calling a permanent halt to the Fed's purchase of still more Treasury bonds and notes, the central bank would be signaling the administration to get its fiscal house in order lest it abort the recovery. That's what an independent central bank is supposed to do, but at the right time -- and Bernanke is not as certain as his colleagues that now is the hour. But Obama is unlikely to appreciate such a move, especially when it will come right before the November congressional elections, in which the president will be campaigning to have his party retain control of both Houses of Congress by claiming credit for the economic uptick.
If the Fed does hang tough, the president is likely to use his power of appointment to transform its board. Bernanke's term as chairman expires in January 2010, and he is unlikely to remain on the board if not reappointed chairman. Don Kohn has indicated a desire to step down in June 2010 when his term as vice-chairman expires. And there are two vacancies on the seven-man board. An angry president can be counted on to appoint a crew more sympathetic to his views, and less fixated on formulating the sort of anti-inflationary exit strategy that Bernanke has been touting, and the Chinese, their vaults stuffed with dollars, are demanding. There may indeed be a new chairman in the Fed's future.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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