Recession: Steps to Take

If we are in a recession, and it is increasingly clear we are, what are the main causes? And what can be done about them?

The primary and immediate cause is the housing bubble. Home prices have been bid up beyond their intrinsic values and beyond the means of too many people to sustain. A corollary factor is the subprime "solution" that was devised to sustain the bubble itself. This means that a large number of homeowners were extended loans based not on their abilities to pay but on the expected appreciation of the homes themselves. It was assumed they could draw on additional funds whenever needed by taking out seconds and thirds on their ever-growing equity. This perpetual motion machine reached critical mass when prices peaked and began falling. Homeowners now find themselves without the income or assets to meet their rising adjustable rate payments. This created a cascade effect with lenders, who now have billions in loans that will not be repaid. Foreclosures, though rising dramatically, are not solving their problem because lenders are repossessing homes they cannot sell and that often are worth less than when they financed them. Millions of consumers will lose their homes and lenders will have to swallow hundreds of billions in delinquent loans. There will be blood-in the form of personal and business bankruptcies.

From this we should learn that, as in previous historical bubbles, clever financing mechanisms based on psychology and the notion of endlessly rising prices are houses of cards. The South Sea Bubble and Tulip Bubble of earlier centuries and the Stock Bubble of the 1920s were earlier versions of the same phenomenon. Margin buying in housing is no more financially sound than it was in stocks. In the short term there may need to be allowances made to keep families in their homes. Over the longer haul regulations will have to be written to prevent a recurrence of such unstable financing schemes.

The trade imbalance, led by our constantly worsening energy picture, is a second contributing cause. Oil closed today at an incredible $108 per barrel. That is more than four times the $26 a barrel that prevailed when the Bush Administration took office just seven years ago. We are hemorrhaging more than a billion dollars a day to pay for this oil. The blind obstinacy of this government's refusal to act on the problem is truly one of the great derelictions of American economic history. The inflationary effect of this dynamic is poorly understood. It strikes most Americans as hard to believe that energy and food are no longer included in calculations of the consumer price index. One can only speculate on the reasons for this, but when inflation is officially declared to be 4.3% without including these basic and rapidly escalating items it is not hard to imagine the real figure at 7 or 8% if calculated the former, responsible way. That level of inflation is ruinous over any sustained period. We need a crash program along the lines of the Apollo space program to develop renewable domestic energy supplies.

The imbalanced federal budget is a third important contributing factor. It soaks up funds from lending and investment and weakens the dollar. It necessitates the wasting of $400 billion a year to pay interest on the accumulated debt, much of which goes to China, Japan and Saudi Arabia. To rectify this problem the tax structure must be returned to honesty, so that revenues cover expenditures. It simply is not possible to cut enough to balance the budget without causing social and economic mayhem. The Bush tax cuts must be allowed to lapse when they expire next year.

A fourth contributing factor are unnecessary war expenditures. For one thing they are all borrowed funds that worsen the deficit, funds spent unproductively that could go to build the economy. They also mask a host of other expenses, not only economic but in health and social costs that further strain an already stressed economic picture. $150 billion a year in direct costs and an equal amount in indirect are making a bad economic picture worse.

Finally, for the longer term, a serious shift in educational emphasis is needed to restore American competitiveness in the world. This means providing the incentives to get more of the best and brightest college students to become teachers. It also means making it easier to reward effective teachers, to require remediation in ineffective teachers and to make it easier to get rid of those teachers who are not only ineffective but who cannot or will not improve. It means making it possible for all students of proven ability and drive to attend college. They are a resource we cannot afford to waste. And it also means a concerted national effort to encourage responsibility in parents and students by driving home the crucial nature of academic and vocational preparation. We must rekindle a strong respect for the values of education and responsibility throughout society or in the long run we will surely never remain competitive in the global economy.