Troubles at United States banks are making mortgage, credit card and business
loans scarcer and more expensive. Falling home prices, rising foreclosures and
high gas prices have stalled home building and consumer spending. These
problems are exacerbated by the long-festering trade deficits on oil and with
Asia on consumer goods and cars that tap off demand for US-made goods and
services.
How the George W Bush administration (and its successor) and the US Congress
respond to these challenges will importantly determine how Americans emerge
from the current malaise. With the right policies, the economy can grow at 3.5%
to 4% a year, perhaps a bit more. Without meaningful reforms in banking and
changes in energy and trade policies, the United States is headed for
substandard growth and a declining standard of living for many workers.
Since 2005, US imports have exceeded exports by more than US$700 billion or
more than 5% of gross domestic product (GDP). To finance the trade gap,
Americans sell bonds and other securities to foreigners, including the People's
Bank of China and other central banks.
Until recently, money center banks and securities dealers, such as Citigroup
and Merrill Lynch, recycled foreign funds to US consumers. Consumers borrowed
ever-larger sums to live beyond their means through exotic mortgages,
questionable auto loans and lax credit-card rules.
In the housing market, mortgage companies were aided by real-estate appraisers,
who juiced estimated home values, and Wall Street bankers, who transformed
shaky loans into seemingly low-risk mortgage-backed bonds for sale to insurance
companies, pension funds and foreign investors. The bond rating agencies turned
a blind eye and blessed these transactions.
These schemes now exposed, banks can't securitize mortgages into bonds and must
finance mortgages through more expensive certificates of deposit. US homebuyers
must put up larger down payments and pay higher interest rates and fees to get
loans.
The result is predictable: housing prices are falling. Builders have a 10-month
supply of unsold new homes, and new home construction is down more than 55%
since April 2006.
Rising delinquencies and repossessions are making similar abuses apparent in
credit card and auto loans. Lenders face difficulties selling bonds to finance
new loans and are increasing monthly interest rates and tightening
qualifications.
Consumers can't run up debt as easily to boost spending and live beyond their
means. Sales are falling at shopping malls and restaurants, and consumer demand
for US-made goods is stagnating.
Similarly, banks are making fewer loans to businesses for worthwhile projects,
and business spending on commercial buildings and new equipment and software is
expected to stall in the second half of 2008 and 2009.
Thanks to this grand deleveraging, economic growth has averaged only 1% a year
since the fourth quarter of 2007 and is expected to continue to limp along at
that pace until the second half of 2009. It will take that long for the banks
to clear out all their bad loans, for most of the expected 2 million-plus
foreclosures and resales of homes to be completed, and households, generally,
to restore their balance sheets through more conservative spending patterns.
Getting the economy going again will require getting the banks on a sound
footing, so that mortgage money and other credit are available on reasonable
terms. But if the United States is to grow at a decent, sustainable pace and
avoid another credit crisis and deleveraging, it must reduce its trade deficit
and reliance on foreign borrowing.
Simply, trade deficits of more than 5% of GDP require Americans to spend more
than 105% of what they earn to maintain demand for domestically produced goods
and services and sustain GDP growth and employment. Even if foreigners are
willing to continue buying US bonds, financing American consumption at that
level will require the banks and finance companies to write progressively more
risky loans, as they did during the last economic expansion, until debts cannot
be repaid.
Inevitably, that would end in another banking crisis and credit shortage,
painful deleveraging, and period of slow growth similar to the current slog, or
worse.
To accomplish healthy growth, the United States must slash its trade deficit,
dramatically, over the next several years. Imported oil, cars from Japan and
South Korea, and consumer goods from China account for nearly the entire US
trade deficit. No permanent solution to the US quagmire is possible with
addressing those issues.
Global oil supply has not kept up with demand in recent years, because several
important exporters, including Venezuela, Russia, Nigeria and Mexico, have
shunned the investment and know-how Western oil companies can offer to sustain
their production.
In recent weeks, crude oil prices have receded, somewhat, but this is because
the US, European and Japanese economies are slowing and speculators face more
hurdles in financing positions, and not because the basic global supply
imbalance has been redressed.
Higher oil prices may be here to stay, but the technologies to reduce US oil
imports dramatically are at hand. Hybrids, plug-in electric and even
hydrogen-powered vehicles are no longer fanciful proposals. Coal gasification
is viable at $55 a barrel for oil, and more-efficient building designs,
appliances and heating systems are all possible at affordable costs.
Economists assert that the market will provide, but they fail to reckon with
the fact that most epic transformations in transportation technology - canals,
turnpikes and national highways, railroads and airplanes - got boosts from the
government to overcome the barriers created by habits and costs of switching.
For example, the biggest problem getting into production and use of hydrogen
cars will be the initial investment in fueling stations and quickly achieving a
critical mass of vehicles on the road to sustain them.
Japan, Korea, India and China have promoted their domestic vehicle industry by
limiting imports and exploiting the open US market, and now Japan, the most
mature producer, boasts Toyota and Honda as the leaders in hybrids and greener
vehicles.
The US should not turn to protectionism, but rather, it should use its large
market to its advantage. It should require much higher mileage standards for
automobiles and offer substantial product development assistance to US-based
automakers and suppliers - that includes Toyota and Honda, as well as the
Detroit Three, battery makers and other suppliers - to accelerate the build-out
of high-mileage innovative cars.
The condition for assistance would be that beneficiaries do their research and
development and first large production runs in the US, and share their patents
at reasonable cost with one another. The huge US market would attract producers
from around the world and rejuvenate the US auto supply chain.
Similarly, accelerating clean coal gasification, nuclear power and the hydrogen
transformation, as well as mandating much more efficient buildings and home
heating systems and appliances, would propagate exciting new technologies
Americans could sell around the world.
Since January 2007, the dollar has fallen 12% against the euro, and a burst of
commodity and manufactured exports have helped reduce the US non-oil trade
deficit. However, as the dollar has weakened against the euro, China has
stepped up its intervention in currency markets to keep its yuan inexpensive
and exports growing. Factoring in higher oil prices too, the overall trade
deficit is down only about $20 billion.
Although China has permitted the yuan to fall by 17% since July 2005, it has
increased purchases of dollars with yuan to $640 billion annually in 2008, up
from $462 billion in 2007. This provides a subsidy on exports and domestic
import competing products equal to about 17% of China’s GDP, and pressures
other Asian nations to pursue similar currency policies lest their industries
lose competitiveness to Chinese manufacturers in vital US and European markets.
Moreover, by artificially accelerating Asian growth, this policy boosts Asian
oil consumption and provides the hard currency to subsidize oil imports and
domestic fuel prices, further exacerbating international oil shortages.
Cutting the US trade deficit with China and other Asian exporters requires that
Washington find a way to persuade Beijing and other governments to end their
currency market intervention.
Negotiations have not worked. The United States may have to resort to a tax on
yuan-dollar transactions at a rate directly proportional to Chinese currency
intervention to reduce imports in the near term. This would encourage China to
stop intervening in currency markets and redirect investment toward more
domestic consumption and investment in schools, hospitals and public
infrastructure. Then the tax could be removed.
That may sound radical but redressing the trade deficit with China and other
Asian exporters would also require major changes in American habits too.
As China and other foreign governments ended their purchases of dollars, US
Treasury securities and private bonds, Americans would have to borrow less,
save more and start living on what they earn. The US government would have to
cut its budget deficit to near zero, and American households would have to save
5% to 10% of their disposable income, as opposed to the near zero levels
accomplished during the recent economic expansion.
Getting through the current crisis requires unusual steps in credit markets.
Federal efforts to route capable but currently distressed homeowners into
sustainable mortgages and Federal Reserve to help the money center banks and
securities firms will help avoid economic Armageddon. The same is true of
Federal efforts to assist mortgage guarantors Fannie Mae and Freddie Mac.
However, achieving a sustainable economic expansion requires strong new
disciplines, from loan officers on the ground to the executive suites at those
New York banks. So far, federal credit market reforms have been focused on
mortgage brokers and small lenders, rather than the business models pursued by
the large money-center banks and securities dealers that bundle mortgages,
credit-card debt and auto loans into bonds. These firms are largely locked out
of the fixed-income market for the purposes of securitizing mortgages, owing to
the absence of transparency in past practices and the dearth of meaning
management reforms.
The Federal Reserve should start conditioning its discount window lending to
large money-center banks and securities firms to meaningful reforms in
securitization and management practices, or US credit markets will take several
years to rebuild.
Regional banks or other financial institutions could emerge as major bundlers
of mortgages and consumer and business loans for sale to insurance companies,
pension funds and foreign investors, but that would take many months to effect
too.
Either way, adequate credit to both home construction and business investment
will not be available before 2010. Until then, growth will be slow, and closer
to 1% than 3% per year.
At that point, if positive steps have been taken to encourage substantial new
investments in alternative energy sources, conservation and transportation, and
to substantially cut the trade deficit with China and other Asian exporters,
the US economy could grow at 3.5% to 4% for quite a long time.
Otherwise the US economy will grow in spurts above 3%, punctuated by banking
crises and periods of deleveraging. In some years, growth would exceed this
rate, and for others, it would be less than 1%. Overall, the pattern will be in
the range of about 2% a year or less.
Peter Morici is a professor at the University of Maryland School of
Business and former Chief Economist at the US International Trade Commission.
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