Today’s announcement from the Department of Commerce of a third-quarter drop in gross domestic product of 0.3 percent in the annual rate was not unexpected. It hasn’t been much of a secret that the economy has been in decline for most of the year. The stock market took a turn for the worse recently, but job losses have been mounting since the beginning of the year. In fact, we are expected to approach 1 million total with the announcement for October next week. The question is whether this will be the kick the administration needs to do what is necessary to address the problem after many months of being a day late and dollar short in taking action.
The 0.3 percent GDP decline was the biggest decline since the last recession in 2001. The last quarterly drop was in the fourth quarter of 2007—a 0.2 percent slide. The intervening period has been marked by sluggish growth somewhat alleviated by the economic stimulus enacted by Congress earlier this year.
There’s little in the Commerce Department report today to give hope for a reversal of fortunes coming soon. Both consumption and investment contributed to the decline. Consumer spending dropped at an annual rate of 3.1 percent, with non-durable goods such as food and clothing falling 6.4 percent. Durable goods such as automobiles and furniture dropped at a 14.1 percent annual pace. These were offset somewhat by an increase in expenditures on services.
Investment continues to be dragged down by the housing market, with residential fixed investment dropping at a 19.1 percent annual rate. This marks the 11th straight quarterly drop in this category. But non-residential investment also fell overall, with equipment and software dropping at a 5.5 percent rate. This is worrisome since current investment is the seed for future economic growth, and fewer seeds mean a smaller harvest in the future.
If there’s a silver lining it’s in the declining trade deficit. Exports increased and imports declined. The dark core inside the silver lining is, however, that with other economies around the world now flagging as well, and the dollar regaining strength, exports are not likely to continue their growth. And imports aren’t likely to increase much either, given domestic consumers’ current mood.
The 0.3 percent decline could have been worse. The biggest single savior in the third quarter was government expenditures. In particular, federal defense expenditures grew at an annual rate of 18.1 percent. But that level of growth is a spike that will not be sustained, and defense expenditures produce little long-run return in economic growth. In addition, state and local growth is clearly coming to an end as those governments face declining revenue and growing demand for the safety net services they provide.
It’s hard to say that this all could have been averted. But it is clear that if the administration had acted more aggressively and earlier—as many suggested—we would be in a far stronger position. The last eight years have been lackluster economically with stagnant or falling incomes and weak job growth being particular sore points. But it’s been apparent for at least 10 months that the country was entering an even more problematic phase.
The Bush administration has acted like the mechanic who tries to fix the car by starting to replace the parts one-at-a-time, beginning with the cheapest. The $30 billion to bail out Bear Sterns might not have seemed like a “cheap” part at the time, but it was a small and cautious step in the face of the much larger problem, which needed a much more comprehensive solution. The failure to seriously address the underlying causes of the financial problems—failing mortgages and falling home prices—has been even longer-running. But those steps were too much of an intervention in free markets for this administration, and the pattern of too little, too late, has continued throughout the year.
The latest indignity has been that the administration is pouring money into banks on the premise that this will get them lending again, freeing up the credit markets and getting the economy back on track. The banks, however, don’t seem much interested in doing that. Taxpayer dollars appear to primarily be finding their way to bank shareholders who continue to cheerfully receive dividends that most of the banks refuse to cut.
The Treasury Department’s excuse is that if they had put requirements on the banks to, for example, get back into lending and provide the credit the economy needs to stabilize and get back on its feet, the banks would have refused to participate. Yet countries around the world have put such requirements on their banks in exchange for infusions of capital. If U.S. banks refuse to commit to what we need them to do for the good of the economy, it truly begs the question of whether flooding them with capital is a good use of taxpayer dollars.
Ironically, the Treasury Department’s failure to insist that banks do what banks are supposed to do has resulted in other industries—most notably auto and insurance—lining up directly at Treasury’s door for, essentially, banking services. Treasury hasn’t said what it’s going to do about these requests. Maybe it will spur the administration to push the banks harder, or maybe Treasury will help directly—once again paying the price for initial meekness with a greater market intervention later in the game, and unneeded pain inflicted during the interim.
The Federal Reserve has already taken some actions that have gotten it deeper into what has previously been the preserve of the private financial sector by getting involved in the commercial paper market. It may be Treasury’s turn. It is obviously not a long-term solution for the Treasury Department to act as a bank, and it’s hard to believe they would be particularly good at it. Nevertheless, if important industries are going to fail and cause irreparable harm to the economy because bankers are hoarding their resources, then action is appropriate. Perhaps the threat of the U.S. government entering banks’ business will give them the kick they need to once again play the role they’re supposed to play in the market economy.
An area where the administration has even more shamefully allowed its free-market principles to keep it from taking aggressive action—where the market was clearly failing—has been in housing. Since the beginning of this crisis, there have been calls for the government to aggressively step in and create a legal and financial environment where lenders and borrowers could work together to modify mortgage agreements to the benefit of all: lenders would get a paying mortgage, borrowers would stay in their homes, and the economy overall would benefit as mortgage and home values more quickly stabilized.
Amid reports that meaningful action was finally forthcoming on this front, the following statement from a White House spokesperson was reported today in the The Washington Post: “We have been reviewing a number of housing proposals for some time and no decisions have been made on any of them. … Any inference that we’re nearing a decision on any one of them is simply wrong.” That about sums it up.
The hope, of course, is that perhaps a drop in GDP will wake the Bush administration up if accumulating job loss, crashing home values, ballooning foreclosures, and a diving stock market hasn’t convinced them that the free market isn’t working terribly well on its own and something more than throwing money at banks is needed.
A much more rigorous intervention to stabilize the financial and housing markets is absolutely needed. But the administration also needs to shift from its single-minded focus on banks and other financial institutions. We need these institutions for a strong economy, but that’s not all we need. In the short run, we also need economic stimulus, and soon. Congress is almost certainly willing to come back for a lame-duck session to address this if the president is willing to sign a good package. Of particular importance are steps to help state governments so that they don’t become a drag on the economy as their revenues dry up and demand on their services grows. In addition, moves to help the unemployed and those who are being hit hardest by the deteriorating situation should be included.
These are vital first steps to getting our economy stabilized and providing stimulus to stop the bleeding. That leaves the substantial task of recovering the jobs lost and long-term growth to a new administration and Congress come this January.
The positions of American Progress, and our policy experts, are independent, and the findings and conclusions presented are those of American Progress alone. A full list of supporters is available here. American Progress would like to acknowledge the many generous supporters who make our work possible.
Vice President, Economic Policy