The Pessimists Roll In As The Recovery Takes Root

It may be that some people just want to spoil a good time. As earnings, GDP, employment, and housing sales begin to show the trends that have encouraged analysts to call an end to the recession, the voices of pessimism are increasing in volume. New surveys of economists by The Wall Street Journal and Bloomberg both show experts say the recession is over.

One of the premier critics of the idea that the American economy is well on its way to 8% unemployment and 5% GDP growth in 2010 is Harvard economist Kenneth Rogoff. That has to bother Lawrence Summers who heads the National Economic Council for the President. Summers was one of the youngest tenured professors in the history of the Harvard economics department and served as head of the university until he was forced out after questioning the intelligence of women who might be candidates for senior academic positions in science and engineering. Rogoff seems to enjoy poking holes in intellectual positions that Summers has to defend. The most obvious of those is that the Administration is the hero of the nascent recovery.

Rogoff recently said that GDP was unlikely to grow better than 2% over the next five to seven years. That would completely undermine the budget forecasts made by the White House which have been attacked by a number of groups including the Congressional Budget Office. Rogoff’s prediction, if it ends up being even close to accurate, would mean that the stimulus package will fail although it is in its earliest stages and that healthcare reform can hardly be “self-funding.”

Rogoff also played the highest card in the deck held by economists with a penchant for pessimism; he claims that the odds of a second recession in the next five years are about 50/50 as Reuters reported. Rogoff’s major concern is that the commercial real estate market will go through a massive credit crisis not entirely unlike the one in residential real estate and related derivatives that crushed the financial markets just a year ago.

There are some important voices that say the legacy problem of bank balance sheet assets have not receded and that a number of banks, especially in the middle tier of the industry, may be severely crippled by  “toxic assets”.  During an appearance on Reuters TV, Elizabeth Warren of The Congressional Oversight Panel claimed that no one knows what the bad paper on financial firm balance sheets is. She is implying that the financial crisis could return, full-blown, with little or no warning.

Rogoff and Warren are ultimately both pointing to the same thing. Real estate values are still dropping rapidly and the leverage built up to buy property, both residential and commercial, has yet to be relieved.

Property values have no reasonable opportunity to recover, if almost all of the current trends continue, and the loans on which they are based are coming due quickly, many of them during the next year.

The conclusion that the danger of bad debt based on real estate becomes a new wave of the old crisis can be reasonably defended. It would require impressive inflation to move up the value of property along with almost everything else. That might, temporarily sooth the default issues that go with leverage, but the rest of the economy would have to pay a terrible price in return. Mr. Bernanke says that the Fed spends very little time worrying about inflation and that he and his colleagues have made careful plans to make certain that it cannot be a threat. Rogoff is saying that, if Bernanke is right and inflation does not appear soon, the falling commercial real estate prices will ruin the recovery. Bernanke may want to review his objectives:  would it be better if the prices of goods and services rose?

Douglas A. McIntyre