On the Record

Evaluating the Economy and the Possibility of a “Double Dip” Recession

The economy is showing some bright spots, but rising unemployment, weak consumer spending and the housing market continue to be concerns. Senior Fellow Robert Litan examines the current state of the economy and offers insights into job creation and entrepreneurship, the possibility of a “double dip” recession and higher capital requirements for lending institutions.

TRANSCRIPT

“One of the little known facts about the economy is that, not only are most new jobs created by entrepreneurs, in fact between 1980 and 2005 all of the net new jobs in the U.S. economy were created by firms less than 5 years old. So that raises the question, given the current recession, how are new firms doing now? If you look at the bald statistics (at least through 2008) the number of new starts is, actually, slightly up compared to 2007. So that is good news. What we don’t know is that, given the current credit crunch, whether those new firms are going to be starved for capital and whether they are going to be able to grow in the same way that young firms have been able to do that in the past. That is an open question, but the answer to it will, I think, largely determine the strength of the recovery…

“Certainly we could have a double-dip because, so far (at least through the third quarter), we had good numbers but those numbers were goosed up by the “cash-for-clunkers” program, the housing tax credit, the stimulus money that was in the pipeline, the Fed’s buying gobs of securities and so forth. All of that stuff is going to be tapered down and is, eventually, going to come to an end. So there is a big question out there – what in the private sector is going to take over from the government; and are the entrepreneurs and existing businesses going to take the baton? We don’t know that yet. Clearly it is the hope of people in the Administration that the economy has slipped into gear through the massive stimulus programs, but I would say it is an open question how strong the recovery is going to be without some other prodding; or, at least, some slowing down of the planned withdrawal of the stimulus (at least by the Fed) that is supposed to come, but maybe the Fed might have second guesses…

“I don’t think anybody is talking about raising the capital requirements now. I think everyone is saying in the longer-run, after this crisis has passed, we clearly have to raise capital requirements across the board so that banks have a greater cushion against the kinds of losses that we have just seen. Secondly, capital is going to be increased disproportionately for larger institutions because we want to try to attack the “too big to fail” problem that has bedeviled us in this crisis. In the short-run, there is no real way that we can raise capital standards without harming the recovery, which is why it is not going to happen. The more problematic thing, actually, is that even with the existing capital requirements banks are afraid to lend because they are nervous that there are more losses coming (especially in commercial real estate). As they take losses on their balance sheet, that impairs their capital and puts them closer to the edge where regulators get nervous. Even under the current regime, I think there is a reluctance on the part of banks to lend because they don’t know how much additional loss they are going to have to take. Banks, frankly, need to earn money to refill the coffers so they get back up to the point where they can feel comfortable lending again. So making money is not a crime, it is part of the recovery process. In fact, the so-called upward sloping yield curve that we have right now that has been engineered by the Fed – the very low-term interest rates coupled with, actually low (but higher) long-term interests rates – that margin which is roughly three percentage points is what has allowed banks to make money and they are going to need that margin for some period of time to repair their balance sheets.”