The Economic Outlook and Washington Area Nonprofits

This is a big crowd of amazing people. It includes many of the hardest working, most dedicated people in the Washington region, who run and staff nonprofit organizations devoted to good causes, and many of the philanthropic organizations that fund these good works. And this is a worried group, concerned that they may be unable to continue their services to the community just when those services are needed most.

I have been asked to talk briefly this morning about the outlook for the national and regional economies and the implications of the recession for Washington nonprofits. I will also add a few thoughts about what philanthropic and nonprofit organizations might do, individually and together, to help nonprofits survive the recession and emerge stronger and more effective as the economy recovers.

I bring no cheer about the national economy: I expect that the recession that started about a year ago will be long and deep. It will get a lot worse before it gets better. I am not a professional forecaster, but most of the available forecasts see the recession lasting through much of 2009, then bottoming out with positive growth returning in 2010. These forecasts seem to me likely rather optimistic. Forecasters depend on models of the economy that are based on data from the past, especially the last several decades. Essentially they tell you what will happen next if economic history repeats itself. In the post-World War II period recessions have occurred about once a decade. Most have been fairly mild, especially the two recent ones, 1990-91 and 2001-02. But there are reasons to believe that this recession might be worse than any in the post-War period. [An earlier speaker] said unemployment rates are “through the roof,” but actually we have not hit the roof yet. I expect unemployment rates to keep rising for quite a while—possibly into the range of 10 percent nationally. Unemployment will be worse in some places and better in others. We’ll be one of the better ones.

This recession is likely to be serious, because it is not an ordinary recession. We’ve had a lot of what economists think of as “ordinary recessions” over the last several decades. The worst one was in 1982 when unemployment did get up to around 10 percent. Most have not been that bad. But the other recessions since World War II have not been precipitated by financial crises. They have just been the economy running out of steam or the Federal Reserve raising interest rates in order to control inflation. That was what happened in 1980-82 when inflation was very high and the Federal Reserve’s response knocked the economy into a steep recession.

This is different. This is more like the 1930’s because it started with a financial crisis. Actually most of the economy was doing quite well until the crisis hit and credit dried up quickly. We had a bubble in the housing market, but it was not a simple bubble, whose bursting affected only the American housing market. It was a bubble in the U.S. housing market that precipitated a worldwide financial crisis that brought activities of big banks and financial institutions all over the world to a screeching halt. Some of them failed, though not many. The central banks and Treasuries of the world pulled together quickly and pumped money out to keep major financial institutions from going down. We don’t know what would have happened if they had not done that. It might have been much worse, although it is unlikely the situation would have been as bad as the banking crisis of the Great Depression. At that time we had banks failing all over the country and nobody could get their money out. We are in fact not worried about that right now. You should not worry about losing your deposits and run to the bank and say “I want my deposits back.” That would precipitate a huge crisis, which is not happening because your deposits are insured. They are even insured for more now than you thought they were. Most people don’t have $100,000 in the bank and the limit has now gone up to $250,000.

Of course, the reason we are not worried about deposits is because we learned something from the crisis of the 1930s and established the Federal Deposit Insurance Corporation. Because of the institutions established as a result of the Great Depression, we are not going to have the kind of meltdown that the financial crisis of the 1930s precipitated, when unemployment went to 25 percent and almost everybody was in deep trouble. Referring to the current crisis as the deepest recession since the Great Depression does not mean it will be comparable to the Great Depression. But, it could be long and deep like the recession of 1980-82.

It is important to remember why we got into this mess. We are in trouble basically because as a country we were spending too much, borrowing too much, and living beyond our means. That is something people like me have warned about for a long time, but few of us foresaw that it would precipitate this kind of meltdown. The reason it did is that we had not modernized our regulatory systems to keep up with innovation in the financial sector.

It is rather amazing in retrospect that we did not take more precautions. There was a pervasive ideology of “the markets are always right, we don’t need to worry about them,” and nobody thought through the details of what had actually happened to our financial structure and what might go wrong. There was the fact that mortgages were not made and held by local bankers who needed to be sure the person borrowing the money could pay them back. Bankers stopped having to worry about the credit worthiness of the borrower because they were not going to hold the mortgage and collect the money. They were going to sell the mortgage to somebody else. If you could sell the mortgage to a larger investor and get the money and lend it out again then it was very tempting to push the money out the door as fast as possible. Existing regulations did not apply uniformly to all mortgage lenders, so standards in some lending institutions got very, very lax.

People on Wall Street were also tempted by the fact that growing economies in China and other developing countries were generating a lot of cash, and they wanted a place to put it that would earn good returns. Our financial institutions were able to say “American homeowners always pay, we have very low default rates here, and these mortgage-backed securities are secure investments with quite good yields. We have a track record on this. Buy it and you will get good returns.” And it went from there.

We need to remind ourselves of that history because the reason we got into this has something to do with how hard it will be to get out. We don’t want to go back to the economy that we have been living with for the last several decades in which we were over-borrowing and overspending. We need to change the habits of the American public, to become more careful, more cautious; more reluctant to borrow when it may be hard to afford to pay the interest. More reluctant to buy a bigger house than you really need, more reluctant to buy a bigger car than you really need for energy conservation reasons besides the overborrowing. We want to re-establish a mentality of more caution, more saving at the individual level, at the family level, at the government level; indeed, at every level so we are not taking these big chances in the future. When you think about what that transition to more saving means, you realize it is going to be hard on retailers, those who sell consumer services and on home builders. It is going to mean that we can’t just say “OK, recession over, we’re going back to what was before.” We will be going forward, I hope, to an economy which doesn’t spend as much, invests prudently and grows more steadily. We need to increase public investment, as our new president emphasizes in the recovery package, to improve our skills and infrastructure. In the end that will improve our rate of growth, but it will be solidly based, less based on borrowed money, both our own and the huge borrowings we have taken out from people overseas.

Now, what has the government done in this crisis? It has tried to respond to what happened in the financial system. We have been in a credit crunch—meaning that all these big financial institutions, and many smaller ones, realizing that they had lent too much, and that their assets weren’t worth as much as they thought they were, decided they had better not lend anymore. All of a sudden people in this room, who thought they good relations with the banker and were going for a perfectly routine loan, are hearing the bank say “no, we can’t do it.” So the government has been trying to keep the financial institutions afloat, to let them borrow from the government on easy terms, and encourage them to start lending again. So far it has not meant that the credit crunch is over. It is a little better than it was. It may get better still, but when you say “have all of these efforts and these billions worked,” you cannot see that it has, you can only speculate that the credit crunch is better than it would have been if we had not done it. It is a hard thing to convince yourself that it was worth it.

What will the government do in the future? It will certainly make a bigger effort to help homeowners directly. That is very hard to do right now because of what has happened in our mortgage markets and the fact that the local banker no longer owns the mortgage. Somebody else does, and it has been divided into risk tranches and sold to a whole bunch of investors that nobody knows how to pull together. If you are going to renegotiate the loan you have to find them and get their permission to do it. So the process of helping homeowners stay in their homes is slow. I think we will see aggressive efforts to bring down mortgage rates, because that may be the most straightforward way of to ensure that people can continue to make their mortgage payments, can renegotiate their loans to a lower rate, and even think about buying another house. We will see a large stimulus package and we will see substantial public investment to create demand and jobs.

I believe the most important thing for the government to do as part of the stimulus is to get money to low- and moderate-income people. This can be done with tax cuts, increases in food stamps and unemployment compensation and helping the unemployed pay for health insurance. Increasing the federal contribution to Medicaid will help to keep the states from cutting back on Medicaid, which they would otherwise do in a fiscal crisis. We will see infrastructure spending initially on repairs and other shovel-ready projects. We will, as I said earlier, need to have a major investment in improving our infrastructure of all sorts. But that shouldn’t be thought of as stimulus; it really should be thought of as longer-run investment. It should be carefully planned, we should do the right things—not just highways and bridges, but mass transit and energy saving investments.

And finally, this is actually the right time for comprehensive reform of the health system. A lot of people are saying “no, wait a minute, we cannot do that. We thought we were going to be able to have comprehensive reform, meaning more people are covered and we have put in place ways of making the system more effective, but we cannot do that now because there is this recession and it is not the moment to think about big new adventures.” I think that is absolutely wrong.

This is the moment; both because more people will be uninsured and therefore more people will be conscious of the problem, and because of the nature of health reform. Health reform requires upfront spending to improve the efficiency of the system as well as to cover more people. That means heavy investments in information technology, in individual health records, in gathering the knowledge that will allow us to have a more evidence-based reimbursement system. We have a very wasteful system now, but we do not have the knowledge to fix it right away. So it takes heavy investment up front to get a slower rate of growth in health spending later. This is the ideal moment to do that. And it is the exact opposite situation of 1993 when those of us in the Clinton Administration were trying to do comprehensive health care reform. We were trying to do it in the context of a deficit that had to be reduced immediately. That was not a good moment to do comprehensive health reform. We had to do it on the cheap; we had to make it more complicated than it needed to be because we couldn’t afford to spend for the necessary investment. This is a better time and I hope those of you working on comprehensive health reform will not give up.

So how will this affect Washington? Our economy will be less affected than the rest of the country. Be glad you are not Detroit, be glad you are not Cleveland, and be glad you are not even Baltimore. This economy is much more solidly based on employment that will not go away. Indeed, some of it may even expand. So we will not have in our regional economy as big of a problem as many places. However, especially in the outlying counties, we will certainly have very serious shortfalls in revenues because of the downturn in property taxes and some downturn in income as well. Our local public sector will feel it. But the fact that our economy will not be as heavily affected is not all good news for nonprofits on the funding side. The major funders, the foundations and others, disburse funds on the basis of the value of their assets and those assets have plummeted and are not going up fast anytime soon. Because of the drop in the stock market and the real estate markets, funding from foundations and other endowments is going to be restricted. On top of this, the nonprofits will be faced with many more people who need help. You all know about that already, but it is going to get worse before it gets better.

What to do? Well, as surely evidenced by the number of people in this room, we have a very large nonprofit sector. And as I have worked with nonprofits in this area over quite a long time, I have thought “wow, this is a dedicated, wonderful group of people. They are working hard, they are very well motivated, and they are doing useful things. But there are too many of them, too many individual nonprofits.” It is a very inefficient system, although it is probably no more inefficient here than anyplace else. This tends to happen every where. Somebody has a good idea, starts a nonprofit, gets some funding, gets a group of people who are committed and they implement their idea, which is only a little different what some other people are doing. That is the reason we have so many nonprofits in this room all working hard to do good and keep afloat.

So this is, as Terri said, an opportunity. It is an opportunity for the nonprofit sector which you must take advantage of. You must think about ways to work together, to improve efficiency, to stretch the dollar. Shared services come to mind. Aggressive efforts to work together to share payroll, accounting, tax filing and all that back office stuff; to work together on fundraising and public relations and to share space. This is hard because you all have your special thing, but it may not be impossible in a crisis. Also think about consolidation. It is a lot better to pull several nonprofits together to jointly do what you are good at than to have people going out of business or limping along not able to do what they really need to do. I understand the resistance to this. The resistance is very great in the nonprofit community because everybody thinks they are doing something special – and they are. But it is better to work together proactively than to let nature take its course. If nature takes its course a lot of people in this room will not be running nonprofits in a couple of years. Rahm Emmanuel has been much quoted saying “a crisis is a terrible thing to waste” and he is right. Don’t waste this crisis! Get together, figure out how you can do your jobs better collectively and we will have a stronger nonprofit sector when this terrible thing is over. Thank you.