Washington & Wall Street: Jobs, Credit, and Economic Growth

Last week, a raft of economic data came out that confirms what all of us already know, namely that the US economy is growing far more slowly than before the 2008 financial crisis. Most politicians and economists tell us that the economy will eventually grow faster, but is this really true? The fact is, neither politicians nor economists can or will tell the American people the truth in the wake of the great housing bust.

For decades now, politicians in both parties have used housing as a means of growing jobs and consumer spending. If you really go back and examine the roots of the 2000s housing bust, it reaches all the way back to Lyndon Johnson in the 1960s. By dropping credit standards and enacting public mandates like the Community Reinvestment Act, Washington’s political class spurred growth in employment by making it progressively easier for Americans to buy homes and other consumer goods. Government agencies like Fannie Mae and Freddie Mac accelerated the expansion of housing as an engine of growth. Wall Street’s contribution leading up to 2008 was really the final act of insanity.

Today, though, the situation is very different. Indicators like new job creation and bank lending are all basically flat, reflecting both a lack of demand from consumers and also continuing shrinkage in the supply of credit. Ponder the fact that the May report showing non-farm payrolls growing by 175,000 is roughly half the rate of job creation needed to simply keep pace with US population growth. The culprit here is continued deflation in the financial sector, another way of saying too little credit growth.

Irving Fisher, perhaps the greatest American economist of the 20th Century, wrote about the link between credit creation, jobs, and spending. More important, his 1933 essay, “The Debt Deflation Theory of Great Depressions” was largely ignored in favor of the Keynesian path, a fateful decision that explains why growth today is so weak. But Fisher’s work clearly informs the policy moves of Fed Chairman Ben Bernanke, who did the right thing to fight deflation with the wall of money. Now the Fed has done it too long. 

The Fed managed to quench the worst aspects of deflation using zero interest rates, yet the central bank cannot change long-term trends like demographics, new regulations, and declining real income. The latter problem – falling real income – is a result of past Fed monetary excess. Easy money is a future tax that costs American consumers and employers. A century ago, when inflation was a serious national issue for Americans, the loss of purchasing power was called “shrinkage.”

New state and federal laws put in place to supposedly “protect consumers” (and punish large banks) are having a profoundly negative impact on private credit creation. The Dodd-Frank legislation, Basel III, and the state AG settlement on home foreclosures together constitute a huge drag on credit creation and thus new jobs for the US economy. 

Economist Paul Krugman whines interminably about efforts to reduce budget deficits and the need for “temporary” increases in federal spending to boost employment, but what is really needed is attention to removing ridiculous regulatory regimes and rebuilding private markets to finance long term growth. Over the past thirty years, we have had temporary Fed easing and/or Keynesian fiscal stimulus more often than not. During the quarters between 1980 and today, only a handful did not have some type of extraordinary monetary or fiscal policy in place. I called this atmosphere the “neverending crisis” in a 2010 paper for Indiana State University.

Look at the sharp declines in new loan applications from the Mortgage Bankers Association and you start to get a sense for what lies ahead. For the past several years, banks have been refinancing existing mortgage customers under subsidized federal programs like HAMP and HARP rather than make loans for young families who want to purchase new homes. The “shrinkage” affecting the mortgage market is a serious national problem, one that already affects millions of realtors, builders, and others who once made a living in the housing sector. 

Just look at major banks shedding thousands of people in mortgage originations and you will see why it is so hard for the US to move the needle when it comes to jobs or the economy. But this is not a function of too little public spending.

Krugman and his fellow travelers complain that “depression becomes the new normal” because public spending is constrained. But in reality the long-term goal for the US should be the withering away of the Keynesian socialist state and a renewed focus on private sector credit and job growth. The Fed, private businesses, and other players on the national economic scene ought to lead the discussion on how we can rebuild private markets to finance private sector growth, rather than resort to more futile monetary policy gestures or Keynesian pump priming.


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