The Recession America Needed

"It is probably well that we had the war when we did. We are better off now than we would have been without it, and have made more rapid progress than we otherwise should have made." –Ulysses S. Grant, writing about the Civil War in his "Personal Memoirs", 1885.

The human toll of the recession, reported to be the worst economic downturn since the 1930s, has been so searing that it could be considered cruel to evaluate this event for any benefits. More than six million people have lost their jobs since this financial catastrophe began and, according to The New York Times, well over one million of those will lose their unemployment insurance benefits between now and the end of the year. The number of people who have no means of support will almost certainly rise as unemployment moves toward 11% and a life of deprivation becomes more commonplace in America as each month passes.

Many economists believe, or at least want to believe, that GDP will begin to stage a modest recovery near the end of this year. The second quarter contraction of the economy was only 1%. Recent figures on housing, both from private sector sources and from the government,  have led some analysts to the conclusion that both the pace of home sales and the value of real estate will begin to rise in 2010.

All of this potential recovery takes place in the shadow of a national debt that, according to the CBO, could rise an average of $1 trillion a year for the next decade. The Heritage Foundation expects that the national debt will be $12.5 trillion ten years from now using inflation adjusted dollars. This number means that the debt would be 67% of GDP. The organization's numbers could be off by a significant amount because they are thought to be somewhat pessimistic, but even a more sanguine view is likely to yield the conclusion that the deficit and the interest that will have to be paid on it are beyond the economy's ability to support it, even if GDP growth is moderately good during the next few years.

The recession came at the best time that it could because it has given the US a chance to make permanent adjustments to the government's economic and regulatory policies and has offered businesses and individuals the opportunity to change decades-old habits. It has also allowed the nation to look at its place in the world, especially its best options to compete with China and other emerging countries, in a way that would have been forestalled if the recession had not happened in 2008 and 2009.

The cause of the recession is often blamed on financial firms that took astonishingly large risks with the goal of multiplying their earnings at unprecedented levels and consumers who were willing to aggressively borrow against inflated home values that were not sustainable. Government policies might have prevented this if regulators could have looked ahead in 2005 and seen the danger in financial firms trading in exotic financial instruments and offering homeowners loans based on rapidly rising home prices that, in some cases, were doubling every three or four years. Prescience, born of powerful deductive skills, could have caused regulators to sound alarm bells, but the collapse of the over-leveraged system was seen by very few experts until it was on top of the economy and in the process of ruining it.

Congress would like to regulate every corner of the financial system based on the idea that monitoring everything can prevent anything bad from happening. There may be a certain truth to that, but it is also true that a massive framework of regulation would serve to push almost all risk taking out of the market.  Overly tight regulation will diminish the rewards that could come from improving bank earnings and perhaps destroy the system where credit-worthy individuals and businesses have relatively easy access to capital. The federal government could ban or curtail financial activity in the derivatives, commodities trading, bank lending, and proprietary trading portions of the broad banking system. The government could simultaneously take many of the risks out of owning homes by allowing millions of people to modify mortgages. This could offer artificial support to housing just as unemployment offers an artificial support to consumer spending, but regulation and aid interfere with normal economic forces and make it impossible to tell what part of a recovery is permanent and which part is transitory because the government intervened.