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What the Double-Dip Recession Will Look Like

What the Double-Dip Recession Will Look Like

by Douglas A. McIntyre
Monday, August 16, 2010

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"Nearly two-thirds of Americans believe the economy has yet to hit bottom, a sharply higher percentage than the 53% who felt that way in January," according to a recent Wall Street Journal poll.

A growing and vocal minority of economists believes that there will be a double-dip recession primarily because of the intransigence of high unemployment and the rapidly faltering housing market. The notion of a "jobless recovery" has been around since the recessions of the 1950s and 1960s. It is a concept built on a relatively simple idea: employment lags during a recession but it is always part of a recovery cycle. Production rises as businesses see the end of a downturn and anticipate improving sales. They are reluctant to hire new workers until the recovery is confirmed, but once it has been, hiring picks up.

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The 2008-2009 recession was — if it is indeed over — different from any other because of its depth and causes. The first trigger was the drop in housing prices, which robbed many people of their primary access to capital. As that access disappeared, so did the availability of credit. Consumer buying power evaporated and business cut inventory and production. Joblessness rose. Finally, consumer confidence plunged.

The last downturn was so great that in some months more than 500,000 people lost jobs. The unemployment rolls are now more than 8 million, and perhaps more gravely, over 1.4 million people have been out of work for over 99 weeks — which means they are no longer eligible to receive unemployment insurance benefits. This segment of the population has already begun to add to the number of indigent Americans and will continue to do so unless they can find homes with friends and family.

The second dip of the recession that ended in 2009, according to economists and the federal government, is likely to begin within the next two quarters if certain conditions are met.

Unemployment claims are running well above expectations, and recently hit a six-month high. The four-week average of initial claims rose 14,250 to 473,500 this week. The last peak, in February, was during a period when GDP was in the very early stages of recovery. There is nearly no jobs creation in the private sector. Real estate prices continue to drop, particularly in the hardest hit regions such as California, Nevada, Florida and Michigan.

The federal, state and local governments are in no position to lend assistance to businesses, most of which lack access to capital. Similarly, banks are not prepared to lend to small businesses, especially those with modest balance sheets and relatively low sales. This presents a problem for employment since companies with less than one hundred workers have traditionally been the largest creators of jobs.

This is what a double-dip recession would look like:

1. Housing

The cost of homes in the areas where prices have already dropped by 50% or more will continue to fall. These regions typically have the highest unemployment rates, the local governments are hard pressed to offer basic services, and potential buyers are aware that home prices could drop further. Real estate values in these areas could drop another 20%. In the rest of the country, protracted unemployment and the unwillingness of banks to lend would make otherwise attractive all-time low mortgage rates unappealing.

[See Housing's Future: 10 Million More Renters]

2. Unemployment

Unemployment would move back above 10% quickly. In the 1982 recession, the jobless rate was over 10% for 20 consecutive months and reached 10.8% for two months. During this period, the manufacturing base had not been destroyed. The economy is now arguably worse than it was in 1982. Many Americans who worked in manufacturing before the recession cannot be retrained, and the factories where they worked will not be reopened. Many companies have recently adopted the policy that they will keep as much of their work-force temporary for as long as possible. This keeps the cost of benefits low and allows firms to fire people quickly and without severance. A hiring strike by American businesses would contribute to putting 200,000 to 300,000 people out of work per month. At the peak of the recession that just ended, there were nearly six job seekers for every open job, according to the Labor Department. The job market could return to that point.

3. Consumer Spending

One of the primary reasons that consumer buying activity did not grind to a halt at the beginning of the last recession was that people still had access to a huge reservoir of home equity loans, most of which were taken out at the peak of the real estate market in 2005 and 2006. The New York Times recently reported that "lenders wrote off as uncollectible $11.1 billion in home equity loans and $19.9 billion in home equity lines of credit in 2009, more than they wrote off on primary mortgages, government data shows. So far this year, the trend is the same." Retail activity was helped somewhat by the capital available on these lines of credit, so store closings were probably deferred to the latter part of 2008. With more than 11 million mortgages underwater, 24% of the national total, and several million more within a few percentage points of being negative, the consumer will have no cushion as the economy deteriorates over the next six months.

4. Consumer Confidence

Consumer confidence, the critical gauge of the activity that represents two-thirds of U.S. GDP, will plummet again. The Conference Board's Consumer Confidence Index would certainly move back toward the all-time low it hit in February 2009 when it reached 25. Currently, the measure in most months is closer to 60.

[See 21 Things You Should Never Buy New]

5. Auto Industry

Auto sales, one of the primary barometers of consumer economic activity and manufacturing output, would probably drop back to recession levels. People concerned about employment will defer car purchases. Annual car sales in the U.S. were over 16 million in 2005 but dropped to just above 10 million in 2009. The car companies hope that domestic sales will rise to 11.5 million this year. In a double-dip recession, at least 1 million of those annual sales would be lost.

6. Trade

The nominal balance of trade would almost certainly drop, probably to a deficit of $25 billion a month, as the U.S. takes in fewer imports due to low demand for consumer goods and business inventory. Exports would also drop because an economic crisis in the U.S. would spread quickly worldwide. This is because of the tremendous size of the U.S. GDP in relation to that of any other country. The drop in imports would be a signal that business activity had slowed in China, the rest of Asia and Europe. Demand for consumer and business goods would drop in most regions, forcing a nearly universal cut in jobs outside the U.S.

7. Budget

The budget deficit would grow beyond the $1.5 trillion it should reach this year. Treasury receipts fell to $2.1 trillion in the federal fiscal year 2009 and are down to $1.7 trillion so far in the 2010 period. If history is any guide, receipts in a second recession could drop by as much as $200 trillion a year as tax receipts from both business and individuals falter. The demand on the federal government to render aid to the unemployed could add $50 billion to annual government outlays. Unemployment insurance will cost Washington $44 billion this year. As states run out of money to cover benefits, more of the burden could fall to the federal government.

8. National Debt

The rise in the deficit and a rapid increase in the American national debt would cause concern among the capital markets investors who purchase U.S. Treasuries. The inability of the Treasury to rein in spending will cause borrowing to increase. This in turn could bring the government's debt rating down, in turn causing U.S. borrowing costs to rise. Increasing costs will then raise the annual expenditure to run the government by increasing debt service.

9. Stock Market

If the performance of the equity markets in 2008 and early 2009 is any indication, the S&P 500 would drop from its current level of about 1,100 to a low of 676, which it hit in March 2009. This would take trillions of dollars off business balance sheets and from consumer retirement and brokerage accounts. Businesses would become less likely to invest in new plants, equipment and services. For individuals, many would see a large part of their retirement disappear. That would cause a huge drop in consumer spending as people attempt to preserve cash, perpetuating further drops in the stock market.

10. Banking

The effect on most of the financial services industry would be catastrophic, particularly at the regional and community bank level where a number of home and commercial real estate loans are held. The FDIC would be forced to borrow money from the Treasury to cover bank closings. The number of failed banks could reach the level of the savings and loan crisis during which over 700 banks and mortgage lenders were shuttered.

11. Interest Rates

As the great majority of economists have pointed out, the Fed has already dropped interest rates to zero. This means the central bank is out of ammunition.

http://finance.yahoo.com/career-work/article/110344/what-the-double-dip-recession-will-look-like

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