[Editor: Once in a while, we promote a post from The Heartland Institute's social community, The Freedom Pub, to the main "house" blog. This is one of those times. Kevin R. Mullins' posts on the economy have been consistently smart and insightful. This post is no exception.]
There has been much discussion regarding the most recent recession, often referred to as “The Great Recession.” I have often felt that using the word depression may have been avoided due to the ensuing panic this would have caused.
Even though we are technically in an economic recovery, there are many statistics that clearly show that the recovery is not sustainable. I would like to explore some of the key data that has not received much attention by the mainstream media or economists.
First of all, we need to start with our Gross Domestic Product (GDP). I will spare you all of the details that comprise our GDP, but I do want to give one simple definition for you to grasp. Our GDP is simply the total economic output for our economy.
While most economists refer to the absolute level of GDP, there is one measure that has not received much attention and this is what I would like to share with you. The data is the measure of the percentage change in GDP versus the prior year. The graph below clearly shows that during the Great Recession, we experienced the largest decline in our GDP dating back to 1947.
If you look at all the past recessions (shaded in Gray), we have never experienced such a sharp decline in our GDP. Even during the Recessions of the 1970s, 1980s, and early 1990s, these all look mild compared to what we experienced beginning in 2008.
One last observation to conclude from this data is the percentage of growth in our GDP immediately following the Great Recession. Compared to prior recessions, the rate of growth is anemic at best.
One other measure of our economic health is the unemployment rate. The pace of the increase in our unemployment rate is the greatest we have experienced in such a short period of time since we began tracking data in 1947.
Below is a graph containing this data:
There are only four years in our history that the Unemployment Rate has exceeded 9%. This occurred during 1983, 1984, 2009, and 2010.
It should be noted that during the early 1980s, the unemployment rate was 7.5% before it accelerated to exceed 9%. However, during 2008, the unemployment rate was 5.75% before it accelerated to exceed 9%. In addition, the workforce was much larger during 2008 as compared to 1983 — and this further implies how dire our current prospects are for a sustainable economic recovery.
This leads me to what happened that caused our economy to experience such a material decline (GDP) and a resulting increase in our unemployment rate through the loss of jobs. There is one explanation that far exceeds all other arguments and this is the residential housing crisis that began in mid to late 2008.
Listed below is a graph that shows home ownership rates from 1984 to 2010.
As this graph clearly shows, the trend was relatively flat for home ownership until 1995. From 1995 to 2004, the rate of home ownership increased more dramatically than anytime in our history.
There are three reasons that contributed to this large increase. During the mid-1990s, our leaders in Washington defined the American Dream as “owning a home.” This sentence from every politician was common: “Everyone should have the right to home ownership.” For this to occur, there are three actions that were required.
The first action began with the Clinton administration and carried into the Bush administration — the use of the Homebuyer Tax Credits through the Internal Revenue Service. The Homebuyer Tax Credits enabled many people to purchase a home by using the tax credit instead of a down-payment. The tax credits increased in their appeal with each passing year and the requirements to qualify for the tax credit were eased.
In addition, many states offered their own version of the Homebuyer Tax Credits. With federal & state tax credits available for buying a home, this caused a dramatic increase in the percentage of Americans owning a home. From 1995 to 2004, the home ownership rate in the United States increased from 64% to 69%. Although the percentage change may be seen as insignificant (69% – 64% = 5%), the number of Americans owning homes was very significant.
The second action to increase the home ownership in the United States was the mandates placed by Congress on Freddie Mac (FHLMC) and Fannie Mae (FNMA). To be brief, Congress placed pressure on these two government-sponsored agencies to make their underwriting criteria more accommodating. This resulted in credit scores being lowered, down-payments being lowered and in some cases eliminated, and “loan-to-values” being Increased.
To make matters worse, there was a period of time where income verification was eliminated, known as the “Low Doc Program.” I find it appalling to see Congress criticizing both of these agencies when it was Congress that called for the relaxed underwriting standards.
The third action that attributed to the residential housing crisis is the Federal Reserve’s Policy of low interest rates and the Community Reinvestment Act (CRA). The CRA requires banks and other financial institutions to offer loans for low to moderate income families. In a later article, I will address the Federal Reserve’s monetary policy and the specifics for the CRA laws.
All of the above actions allowed Americans to own homes that could not afford to pay for them. With all of the new purchasers of homes in the market, this caused residential real estate prices to increase at a rate not seen in our history.
In conclusion, I will let you decide if the Great Recession felt more like a Great Depression. All of the above factors played a role in making our last recession, and the anemic recovery following that recession, more difficult than other recessions in our history.
If we had avoided these policies, it is evident that we could have avoided the Great Recession. When our government starts to interfere with the free market, the outcome is always unintended consequences.