How will Washington solve the credit divide? | Notes from Jim Haughey

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Notes from Jim Haughey
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How will Washington solve the credit divide?

Jim Haughey

RCD Chief Economist

Dec 24, 2008

How the new Congress and the New President decide to balance reducing the pain of our neighbors and fixing the economy for the long term will determine how deep the recession is and how long it will take to get back to sustainable 3% plus economic growth. We will have the answer in a few months. Until then the economic outlook for 2009-10 is fuzzier than usual at the beginning of 2009. Democrats won the election by focusing more on the short term pain than on the long term growth of the economy. But all but the most progressive of them appear to realize that postponing the changes in the credit market required for long term growth is perilous.

The Reed Construction Data forecast assumes lot of speeches about relieving pain but also a grudging willingness to let unsustainable enterprises fail whether they be companies, banks, households or local government. Congress will provide enough money to rescue some but not all of the failed enterprises. This will halt the decline in overall spending no sooner than by the end of spring but at least by the end of summer. The recovery will be relatively slow with the economy able to sustain full potential growth sometime in 2011.

The construction market recovery will follow the same path. Expect a subpar market for two more years with a steep pace of decline early in 2009 and steady but subdued recovery in 2010.

While those below the credit divide struggle to survive in the next two years, it will be a great time to borrow if you have a prime credit rating. The amount of non-financial commercial paper continued to expand through mid-December and the interest rate has dropped to 0.3% from 2.05% in August. Similarly rates have declined 200 basis points for financial commercial paper and the amount outstanding has recovered from a brief plunge back to 70% of the August level which is back to the mid-2007 level. Over the same period 30-year mortgage rates are down 130 basis points and Aaa corporate bond rates are down 25 basis points.

Banks have added three-quarters of a trillion dollars to their excess reserves at the FRB and have parked even more in 0.0% return Treasury bills as they search for loan opportunities with prime borrowers.

During the recession, more households and businesses will fall below the credit divide. This will includes households that lose their job or suffer an income reduction and businesses and governments afflicted by the abandonment of foreclosed houses in their neighborhood. Washington will heart their cries for relief and debate whether to provide help. The balance between relieving pain and fixing the underlying economy will dominate federal policy discussions for several years. Every major proposal for changing the mix has the potential for altering the economic outlook for several years.