Can We Get Real (Worse than we thought, Part II)?

The gloom-mongers at FT now turn to Europe:  Wolfgang Munchau warns that the worst of the Eurocrisis is yet to come.  His reasoning is simple:  All the bail-out plans for Greece, and for bond purchases to boost Italy and Spain, depend on those economies returning to growth.  But there is no sign of that.  Add that all major European countries have adopted austerity measures (e.g. counter-growth fiscal policies), and the European Central Bank is maintaining high real interest rates to head off inflation, and the Euro rescues seem bound to fail.

In the US, it increasingly appears that the signs of life the economy showed in Spring were transient, pushed by stimulus and the housing support program.  As soon as the latter expired, housing prices began to drop again.  Remember that the fall in house prices is what put us in this mess in the first place.  Banks still hold many billions of toxic assets backed by houses — as those houses suffer further price declines those assets grow more toxic.   Short sales and foreclosures are needed to dispose of those toxic assets. But they have a long way to go and they will depress house prices further as they do. This will set of a spiral of declining strength in the financial sector and then the economy across the board.

Here is what the latest Case-Shiller data on home prices shows:

“But this year, home prices in many cities have reached their lowest points since the housing market went bust more than four years ago.  Prices in Cleveland, Detroit, Las Vegas, Phoenix and Tampa are at 2000 levels. …  The pace of sales for previously occupied homes is trailing last year’s 4.91 million sold, the fewest since 1997.  …  Sales of new homes dropped in July for third straight month. This year is shaping up to be the worst for sales of new homes on records dating back to 1963. Foreclosures  and short sales – when a lender agrees to sell for less than what is owed on a mortgage – made up about 30 percent of all home sales last month, up from about 10 percent in past years. About 1.7 million potential foreclosures are being held up, according to real estate firm CoreLogic, either by backlogged courts or lenders awaiting state and federal probes into troubled foreclosure practices.” (Associated Press article from The Coloradoan, Sept. 2).

Yet the ‘plans’ for recovery and  budgets all assume we will soon be returning to healthy 2-3% annual growth.  This looks more and more like a fantasy, and plans made on this basis will fail.

We ‘stress-test’ banks to see if they can withstand adverse market conditions.  Shouldn’t we be ‘stress-testing’ the bail out and deficit strategies of the US and EU to see if they will survive 3 years of under 2% annual growth?  That looks like a plausible scenario, but right now the plans won’t survive that stress.

About jackgoldstone

Hazel Professor of Public Policy at George Mason University
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