Shakespeare noted that “hope springs eternal in the human breast,” but sometimes people take it to ridiculous extremes.
A wire service story last week provided an example with this opening line: “Ben Bernanke bluntly warned Congress it risks a recession, with higher unemployment and increased home foreclosures, if it fails to act to bail out the financial industry.'”
The story factually reports Bernanke’s statement. But in implying that if Congress does act, we won’t have a recession, the Federal Reserve chairman’s statement seems wildly divorced from reality. Take it from me, we are going to have a recession. We probably are in one already.
The only unknown will be whether it will be a bad recession or an extremely bad one. People who still believe our country will somehow bounce back to 2005, with home prices rising and households spending merrily, are just plain nuts.
Economic theory, even the sophisticated sort that wins Nobel prizes, remains remarkably useless in forecasting the future. But history provides valuable lessons.
No nation in modern history has experienced a financial crisis like ours without a subsequent recession. In U.S. history, there were severe crises in the 1830s, in 1873, 1893, 1907 and 1929. Recessions followed in all cases.
The current crisis in the financial sector is the worst in the lifetime of most living Americans. It is as severe as any before 1929. It may approach the scope and depth of that historic collapse. (That does not mean, however, that the ensuing recession need be anywhere as severe as the Great Depression.) It already surpasses 1929 in complexity, as U.S. household and government debt levels and U.S. international financial flows are far more out of whack than in 1929.
Current problems are comparable to those faced by Korea or Thailand in 1997 or by various European governments when the European Monetary System blew apart in fall 1992.
They are as bad as Sweden suffered in 1992 after letting its own real estate and securities bubble develop from the late 1980s on. That particular crisis led to a three-year decline in Sweden’s gross domestic product and unemployment rising from less than 2 percent to more than 12 percent. The bailouts cost the Swedish treasury some 6 percent of GDP. It left the Swedish government in temporary control and ownership of the banking system for an extended period.
So yes, we are going to have a recession. It is likely to be a severe one. Things are going to continue to get worse for an extended period of time before they begin to get better.
The question now is not whether we can stave off a recession, but whether we can lessen its severity. In a financial crisis, public officials feel they need to err on the side of optimism, to avoid further downward pressure on public confidence.
But while hope may naturally spring eternal, it is never wise for a household or business to delude itself about what is likely. Realists survive hard times better than dreamers.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.