For over a year economists I respect claimed this economy has hit bottom and is slowly recovering.  Yet long after the bottom is in we see unemployment anemic and even increasing.  While a recovery in employment does lag the economic recovery there are some differences in this cycle that should be recognized.

1. Higher minimum wages may not have affected employment during the boom but like any other higher price it will cause a decrease in consumption of jobs.  Only now is the real cost of the higher minimum wage  adding to the high unemployment.
2. Generous unemployment benefits discourage job seekers.  There is a longer term effect here as well: when someone has not worked for two years they become increasingly unemployable.  I have stated before that I never had an employee asked to be laid off…. until this recession.
3. We have accumulated onerous regulations for decades and this administration had added so many costly and uncertain costs that the small businesses have capitulated from exhaustion.  I have seen many small businesses shut down and very few start up. It is the death of fresh entrepreneurial activity that is causing such a slow recovery.  There is just too many barriers to entry such as tight credit, low collateral values, threats to wealth accumulation, and absurd regulations.  A high level of regulations is an advantage to large businesses who have the administrative structure in place to comply.  Unfortunately the job growth usually comes from the smaller businesses.
4. For a half century we have depended on the Fed to cover for the reckless fiscal policies of Congress.  This financial collapse has tapped out the ability of the fed to meet its dual mandate of stable money and low unemployment.   Instead of fulfilling a single mission well (sound money) it is proving ineffective at both missions.
5. While the tax cuts were extended, their future is still uncertain.  Businesses do not make long term investments without knowing the future return.  Today’s investments are tomorrow’s jobs.
6. The continuous jawboning about the wealthy does not attract investment to this country from within or abroad.  We have the most progressive tax structure and one of the highest corporate taxes in the G20, yet to this administration it is not enough.
7. The health care bill alone is killing more jobs that even the most pessimist estimates.  It is particularly harsh on small businesses where we usually see the biggest job growth at this time in the recovery cycle.

While economists can point to many recovery statistics that indicate that this recovery is following a similar path to previous recessions, it is foolish to ignore parameters that are making this one different.  Persistently high unemployment is largely a direct result of poor policy decisions. It can be corrected by reversing them.

(this was published previously in the Macon Telegraph)

Being in the middle of a record economic crisis presents a rare learning opportunity.  Several books are worthwhile for those seeking to understand what just happened.

Too Big to Fail by Andrew Ross Sorkin details the action of the Fed under Benanke and Treasury under Paulson during the crisis period between August and December.  While Geitner as head of the New York Fed was also featured the central player of this crisis was Hank Paulson.

Monumental decisions involving billions of dollars of assets were made in days, sometimes hours.  Both Paulson and Geitner had a sense that the market was due for a correction long before the crisis hit, but they probably did not see it coming as fast and as broad as it did. Bernanke noted that just as there are no atheists in foxholes there are no ideologues in economic crisis either. Neither Republicans or Democrats wanted to bail out Wall Street , but the crisis dictated actions that were against the grain of capitalists of both parties.

Paulson worked tirelessly to find appropriate merger partners for weak players like Merrill Lynch, Wachovia, and Lehman.  He almost had Barclays ready to buy Lehman when the British Financial Services Authority ( FSA) refused to approve the acquisition/merger because of the risk it brought to the British financial system.

Lehman was singular in the fact that it was not acquired or bailed out and thus had to go bankrupt.  Part of this was timing; Congress was just in no mood to bail out a Wall Street player.  Part of the reason was George Bush’s cousin who worked for Lehman and his brother Jeb’s association with the firm. Such close political relations probably worked against the interests of the firm.

In retrospect bailing our Lehman’s may have forestalled the panic that engulfed the rest of the system. With Bear Sterns gone and now Lehman’s gone, depositors wondered who was next and there began a run of the other banks like J.P Morgan and Morgan Stanley.

While Paulson’s association with Goldman was suspect the fact was he had to severe his tie and sell his stock ($485 million worth) in order to take his job at Treasury. Since his actions were so scrutinized he was careful to avoid even conversations that would indicate favoritism toward his old firm.

The most difficult decision was to bail out AIG whose credit default swaps acted as insurance against many of the cdo’s (collateralized debt obligations) that infected the financial markets. As the underlying assets plummeted in value AIG was downgraded and had to put up more capital that it could not provide.

Having to make such massive changes and decision in such short time meant that perfection was not obtainable. Barney Frank justifiably wanted some assurance that compensation to the executives would suffer from their misdeeds, but there simply was not enough time to rule of thousands of contracts during the time period that decisions had to be made.

Wall Street clearly engaged in risks it did not understand, but neither did the regulators such as Greenspan and his successor Bernanke. Complicated risk models gave the CEO’s delusional certainty, but eventually the party came crashing down for the same reason all bubbles burst;  lack of trust and confidence.

But Sorkin spends little space getting into the detail of the causes of the crash and suitably stays focused on the urgency and the actions required in response. 

For more information on the background that caused the crisis I recommend The Housing Boom and Bust by Thomas Sowell,  Financial Fiasco by Johan Norberg, most of all After the Fall: saving Capitalism from Wall Street – and Washington by Nicole Gelinas.

Sowell and Norberg focus more on the misguided Government fiscal and monetary policies that inflated the housing bubble, but Nicole Gelinas also analyzes which good regulations were unfortunately removed (and by who) and which bad ones were inappropriately applied.

A crisis of this nature required the perfect storm of many great errors to all focus their retribution at the same time. Unfortunately the media large engages in partisanship and demonization and few people will take the time to understand what happened and why.  It is complicated but engaging the problem reveals basic principles of sound policy that were violated as they were in previous bubbles.

History repeats itself but never the same way.

“Despite elite concerns of a public backlash against capitalism, it has been the public, not Wall Street or Washington, that has supported capitalism all along.  Financiers were disconcertingly quick to run straight into the governments arms, while the public has stuck up for markets and fought against taxpayer subsidy of failure. The hope for free markets is “political constraint,” says former St. Louis Fed president William Poole.”

“The public intuitively grasps unfairness when it sees it. In poll after poll, citizens have opposed bailout after bailout, not just for the banks but for their own neighbors.  This opposition is not a reflection of a heartless and mindless populism. Ordinary people understand that bailouts have perversely punished individuals and companies that acted responsibly, creating an incentive to act irresponsibly in the future.  They can perceive the difference between a government that acts as an honest, transparent referee of competitors and one that acts as a guarantor of perceived favorites.”

From After the Fall:  Saving Capitalism from Wall Street- and Washington by Nicole Gelinas

Wall Street’s financial leaders have been paraded before Congress to explain their efforts to restore stability to our financial system. Obama has turned on the populist spigot to demonize Wall Street to justify bigger taxes and fees and hip shot regulation.

Wall Street deserves the scrutiny and reform is needed.  Yet this fiasco was as much a government failure.  Fannie Mae was exempt from regulation by the SEC, FDIC and the Fed.  When Congress was solidly warned about excessive risks taken by the Fannies,they rejected calls to increase oversight, largely along party lines. Little protest is heard from the halls of Congress over some of the huge bonuses paid to Frank Raines and others at Fannie Mae while the system was imploding.

Some recent regulations such as the mark to market rules made this crisis much worse than it would have otherwise been.  Other regulations such as control  of derivatives  by the Commodities Futures Trading Commissions were removed (under Clinton) at a pivotal time. The Fed ’s monetary policy was also a factor.

A hearing to truly understand what happens and what needs to be done would have our Congressmen on the other side of the microphone.

The poor business environment is driving down wages and costs, but inflation looms because of the government’s record deficit.  Record low interest rates are not having the desired effect because the recession is more due to political policies than economic. Business owners are not hiring and growing despite low interest rates because pending legislation such as the Union Card Check bill, Cap and Trade, healthcare reform substantially raises their risk of and costs.

Low interest rates weaken the dollar causing industrial commodity prices to rise.  If the Fed raises interest rates, especially in the midst of a record high unemployment, they risk driving business into a double dip recession.  If they keep interest rates too low for too long they risk creation of another bubble.

The Fed is betting that they can time the change in interest rates and the money supply so precisely that can avoid another recession and inflation. They have failed at this before with less uncertainty and extremes in the market.

The Fed may need magicians rather than economists to succeed this time.