Eugene Weekly : Cover Story : 10.09.08


Economic Bridges Falling Down
Will Lane County suffer more or less than the nation?
By Bryce Ward and Ed Whitelaw 

The economy is in trouble. Big trouble. It’s hard to miss the signs. Home values are falling. In places like Phoenix or Las Vegas, a house purchased for $350,000 two years ago would now sell for $230,000, if the owner could find a buyer. Prospective home buyers can’t find lenders. Banks and financial institutions face the same problem. Institutions we recently assumed were rocks have turned to sand: Washington Mutual, Wachovia, Bear Stearns, Lehman Brothers — and they have plenty of company. Far too many workers have lost their jobs, and firms aren’t planning to hire anytime soon. 

Bryce Ward
Ed Whitelaw

And stock markets around the world are tanking. An individual who invested $1,000 in stocks only a year ago would hold about $700 today. Those who held assets in home and stocks a few months ago have seen over $10 trillion of their wealth disappear. This amount is larger than the entire U.S. national debt and nearly the value of everything produced in the U.S. last year. More telling, or more foretelling, we — households and firms, buyers and sellers, employees and employers, and local, state and federal governments — have seen trust and confidence disappear. And there’s the rub. Without trust in the economic habits, networks and institutions by which we borrow and lend, buy and sell, and consume and invest, we lose our confidence in tomorrow and so stop our economic activities today. 

As the economic troubles worsen, more folks turn to economists, asking: What the heck is going on? How did we get here? What’s next? How will this affect our local economy? 

The short answer to all these questions is straightforward but not reassuring: Economists, while having many opinions, don’t really know. Already, economists have spent thousands of hours dissecting this crisis, describing what transpired, identifying its causes and hypothesizing what could have been done to prevent it. And they will spend thousands, even millions more hours doing the same. But right now, in the moment, economists at best have some basic ideas about where we are, some broad agreement about the general (but not the specific) causes of the crisis, and wildly diverging (but mostly pessimistic) views about where the economy is headed.

What’s Happening? 

In brief, the U.S. economy, along with other economies around the globe, is in danger of grinding to a halt because borrowers and lenders can’t make deals. Few of us appreciate how vital the financial system is to the economy. As Wharton economist Justin Wolfers explains: 

The financial system does something pretty amazing: It converts your savings into productive capital. It’s a bridge between borrowers and lenders. When it works, it’s a beautiful thing: Your savings are redirected to help young couples buy houses, entrepreneurs turn ideas into innovations and employers invest in their workers. 

Wolfers’ bridge lets borrowers and lenders shake hands over credit deals. Without that bridge, those deals don’t get made. And without those deals, the economy is in deep trouble. Consumers and businesses can’t buy durable goods such as cars, computers, home furnishings and fixtures. And workers who make, transport and sell such products lose their jobs. Without credit, many businesses (and governments) cannot pay their bills or their workers and will have to cut back or shut down. Without credit, investment in the new equipment and the new ideas that generate new jobs doesn’t happen.

While the economy faces a number of problems ranging from declining house and asset prices to stagnant wages and rising energy and health care costs, the one that set off alarm bells and was the impetus for the controversial “Wall Street bailout” (aka TARP — the Troubled Asset Relief Program) was the breakdown of the credit market. TARP is intended to help rebuild Wolfers’ bridge, restore confidence, and revive the credit market.

Will TARP work? Will it rebuild the bridge? Few economists are enthusiastic about TARP. Some ultimately supported it because they felt it could help, but many feel that it will not solve the credit crisis because it does not address all of the root causes of the problems. 

The credit crisis appears to have developed from two problems. The first, the liquidity problem, stems from banks and other financial institutions having a large portion of their assets backed by bad mortgages. Understanding the problem and thereby seeking a solution is complicated in no small part because no one really knows how bad those mortgages are. With such pervasive and insidious ignorance, buyers and sellers can’t agree on prices at which they’re willing to trade these assets. So banks holding these assets can’t turn them into cash by either selling them or borrowing against them. They have what economists call a liquidity problem. Banks without liquidity are like gears without oil. Such banks are unwilling or unable to extend credit to others. And that’s real bad for them and for the rest of us. 

TARP is designed to solve this liquidity problem. Proponents argue that by removing these so-called “toxic” assets and replacing them with safe Treasury bonds, troubled firms could sell these assets or borrow against them and resume connecting lenders and borrowers. 

Skeptics argue, though, that simply removing toxic assets from bank balance sheets is insufficient to solve the credit crisis because there’s a second problem, a second source of the credit crisis: the insolvency problem. The banks may be insolvent. That is, many economists believe that even after selling their bad assets to the Treasury, many firms’ debts will exceed their assets. Potentially insolvent firms will not be able to borrow from other banks or attract investors (because insolvent firms are unlikely to repay their debts). Economists appear to be converging toward the idea that solving the credit crisis will ultimately involve direct transfusion of capital (or money) into troubled financial firms in exchange for a share of their future profits (although there is disagreement about how to actually do this).

Thus, the controversial bailout may help prevent catastrophe, but it may only delay the problems or slightly reduce the odds of them occurring. Ultimately, we still face several other problems, so don’t expect this program to magically solve all our economic problems or end any chance that we will have a recession.


What’s going to happen next? 

Under normal, fairly calm, economic conditions, forecasting is a formidable challenge. Under our current conditions, with so many important factors changing rapidly, it is nearly impossible. 

That said, it appears that the U.S. economy has already entered a recession or will be there soon. For those forecasters who’ve reached this conclusion, the main question begged how bad the recession will be and how long it will last. As recently as a few weeks ago, many economic wonks proffered forecasts of a relatively mild and short recession. But with each passing day, the ranks of the relatively optimistic forecasters have thinned, and the pessimistic forecasters have increased the chances of a severe recession. Granted, TARP needs time to work its way into the economy. But the credit markets still seem frozen, banks around the world continue to collapse and the stock market … well, you’ve been watching it.

At this point, economists are simply hoping that the recession will last less than two years and that unemployment will remain below 10 percent (it is currently 6.1 percent). To help put that number in perspective, a 1 percentage point increase in unemployment corresponds to an additional 1.5 million people looking for work. Former Treasury Secretary Larry Summers conservatively estimates that economic output will fall by 5 percent if unemployment should reach 7.5 percent (a number that would leave him “pleasantly surprised”). This amounts to an annualized reduction in GDP of approximately $750 billion or a average loss of $8,000 per family of four. Some families will lose more and others less, but this is a fairly significant shock to our economy (and it could be significantly worse).

What are the likely Effects on the local economy? 

It is hard to imagine any area escaping relatively unscathed from these worsening global economic conditions. Certainly some areas, like Wall Street or Phoenix, are likely to suffer much more than Lane County, but Lane County won’t get a pass. 

First, while the bursting housing bubble has not yet produced enormous declines in area property values, property values, are, on average, declining. From the peak of the housing market, which occurred locally in 2007, through last spring, house values fell by less than 10 percent. This represents a significant loss in household wealth (and welfare), and it is possible that housing prices will decline further (nationally prices are expected to fall another 10-20 percent). 

Second, anyone with significant savings invested in the stock market  — either directly or via a 401(K) — has seen their savings (and wealth) deteriorate. However, there is no reason to expect Lane County to suffer disproportionately from these effects.

Third, two major manufacturing industries and the construction industry are — or shortly will be — suffering. The collapse in the housing market has reduced the demand for lumber and wood products, and for construction workers. Similarly, the loss of wealth in households’ houses and stock portfolios has reduced consumer demand for large durables like custom RVs. 

There is, however, a bit of good news for the local area. Enrollments in universities and community colleges tend to surge during economic downturns. Granted, students’ incomes aren’t high, but we can expect more of them.


The authors alone are responsible for the views in this piece. Bryce Ward is a senior economist at ECONorthwest in Eugene. Ed Whitelaw is a professor emeritus of economics at UO and founder and president of ECONorthwest in Eugene.