Adam Posen: It's not too bad

The Global Credit Crisis: How Bad Will it Get? April 14, 2008

Adam Posen - Deputy Director, Peterson Institute for International Economics

Essentially, if you think about this from a historical perspective, you will often see lots of lines about "This is the worst financial crisis since the Great Depression," this is "the worst financial crisis since Rome overthrew Jerusalem," you know. You get all this sort of stuff. But it always seems like that when you're sitting in the middle of it. If you're Suharto in Indonesia, circa 1997 you think the world's coming to an end. If you're sitting in Japan in 1993, you think the world is coming to an end, and as Michael, I think very nicely pointed out, if you're sitting in the U.S. in the midst of the real estate crisis and the banking crisis of 1990-91, there were people who thought the world was coming to an end. And I guess it's showing my age as well as my hairline, but I make the point now where you have to say, "Show me why it's different this time." And to be honest, most of the reasons that people say why it's different this time to me, are not very persuasive. So let me give you four quick reasons why I think the U.S. is going to recover pretty quickly, and I don't think things are going to be too bad, and then, in the remaining one and a half minutes, just some broader takes on how that fits with some of the patterns Michael said.

The key point is, as Michael set it up, and this is where I think all of us are going to organize our thoughts and where we're going to differ, is how much you think this lockup in the Interbank money center credit markets affects the broader economy in the U.S.-what we call "the real economy"-and how much it affects the global economy around. And my answer on both of those is I think, not much. If I'm wrong, the GE announcement of yesterday probably will be seeing a lot of [some data?] Nouriel will mention, as the watershed moment. If I'm right, not only do I win the prize, but the GE announcement will just be remembered as one more brave act by GE to keep their stock prices up through honest.

So let's talk about what's going on. Whey isn't it different this time. Well, first point is housing bubbles come and go a lot, and there is evidence out there that they are sometimes costly to the real economy. But they're not costly to the real economy in the way people think. It's not automatic. It depends a lot on whether you're policymakers respond or not. And as we're all well aware, the Fed has been doing plenty of response. Real interest rates have come down; so then people will say, "Well, but they didn't come down as much as they would have usually." Flip that around. We're coming out of this enormous bubble. We're coming out of this enormous period of very loose credit. We've got all these financial problems, and the actual lending terms for most people on mortgages and loans has not changed. The Fed has actually done quite a bit to achieve that feat. If, as Michael says, his bank, fairly or unfairly, can't borrow as well as some high-yield borrower, what that also means is there is some non-financial corporation out there that's relatively small, in Montana, in Idaho, in Arizona, in one of those other funny states, that is pretty darn small and is still managing to go to capital markets and get money for its activities. The biggest difference, if you look structurally now versus then, now versus the eighties savings & loan crisis; now versus the '90-'91 crisis, is that we have more spare wheels. If you had asked me twenty years ago, fifteen years ago, "Oh my god, there's a lockup in the Interbank market, what do you think would happen?" of course my answer would be "We're doomed!" But we're now living in a world where a surprisingly large number of companies and even households can get access to credit without necessarily having to go through that whole chain that Michael was referring to. And if you look at what's actually going on in the economy, yes, there's some tightening of interest rates and lending standards, one would hope so after a multiyear boom and exceedingly low interest rates. But do they come to levels of credit tightening and interest rates and inability to get access to capital that we've seen in the past kinds of situations where we've had financial problems? And the answer is no. So that's the first one. People are still getting capital. Not perfectly. I'd really like to see people do something about the student loan market; I'd really like to see the government do something about certain parts of the mortgage market, but that's a very different thing than saying we're having a credit crunch of massive proportions.

The second thing is the U.S. is less important to the world economy than we used to be. So we always talked, and when Larry Summers, who Nouriel worked for and I did some consulting for during the Clinton Administration, why do we always worry so much about Japan then, for example? Well, because we knew Europe was, as the German say [plata?], which is just basically doing nothing and the Japanese were going down, and we were worried there was only one engine to the world economy. And then what happens? Well, ex-post we weren't but actually, like a good Boeing plane, one hopes, it can fly on only one engine. Japan shut down for 10 years and actually in the end, ex post, it turned out it didn't matter that much except to the Japanese. And what we're seeing right now to put the more positive spin on it is we're seeing enormous net export growth by the U.S. Decline in the dollar is having-it has some cost to it-definitely, we can talk about that, but it's having the expected effect. Which is suddenly, GE is more competitive than it was. Suddenly Caterpillar can continue to sell lots of tractors abroad.

Lots of things that were in the non-financial sector that were doing pretty badly in recent years, suddenly are doing pretty well. And this isn't just fantasy. If you look at the macroeconomic data, the growth in net exports in the U.S. has been larger than the decline in residential housing construction, as a share of GDP. This has been going on since mid-2006. And according to the Peterson Institute calculations for that they're worth, we see another full year, at least, of continued export growth. Now that assumes that the rest of the world keeps growing. And if you look around at the inflation issues around the world, and you look around at the glut of savings available in most of the emerging markets, and you look around at the opportunities that are out there, there's no reason to think that the world economy isn't going to keep growing. Now, there are-again, I don't want to pretend everything is perfectly wonderful-I would not want to be a Mexican working in the maquiladora sector heavily dependent on particular U.S. products. I would not want to be a Canadian trying to export to the U.S. as Loonie goes up hugely, that's the dollar. There's going to be some pay. But the idea that we're not going to be continuing to get several tenths of a percent of GDP a year out of next exports for the next couple of years, is wrong. And if we're getting that much, that's a very big factor of keeping us out of anything bad. Third point, policy. I already mentioned that I think the Fed actually, if more effective than people give it credit for. Again, there's plenty of Monday morning quarterbacking to be done.

One can make a case, if people are interested, I could go on this for hours. The ECB actually did a better job than the Fed this time. They were more aggressive earlier about injecting liquidity and not cutting rates and getting things done. But be that as it may, we have a huge monetary impulse; we have a huge fiscal impulse. Now, all of you in this room-I shouldn't say all of you, I shouldn't make that assumption-a number of you have just completed your taxes and some of you found out that you're not going to get the fabulous rebate that's been talked about in the press. However, tens of millions of Americans will. And all of our evidence is that they will spend roughly 40% of that rebated. And that's two-thirds of the singles package and the other third singles package is tax credits for small business to get capital and make investment. Which again, if there's lockups in the capital markets, that's exactly where you want to target your stimulus. To let the small businesses who would be most hurt by using access to collateralized bank lending, give them credit, get them more liquid. So actually, to my amazement, the American Congress and the Bush Administration actually put together an extremely good stimulus package in short time. I feel sorry for my friends in the Treasury who have been working around the clock signing all the rebate checks. But the fact remains we're going to get a very large buck. And for all the talk about people not spending it, all the evidence is that they do. Again, you can say it's different this time, why not? I'm out of time, so let me make just one more point. Michael mentioned Citigroup raising capital. And this is the core of the issue. We do have a bunch of banks, and shadow banks, non-banks, investment banks, broker-dealers-whatever you want to call them-who fairly or unfairly, are now under-capitalized. When I say fairly, what I mean to say is, markets make their decisions. If the stuff's under-priced out, it might have been over-priced before, so whatever profits they had in the past, might have been just as unfair as whatever losses they have now. Just got to deal with it. But the fact is, there are a lot of people out there who still want to put capital into these banks. And the challenge is going to be having the American government hold off on calls to inject public capital on the one side, and hold off on being nationalists and restricting foreign capital on the other, and try and let the market work.

One of the best things were doing, in comparison to Japan or comparison to what we did in the savings & loan crisis in the eighties, is we're letting people distinguish between the banks. We're [UNINTEL] see the better and worse banks, what the capitalization is. And that's your first step in working this out. Thank you.