State of the Union January 2009

The Issues: The Economy

Megan McArdle and Ryan Avent compare recessions and depressions, revisit the housing bubble and the banking crisis, consider the future of the 401(k), and ponder whether Obama can prevent a repeat of the 1930s

RYAN AVENT: I don't think that's the case
I think it's easy to see, for instance, how the current failures of our social safety net have made the recession more painful

MEGAN MCARDLE: Look, I'm sure that there are small-government conservatives who do view this as an opportunity to get some items on their ideological wish list (though I think they're bloody-well deluded)
But I don't think it's in question that Democrats are finding that the financial crisis calls for—pretty much exactly what they already wanted to do

RYAN AVENT: But if one were to think that what they wanted to do was largely good policy, then that's ok, right?

MEGAN MCARDLE: Note that the tax cuts, which are pretty much the quickest way except certain fiscal stabilizers to get money out there, are probably going to be trimmed back because of congressional opposition

RYAN AVENT: Some of them, and based, I think, on valid concerns about their potential effect

MEGAN MCARDLE: Just as the small-government conservatives think their agenda is good policy
But no one's idea of good policy is very much related to the actual events
I myself am definitely in favor of things like extended unemployment benefits and other automatic-or-not safety net things designed to ease the problems
of a contracting economy
I am almost ready to sign onto a WPA-type deal
But I'm no fonder of universal health care than I was six months ago

RYAN AVENT: I think some of the things Obama is looking to include in the plan might not necessarily address the immediate crisis (except for their stimulative value) but are closely related to the issues that got us into this mess

MEGAN MCARDLE: At any rate, I wasn't trying to get into a debate about which side had purer or better motives
More to say that I don't think the crisis makes it any more likely that we're going to deal with our giant entitlement program problem
I think it's likelier to go in the other direction -- more projects that last a long, long time, though I don't know what the modern equivalent of the TVA is
The troubling thing is that I think in some ways Obama has a much harder problem than FDR
Better economic knowledge, to be sure

RYAN AVENT: I guess I'd just say that a lot of things contributed to the current mess, but Social Security wasn't one of them

MEGAN MCARDLE: (Thank God there will be no NRA)
I don't think it did
I just don't think we'll fix it, either
And it does need to be fixed, less because of the cost, than because of the loss to the economy represented by 80% of the over-65 set not working
And Medicare, even more so, both because of the cost, and because its structure is a horrifying anachronism that costs more and delivers less than it should

RYAN AVENT: Let me ask you this--
if we see continued deterioration in economic datapoints, does that make Republicans in Congress more likely to cooperate with Obama, or does it galvanize the opposition?

MEGAN MCARDLE: That depends on how long the deterioration lasts
I tend to agree with other pundits that Obama has about eighteen months of free pass, during which it can all be blamed on Bush
But if the economy hasn't improved by midterms, the Democrats are very likely to lose both houses
If, like me, you're essentially a pessimist who doubts the government can do much in the teeth of these things other than alleviate the pain, then what you need to know is whether we're in 1932 (as many jubilant lefty twitters proclaimed on election night), or 1930
If the former, Republicans will shape up and go along
If the latter, they'll get more intransigent and kill at the polls

RYAN AVENT: Well, unless we're on an accelerated time scale, we're in 1930.

MEGAN MCARDLE: Then Obama had better hope hard that I'm wrong and stimulus is very effective
Or that this thing isn't as bad as it looks right now
Neither would surprise me

RYAN AVENT: You know, for whatever reason I'm a little more optimistic than I was a few weeks ago
I think part of it has to do with the fact that credit markets are coming unglued
And part of it is that we survived the interregnum
It's interesting to go back and look at data from late August
It actually looked pretty decent
It's hard to know how much damage has been done thanks to the financial collapse

MEGAN MCARDLE: There are two views, I think
There's the view that we had a short, sharp, panic, and will now have to live with lower growth, but survive
Then there's the, "It's not quite clear what led to the second banking panic . . . ", which haunts my sleepless nights

RYAN AVENT: Right

MEGAN MCARDLE: One candidate: Option ARMS. We're in a lull right now
The subprimes have already mostly reset. But the option ARM swell is due to start later in the year and peak in 2010.

RYAN AVENT: It's also interesting to read magazine archives from 1930. Suffice it to say, they thought a turnaround wasn't too far off

MEGAN MCARDLE: So, the housing market
Bottomed, or not?
You're a homeowner, right?

RYAN AVENT: Yes
I'm the guy who bought high, and who would now like to sell low
My hope is that we'll begin to see some markets recover

MEGAN MCARDLE: Oh, dear

RYAN AVENT: That's what we were seeing in August

MEGAN MCARDLE: When did you buy?

RYAN AVENT: 2005

MEGAN MCARDLE: Ouch
Although, at least DC has secular gentrification

RYAN AVENT: Right, there are worse places I could have bought

MEGAN MCARDLE: It's amazing how much the DC market was affected by the bubble
As you may know, I just moved

RYAN AVENT: I saw that

MEGAN MCARDLE: We finally settled at 9th & Florida, but we wanted Bloomingdale
The weird thing is that Bloomingdale was bubblier than U Street in rents
Tiny little houses supposed to rent for $2500 a month

RYAN AVENT: Interesting
A nice area, but there's not much there at the moment

MEGAN MCARDLE: People are clearly pricing to their overpriced mortgage payments
Not the market demand

RYAN AVENT: People will tell you that the rental market here remains hot, though

MEGAN MCARDLE: Most properties are well priced
But in the bubbliest areas, like Bloomingdale, which still doesn't have the services to support high rents, there's a lot lingering on the market

RYAN AVENT: Of course, Washington also has the lowest unemployment of any metropolitan area in the country

MEGAN MCARDLE: The house next to mine was just repriced from $500,000 to $350,000
You and I have a clear conflict of interest: I want to buy in a couple of years, so I'd like it to fall further
But alas I fear you're right

RYAN AVENT: You probably have 12 more months of falling prices, at least

MEGAN MCARDLE: The rest of the country, however
What do you see happening?

RYAN AVENT: It looks very bad
Particularly now that some places are also seeing falling rents
And commercial real estate defaults are piling up in some local markets
Now, the bright side in places with lots of foreclosures, is that bank sales are so dirt cheap that some buyers are coming back into the market
But a lot of areas are just plain old overbuilt

MEGAN MCARDLE: I think that's the key here
There's simply an overhang of housing inventory that is going to take years to absorb
As Arnold Kling has repeatedly pointed out

RYAN AVENT: It's a wonder to me that the fallout in some of these areas, economically, hasn't been worse
And maybe on the ground it looks different
But you have whole areas in California where whole neighborhoods are empty
I don't know how the local governments haven't just shut down
And left the city to become a ghost town

MEGAN MCARDLE: It looks like some of them may have to
Have you been following the pensions crisis?

RYAN AVENT: Some

MEGAN MCARDLE: CalPERS lost a mint in real estate, among other things
Pension contributions are going to go way, way up for local governments

RYAN AVENT: We can tie this back to our entitlement discussion
What are you doing with your retirement?
Do you still have faith in 401(k)s?

MEGAN MCARDLE: I think all three possible retirement options have massive problems
401(k)s are problematic because individuals have a hard time bearing catastrophic risk
Governments set up systems with very bad incentives and don't control costs
And companies are prone to failing
If I had my druthers, I'd set up a system that combined forced savings with a guaranteed minimum retirement income
Something like Chile or Sweden

RYAN AVENT: Right

MEGAN MCARDLE: Social Security is far too generous and comprehensive
But I don't think that you can simply leave people entirely on their own
I feel the same way about Medicare: to the extent it's needed, it should be part of Medicaid
Providing care for the truly indigent, not subsidizing greens fees and visits to the grandkids
But this is a very unpopular view

RYAN AVENT: Especially among retirees

MEGAN MCARDLE: And has approximately the same chance of being enacted as my plan to subsidize female economics journalists over 6 feet tall

RYAN AVENT: And especially now
So long as there's gender equality

MEGAN MCARDLE: Ah, coalition building! Perhaps we could log-roll a bit with the vertically challenged sportswriters

RYAN AVENT: I think the long-term societal effect of this crisis is going to be significant

MEGAN MCARDLE: Undoubtedly
But in what way, specifically?
Do we end up with more government, less government, or different government?

RYAN AVENT: Well, I think you're going to see major changes in investment behavior
More government, previous arguments notwithstanding
I think you're going to see major changes in familial structures, as boomers struggle to retire
The return of the three generation household
Things of this severity linger, though
Perhaps a long-term shift in the relationship between state and federal government
Better novels?
Who knows?
But I can already detect changes in my long-term expectations, and priorities

MEGAN MCARDLE: Such as?

RYAN AVENT: Most folks under the age of 50 had no idea what a bigtime downturn was going to be like
I'm more risk averse
Discussing professional decisions with my wife, it's clear that we're much more concerned about not exposing ourselves to disaster

MEGAN MCARDLE: Yes
I'm much more concerned with paying down debt—even low-interest debt, like my ridiculously underpiced student loans
Building up an enormous reserve fund

RYAN AVENT: Enormous, eh?

MEGAN MCARDLE: Well, enough to live on for a year
The two-journalist couple is one of those foolish financial decisions you can't help making

RYAN AVENT: Not much better than the journalist-public teacher couple

MEGAN MCARDLE: I think over the next year, you're going to see a lot more home entertaining, a lot less dining out and drinking out

RYAN AVENT: I'd say I should have followed my classmates into investment banking, but that doesn't seem quite right

MEGAN MCARDLE: :)

RYAN AVENT: Yes

MEGAN MCARDLE: A lot less travel
One of the things you notice in the 1930s is the ads aimed at middle class women who are obviously learning to entertain without servants

RYAN AVENT: Yes, it broke our heart to fire Jeeves
But I think you're right

MEGAN MCARDLE: My favorite is the Toastmaster series on "make your own toast" parties
Because if there's one thing that entertains guests, it's toasting their own bread before spreading on the potted meat
The theater crashed and the movies took off
I'd bet the video game industry actually does very well out of the recession
Especially the Wii

RYAN AVENT: I do love my Wii

MEGAN MCARDLE: We should play online!

RYAN AVENT: We should, I'm really good at Mariokart
Another question concerns the geopolitical fallout
Last time we had a Depression, the international scene changed quite a bit, and not for the best
Do you think there's a risk of catastrophic political collapse in, say, China?
Growing unemployment there does not bode well

MEGAN MCARDLE: I think China is a big unanswered question
No one knows if they can grow slower, or if a hiccup will cause the whole thing to melt down either economically or politically
They need to create something like 20 million new jobs a year to prevent civil unrest
A bad sign is that people from the cities seem to be moving back to the countryside for the first time in a generation

RYAN AVENT: Indeed.
I guess one question is how far the government will go to protect output and exports

MEGAN MCARDLE: How far can they go?
They could be selling televisions for $100, and my household would still pass it up in favor of savings
Or at least, putting in real dining-room chairs
Well, maybe not $100
I AM living with a film critic
But we were not tempted even by the deep holiday discounts

RYAN AVENT: What do you build when no one wants to buy any of your stuff anymore?

MEGAN MCARDLE: China needs to build up domestic demand
And I'm not sure how that's going to work

RYAN AVENT: I agree, but it's hard to do that with rising unemployment
Unless they just start cutting big checks to Chinese families
Which, actually, would be nice

MEGAN MCARDLE: Russia and Iran are possibly even more worrying problems
China doesn't have a good target for a chest-beating invasion to deflect their domestic economic woes
Though I suppose I wouldn't buy real estate in Taiwan right now
But Russia and Iran are both suffering mightily from falling commodity prices, and both have a history of local imperialism

RYAN AVENT: Right
We could look elsewhere, too
Things begin to look much scarier when the global pie is no longer increasing
That seems like a positive note on which to end, no?

MEGAN MCARDLE: Well, let's find a positive note
What good came out of the thirties?

RYAN AVENT: Ok

MEGAN MCARDLE: Shirley Temple movies?

RYAN AVENT: Fitzgerald?

MEGAN MCARDLE: He was washed up by the thirties
The Jazz Age was his era
Actually, I'd say there were a number of positive developments in the 1930s
The movie musical

RYAN AVENT: Which has been enjoying a resurgence

MEGAN MCARDLE: Many of the labor-saving home devices we now enjoy
Television
(As a developed medium)
Commercial aviation
Help me out here . . .

RYAN AVENT: Um, the social safety net?
It wasn't a very pleasant decade

MEGAN MCARDLE: Really fun little hats!

RYAN AVENT: Eleanor Roosevelt!

MEGAN MCARDLE: I suppose the best we can hope for is this:
People rebuild their savings and learn to entertain themselves with stronger ties to friends and family

RYAN AVENT: And hopefully don't try to conquer Europe

MEGAN MCARDLE: Yes
Any readers who are planning to conquer Europe should stop that right now
Particularly if they are bad pop musicians
On that note, we should probably end this dialogue
And get back to increasing GDP

RYAN AVENT: Maybe this time next year, we'll be chatting about the depression that wasn't

MEGAN MCARDLE:From your lips to God's ears

Megan McArdle, an Atlantic associate editor, blogs at meganmcardle.theatlantic.com. Ryan Avent is an economist, consultant, and writer who regularly contributes to The Economist's Free Exchange.
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