"making the 2008-2009 contraction in consumer spending the longest since WWII."

Rebecca Wilder on News N Economics:

"Beating down the consumer

Consumers have been under extreme duress throughout 2008. Energy prices surged on oil until it fell below $100/bbl in September, which is the month when the labor market took a significant turn for the worse, and the housing market continues to tumble. Not surprisingly, consumers are pulling back. They would have pulled back more were it not for those credit cards, and the decline may continue for two more quarters (three consecutive quarters), making the 2008-2009 contraction in consumer spending the longest since WWII.

(Click to enlarge chart)

The chart illustrates annualized real personal consumer spending (PCE) growth on a quarterly basis spanning the years 1947:1 to 2009:2 and includes Macroeconomic Advisers’ latest forecast (see their website, which must be opened in Explorer and is a paid subscription; email me if you would like a copy). Going forward, consumer spending is expected to mark three consecutive quarters of decline: 2008:3, -3.8%; 2009:1, -2.6%; 2009:2, -0.1%. Sicne 1947, this would mark the first time that consumer spending fell three consecutive quarters.

It is remarkable that the depth of the decline in consumer spending does not make history as well. The forecasted accumulated loss of 1.1% (not annualized) is smaller than the 2.4% that occurred in Q1 and Q2 of 1980, when real PCE fell by an annualized 8.6% in the second quarter. Nevertheless, consumers are cutting back, and will continue to do so into 2009. Note: an annualized growth rate is the annual rate of growth that would occur if each quarter averaged the same amount of quarterly growth. The accumulated growth is the total reduction in spending over the consecutive quarters of PCE decline (the total % loss over Q1 and Q2 in 1980 for example).

Consumers are stressed in 2008 and 2009

Prices, labor, and housing have kept consumers on edge. Oil hit its peak in July and remained above $100/bbl throughout September. Energy prices seriously restricted consumer purchasing power, and spending was cut (reluctantly). Since September, job loss has quickened. The carnage that occurred in the labor and housing markets – around 1.3 million jobs lost since September and the ongoing destruction of housing wealth - is passing through to consumer spending. Consumers are getting a break at the pump – oil was just $34/bbl ending on 12/19/08 – but that is only a minor offset the negative forces currently underway.

Prices played their part

This chart illustrates monthly nominal and real PCE growth from January 2007 to November 2008. In the spring of 2008, nominal and real PCE growth turned negative on average. This was a sharp turn for the worse relative to the average positive PCE growth in 2007.

Seesawing prices have certainly played their part. From January 2008 through August 2008, real PCE growth was greater (less negative) than nominal PCE growth because prices were rising quickly and consumers were holding on as best they could. Since September, weak economic conditions and a masive job loss have driven down headline prices (-1.7% in November), and real PCE gains were smaller than expected. Nominal spending dropped relative to real spending, which grew just 0.6% on the sharp price declines (PCE price index fell 1.1%). Whatever the underlying catalyst, consumers are cutting back hard.

Why has consumer spending not fallen by more? Credit cards

This chart illustrates consumer bank lending, credit card and other (non-revolving) loans, since Christmas of last year. During the first half of 2008 through June, revolving credit was rather stable and other consumer loans were growing. However, since July revolving credit has surged, and other consumer credit has stabilized, if not declined. Many consumers are living on their credit cards, and have been since July.

It is possible that consumer credit takes a stochastic tumble, which would drag down the forecast of consumer spending (see forecast chart above).

Consumers are in trouble. The economy is in trouble. No wonder SpendingPulse called the 2008 holiday shopping climate one of the worst in modern times. It is not surprising that consumers are cutting back: prices, credit, labor, and housing have wreaked havoc on consumer spending. But this cutback is setting up to be the worst in modern history."

Rebecca Wilder

I'm not as negative going forward for a few reasons:
1) Falling prices have actually increased some people's buying power.
2) Some savings increase is a good thing.
3) I believe that employment will pick up next year.
4) Some kind of stimulus will occur next year.
5) Refinancing of homes will lower some people's debt and payments.
6) The Fear and Aversion to Risk will abate next year.
7) At some point, people will realize that this is not as bad a time as the early eighties.
8) Housing prices will stabilize, and, in some markets, begin rising again.
9) The Bush Administration will be history.
10) The Saver Countries will make great efforts to preserve this current unbalanced system, which will remain in place indefinitely because it suits us.
11) The government guarantee will be total.
12) Prosecutions for Fraud will increase.
13) The war in Iraq will begin winding down for us.
14) Spreads on Bonds will have drastically decreased helping funding as the Fear and Aversion to Risk subsides.
15) Inflation will begin, making people feel that they're back in familiar territory.
16) Investment that had been going into housing will go into areas that have been lacking funding.
17) The CDO and CDS markets will functioning.
18) Millions will have read this blog and believe me.

"But in the current financial crisis, I believe a bailout is warranted

An excellent post this week on the Big 3 Bailout on the Becker-Posner blog. First, Posner:

"Becker has laid out the case for refusing to bail out GM, Ford, and Chrysler. It is a powerful case, and if the drop in auto sales that is driving these companies toward insolvency had occurred two years ago, there would be in my view no case, other than a political one, for a bailout. But in the current financial crisis, I believe a bailout is warranted, provided that the shareholders and managers of the companies are not allowed to profit from it."

That's basically my position.

"The likely psychological impact of a bankruptcy of the U.S.-owned auto industry should not be underestimated. Already consumers, rendered fearful by repeated misinformation from government officials concerning the gravity of the economic situation (including their reluctance to acknowledge that the nation was even in a “recession,” long after it was obvious to the man in the street that we were in something worse), are reducing their buying, precipitating big layoffs in the retail industry, which in turn reduce buying power, which in turn spurs more layoffs. This vicious cycle would be accelerated by the laying off of hundreds of thousands of workers in the automobile industry, including employees of suppliers and dealers as well as of the manufacturers.

The U.S.-owned auto industry may be doomed; it may simply be unable to compete with foreign manufacturers (including foreign manufacturers that have factories in the U.S.); or a reorganization in bankruptcy may be the industry's eventual salvation. But the automakers should be kept out of the bankruptcy court until the depression bottoms out and the economy begins to grow again. (Recall that the government bailed out the airlines after 9/11, allowing United Air Lines to have an orderly bankruptcy reorganization beginning the following year and ending in 2006.) Any bailout, however, should come with strict conditions, to minimize the inevitable moral hazard effects of government bailouts of sick companies. The government should insist on being compensated by receipt of preferred stock in the companies, on the companies' ceasing to pay dividends, and on caps on executive compensation, including severance pay."

An absolutely first rate piece of Political Economy and Economics. Read it all.

Now Becker:

"Bankruptcy would help GM and Ford become more competitive by abrogating significant parts of their labor contracts with the UAW. One of the greatest needs would be sizable reduction in their health costs through sharp increases in the deductibility and co-payments, and a reduced coverage of medical procedures. Bankruptcy should also help bring the wage rates of GM and Ford in line with those of foreign producers in the US. Some of their pension liabilities may be shifted onto the Pension Benefit Guarantee Corp, but even that would be preferable to an overall bailout.

A good analogy is what happened to United Airlines. By entering bankruptcy it was able to reduce its inflated cost structure by breaking contracts it had with the pilots union and other employee unions. It exited bankruptcy a slimmer and more efficient airline. Whether it is able to compete effectively in the long run is still not certain, but it is in much better shape to compete than before it entered bankruptcy.

Bankruptcy may also force out the current management of GM and Ford. I do not know for certain whether they have competent management- GM surely did not have top management for much of its recent history. I do believe, however, that when a coach of a team loses a few games, he might legitimately explain that by injuries, bad luck, or even bad officiating. These excuses become lame when he consistently loses many games, and the correct and common practice is then to fire the coach. The same considerations apply to top management. When a company consistently does badly while some of its competitors (like Toyota) are doing well, its time to fire the management team, and see if another team can do better.

Is GM "too big" to fail? I do not believe the company is too big to go into a reorganization-which is what bankruptcy would involve. Such reorganization would abrogate its untenable labor contracts, and give it a chance to survive in long run. A bailout, by contrast, would simply postpone the needed reforms in these labor contracts, the business model of GM, and its management."

Oddly, I agree with this as well. I accept Posner's reasons for a bailout as opposed to bankruptcy, but I would include Becker's points as conditions of the bailout.

1) Renegotiate contracts
2) Replace management

These onerous conditions, as well as Posner's:

3) Shareholders do not profit by it

This seems to be very similar to the Samuelson and Sachs post earlier.