The $700 Billion Bailout Will Not Stop A Recession

September 25, 2008
The generally accepted definition of a recession is:  A decline in economic growth that lasts six months or longer, that is preceded or accompanied by increasing unemployment, reduced consumer retail spending, and the slowing of housing and car markets.  In other words, economy activity is no longer expanding.

Unemployment hit 6.1 percent last month, car sales are way down, and housing is in the dumps.  While technically it is still just an economic slowdown, since the National Bureau of Economic Research has not made the call, to a whole lot of us it sure feels like a recession.  We may not have reached the point where GDP has actually started to decline yet, but it is just a matter of time because of the rapid increase in oil prices we have experienced recently in addition to the prolonged increase over the last few years.

The $700 billion bailout for Wall Street and the financial industry is being peddled as the only way to stop our country from falling into recession.  The truth is, the very best the bailout bill would do is prolong the point where we actually experience negative GDP growth for a short while.  It is really, after all, just another stimulus package that is intended to jump-start the economy, like the tax rebate checks earlier this year only MUCH bigger.

The bailout may even delay the start of a recession for a quarter or, if we are really lucky, two or three quarters.  But, if we do not address the underlying cause of the slowdown in consumer spending and rising unemployment that we have been experiencing for at least two years already, it will be even worse when it finally does happen.  Didn’t we learn this lesson back in the 70’s - has everyone forgotten already?  The true root cause is high oil prices, plain and simple. 

If we do not attend to oil prices quickly, this recession will be as bad and last as long as the one that began when Jimmy Carter was President, which caused massive economic damage and took years for Ronald Reagan to repair.  We must permanently bring down the price of oil and there is only one way to do that, increase domestic production as much as possible and as fast as possible.

Anyone who isn’t rich understands that tens of millions of households have to cut back somewhere in order to make ends meet after paying for higher gas prices.  That somewhere is called discretionary spending, things that would be nice to have but don’t really need, things you do need but can delay purchasing for a while, going out to eat, going to the movies, ball games, weekend trips, family vacations.  At the same time, high gas prices cause transportation costs to go up and increase the price of everything from food to raw materials to finished goods, which results in even less discretionary spending.

Less discretionary spending by that many people makes retail, restaurant, and service business sales suffer.  When slowing sales, combined with rising costs for goods, squeeze business profit margins sufficiently, they have no choice but to start laying people off, raising prices, or both.  When businesses have to raise prices or people lose their jobs, it begins a viscous cycle as households have to cut discretionary spending even further and then businesses have to cut back even more.

At some point, as gas prices continue to rise and prices for everything else go up as a result, there just is no more discretionary spending to cut back on and households stop saving.  When tens of millions of households stop saving, banks have less money to lend and interest rates increase.  Higher interest rates cause business costs to go up and prices to rise even more.  Households have to cut back even further or start to dip into their savings.  Dipping into their savings means banks have even less to lend and interest rates go up even more, starting another viscous cycle leading to more job losses.

Rising interest rates ultimately hit homeowners with adjustable rate mortgages.  Since they have no more discretionary income to pay for the increase, and they have used up their savings, they fall behind, eventually default, and end up in foreclosure.  If they are among the people who also lost their jobs because of the economy, it happens much sooner.

Although oversimplified because it doesn’t discuss the reasons for the housing bubble, trade deficits, the shadow banking system on Wall Street, and several other factors that were also involved, that is basically how we got where we are now and why the bailout isn’t going to fix the structural problems that will still exist in the economy.  At this point, too many people are on the edge of a precipice.  We are going to have a recession no matter whether the bailout happens or not.  The only questions are when it will start, how deep it will be, and how long it will last.  The only solution to minimizing the effects of the recession is to create at least a million new, good paying jobs and keep our money here at home by drilling for as much oil and natural gas as we possibly can as quickly as we possibly can.