Martin Feldstein Calls a Downturn, Takes Issue With Government Statistics

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Martin Feldstein, who as a Chairman of the Council of Economic Advisers under Reagan and an advocate of Social Security reform, has been a surprisingly open critic of the Fed’s and Bush Administration’s responses to our current economic woes. Feldstein has been regularly writing op eds opposed to some of the viewpoints and actions of those in the driver’s seat. For instance, last month he wrote in the Wall Street Journal against further rate cuts, arguing they’d do little to stimulate growth but would be effective fuel for inflation. Feldstein, who now chairs the National Bureau of Economic Research, has said that the economy started into recession around the start of the year and expects it to last longer than the normal slowdown, a view which no doubt endears him to the officialdom in DC.

Today, in a comment in the Financial Times, “Misleading Growth Statistics Give False Comfort” (and a pointed contrast to Edward Lazear’s whopper, that the ‘data are clear” that the US is still in growth mode), Feldstein goes through the stats in more granular detail to demonstrate that the downturn is in progress (and gives a useful side lesson in how certain figures are derived).

He also urges more aggressive action and suggests an elegant-sounding solution: let borrowers refinance out of their mortgages into lower-interest, secured, but full recourse loans. The problem with this idea is that in most states, only purchase money mortgages are non-recourse. Refis (and half the subprimes were cash-out refis) are recourse loans. They are de facto non recourse because the costs of going after deadbeats are high (or higher) than recoveries, so pursing them isn’t a very attractive economic proposition. Making new loans full recourse thus is an illusory improvement.

From the Financial Times:

Prepositions matter. The recent government report that US gross domestic product inc reased 0.6 per cent in the first quarter was very misleading. It implied that economic activity was rising in January, February and March. But the increase actually refers to the rise from the average level in the fourth quarter of 2007 to the average level in the first quarter. Monthly data since January indicate that economic activity and GDP have been declining since the start of this year.

Private sector payroll employment peaked last November and has fallen five months in a row, shedding more than 300,000 jobs. Industrial production was lower in March than in December and January. Real personal income net of taxes and transfers is also lower than in January. Real retail sales have fallen since the start of the year. Private housing starts are down 13 per cent in just the two months since January and 36 per cent from a year ago.

Although the government does not provide monthly estimates of GDP, Macroeconomic Advisers…estimates real GDP based on the price level of the year 2000. Its most recent estimates (revised figures to be published this month) show that real GDP rose from an annual $11,649bn last October to $11,701bn in December and $11,777bn in January but fell to $11,686bn in March, a decline of about $100bn in two months. Although GDP declined during the first quarter, the average of the monthly figures in the first quarter ($11,711bn) is higher than the average of the monthly figures for the final quarter of 2007 ($11,675bn).

The misstatement that the economy expanded in the first quarter creates an inappropriately sanguine view of the months ahead and therefore reduces the prospect of strong action to prevent the deep decline that may otherwise occur…

Although the tax rebates now under way may provide some temporary help, the combination of falling real incomes, declining household wealth and a dramatic drop in consumer confidence suggests further falls in consumer spending and GDP. But the most serious risk is that the rapid fall in house prices – down more than 12 per cent in the past year and falling at a 25 per cent rate in the past three months – will raise the number of negative-equity mortgages, leading to widespread defaults and foreclosures.

Because US mortgages are “no-recourse” loans (lenders have no recourse to the house’s owner beyond the value of the house), individuals with negative equity have an incentive to default. There are now an estimated 8m negative-equity mortgages – more than 15 per cent of all outstanding mortgages. Defaults are rising and foreclosures are now at twice the rate of a year ago. A downward spiral in house prices would cause a fall in household wealth and in the capital of financial institutions, potentially resulting in a deeper and longer recession than any seen in the past several decades.

Now is the time for policy action to forestall such a house price collapse. There is nothing more the Federal Reserve can do by lowering short-term interest rates or by creating new credit facilities. The Treasury proposal for voluntary negotiations between creditors and negative-equity homeowners has had relatively little success because a large share of mortgages have been securitised. Congressional proposals aim at helping homeowners with negative-equity mortgages and would at best help no more than 10 per cent of that group.

What is missing is action to prevent positive-equity mortgages from becoming negative-equity mortgages. The federal government could achieve that by providing low-interest loans with full recourse that would allow any homeowner to pay down a significant fraction of his mortgage. Homeowners would be in effect giving up the potential to default on their mortgage loans in exchange for lower interest costs.

Although political tensions make it difficult to achieve such a policy, a mistakenly benign view of first-quarter growth contributes to this stalemate. Policymakers must recognise the real economic condition and act quickly.

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  1. a

    “For instance, last month he wrote in the Wall Street Journal against further rate cuts, arguing they’d do little to stimulate growth but would be effective fuel for inflation.”

    If memory serves Feldstein was one of the first chicken littles to advocate cutting rates, to avert recession. Never apologized for taking that position, as near as I can tell.

  2. Yves Smith


    I haven’t cited Feldstein before for that very reason. I’m not terribly keen about his reluctance to let the economy take any pain, when it seems there isn’t much way of avoiding that.

  3. Scott Frew

    It might just be me, but I seem to have noticed a marked change in Feldstein’s willingness to criticize administration economic policy, and to speak freely of economic conditions as he saw them, after he was bypassed for the role of Fed Chairman.

  4. Anonymous

    Scott Frew,

    Second that. He was defending the policies of current administration for a long time until recently.

    Plus, why is it always the Fed and the system saves the wealthy, and powerful yet ignore ordinary people.

    It is crony capitalism, has been this way for a long time.


  5. Anonymous


    Why don’t all these smart guys proposing solutions to “mortgage” problem, club together raise some money and buy up all the problem properties and mortgages?

  6. dug

    I thought that even purchase-money mortgages were only non-recourse in four states – one of them being California, though.

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