It's too late to overcome housing bubble burst

As the economy shifts into reverse and Congress and the president work out the details of a proposed fiscal stimulus, some are asking whether it will be enough to keep the economy out of a recession. The answer is very likely no.

The timing, length and depth of a recession depends on many variables and is therefore difficult to predict. But there are certain things that we already know.

First, we are witnessing the bursting of an unprecedented bubble in house prices. Nationally, a loss of wealth of about $8 trillion would be necessary just to bring these prices back to their normal long-term trend.

Even conservative estimates of the effect of such a drop imply a decline in consumer spending of $400 billion, or about 3 percent of the gross domestic product. Some economists think it would be much more than that, because of the expansion in recent years of consumers borrowing against the previously rising value of their homes.

We also have the first official GDP growth numbers for the last quarter, which shows the economy at a near standstill with just 0.6 percent annualized growth. Consumer spending, which accounts for about 70 percent of the economy, has been holding up; but this cannot last as the price of homes that people have been borrowing against continues to fall.

The size of the proposed stimulus, which is about $150 billion, is just not large enough to compensate for the kind of spending declines that we can expect. Near the peak of the housing bubble in 2005, homeowners were cashing out about $780 billion in home equity at an annual rate. A lot of it was used for consumption, but this ATM machine has run out of cash.

It is worth looking at the total fiscal stimulus provided by the federal government when the last huge asset bubble -- in the stock market -- burst. The federal budget went from a surplus of 2.4 percent of GDP in 2000, to a deficit of 3.5 percent of GDP in 2003. This is about six times the size of the proposed stimulus package, although the federal government will automatically provide at least some more stimulus than the current package, as tax revenues fall and some social spending rises.

Based on the experience of the past three recessions, the Center for Economic and Policy Research has estimated that the next recession could increase unemployment by

3.2 million to 5.8 million people, and poverty by 4.7 million to 10.4 million, with at least 4.2 million also losing health insurance. The range depends on whether it is a mild-to-moderate recession like the past two (2001 and 1990-91) or more severe, as in 1980-82.

Given the magnitude of the risks and economic pain that our economy is facing, it is imperative to demand measures that will soften the blow, especially for the most vulnerable, including the elderly, unemployed and poor. The package that passes Congress will be especially inadequate in this regard.

Out of the Great Depression came the New Deal, which included Social Security, the legal right to organize unions, unemployment compensation and other reforms that transformed the United States into a more just society while setting the stage for the post-World War II boom. Over the past 30 years, the country has become vastly more unequal and economic performance has deteriorated with the ascendancy of the right.

We are not facing a depression, but the hard times ahead will highlight the need for structural changes such as universal health care and labor law reform. These and other major reforms, including a bigger and "green" fiscal stimulus that would reduce carbon emissions, should be pushed to the top of the political agenda.

Weisbrot is co-director of the Center for Economic and Policy Research (www.cepr.net).