2009 looks to be an economic disaster because the political gridlock will prevent the kind of legislative changes necessary to ameliorate our growing economic problems.
The housing downturn is getting worse, price declines are accelerating and are beginning to affect consumer spending. Housing prices are down nationwide about 12 percent, but could fall 30 percent which would bring them into their historic relationship to inflation, rents and income. This will inevitably adversely affect consumer spending since gasoline prices are likely to remain at record high levels.
The impact of the bursting housing bubble is made worse by the increasing disparity of wealth and the slow down of investment in productivity caused by tight money. The Fed has done a good job of flooding the market with money so that lack of liquidity is not the problem. The problem is that many financial institutions made so much money in fees by creating arcane and non-transparent derivatives, that, when people discovered that no one could really value them, a panic ensued and many of these financial institutions were forced to sell their highest rated derivatives at prices far below what they carried them on their books and were stuck with the lower rated derivatives that no one would buy. This raised questions about the viability of some of our largest financial institutions. Citibank, for example, needed a capital infusion of $7.5 billion for which it paid 11 percent and many are predicting that it will need even more capital.
Because the middle class has lost ground and can no longer use its housing as a piggy bank, the decline in consumer spending is likely to exacerbate the lack of investment. The median income of working-age families has fallen by 5.4 percent over the last 7 years, adjusted for inflation, even as the GDP has grown by 18 percent. On the other hand, the growth in income of the top 1% of Americans from 2003 to 2005 exceeded the total income of the poorest 20 percent of Americans according to the Congressional Budget Office.
Unfortunately, we cannot look to Congress to solve these economic problems in time to make a real difference. The classic example is Congress’ failure to deal with the Alternative Minimum Tax which could have affected millions of middle income taxpayers. Congress could have paid for eliminating the AMT on middle income Americans by simply requiring hedge fund operators to pay ordinary income taxes on their income hidden offshore. Instead it violated its own pay as you go rules, eliminated the AMT on middle income Americans and left our children to pay the bill. Another example is Congress’ failure to require the Administration to pay for the war in Iraq leaving the bill to be paid by our children. In short, the Administration’s refusal to eliminate the tax subsidies for the wealthy (do the oil companies really need $13 billions in subsidies with record high prices and profits) have left us with such a deficit (and weak dollar) that it will be difficult, if not impossible, to kick start the economy with government funding or to alleviate the increasing economic pressures on the States because the Administration has been shifting more and more costs to the States.
In short, be prepared for the worst at least until the new Administration and Congress are sworn in.