As the economic slump that began in 2007 continues, the question persists: Why? Unless we have a better understanding of the causes of the crisis, we can’t implement an effective recovery strategy. So far, we have neither.
We were told that this was a financial crisis, so governments on both sides of the Atlantic focused on the banks. Stimulus programs were sold as being a temporary palliative, needed to bridge the gap until the financial sector recovered and private lending resumed. But, while bank profitability and bonuses have returned, lending has not recovered, despite record-low long- and short-term interest rates.
The banks claim that lending remains constrained by a shortage of creditworthy borrowers. And key data indicate that they are at least partly right. After all, large enterprises are sitting on a few trillion dollars in cash, so money is not what is holding them back from investing and hiring. Some (perhaps many) small businesses are, however, in a very different position: Strapped for funds, they can’t grow, and many are being forced to contract.
Still, overall, business investment—excluding construction—has returned to 10 percent of GDP (from 10.6 percent before the crisis). With so much excess capacity in real estate, confidence will not recover to its pre-crisis levels anytime soon, regardless of what is done to the banking sector. The financial sector’s inexcusable recklessness, given free rein by mindless deregulation, was the obvious precipitating factor of the crisis. The legacy of excess real-estate capacity and over-leveraged households makes recovery all the more difficult.
But the economy was very sick before the crisis; the housing bubble merely papered over its weaknesses. Without bubble-supported consumption, there would have been a massive shortfall in aggregate demand. Instead, the personal savings rate plunged to 1 percent, and the bottom 80 percent of Americans were spending, every year, roughly 110 percent of their income. Even if the financial sector were fully repaired, and even if these profligate Americans hadn’t learned a lesson about the importance of saving, their consumption would be limited to 100 percent of their income. So anyone who talks about the consumer “coming back”—even after deleveraging—is living in a fantasy world.