Why the Recession Won't End Soon

06/11/2009 1:00 pm EST


Gary Shilling

Columnist, Forbes

Gary Shilling, editor of INSIGHT, says there are good reasons why the current recession will extend into next year.

Despite the widespread belief that the recession is almost over, we remain unconvinced. In the last several months, the search by the optimists for “green shoots,” evidence of impending economic recovery, has been exhaustive. A recent poll found that 52 economists on average expect the economy to bottom in August.

Evidence of any economic improvement is greeted with wild enthusiasm, and negative news like the 19.1% year-over-year drop in the S&P/Case-Shiller US National Home Price index in the first quarter is largely ignored. These prices of existing houses, as measured by that index, are now down 32.2% from their second-quarter 2006 peak and show no sign of ending their fall.

The stock market has rallied since early March, so the theory is, economic recovery is imminent. The optimists neglect the likelihood that a relief rally was probably in the cards after the fears of financial meltdown in late 2008 and early 2009 were countered by massive bailout measures by Washington and virtually all other developed country governments.

Recessions are seldom straight-down affairs that start at the business cycle peak and then decline quarter by quarter until the trough of economic activity. We see the recession lasting about another year, and the ensuing recovery being weak.

It will probably take until then for three fundamental recession drivers to run their course—the elimination of excess house inventories, adequate fiscal stimulus to break the self-feeding cycle of consumer retrenchment, and the successful bailout of current and emerging financial woes.

We believe that if nothing is done to eliminate surplus housing, prices will fall another 7% between now and the end of 2010 for the total peak-to-trough decline of 37% that we have been forecasting for some time. The resulting further negative effects on the economy will be devastating. At that point, almost 25 million homeowners, or almost half the 51 million total with mortgages, will be under water.

As falling house prices destroy home equity, consumers have no choice but to retrench and slash spending. That, in turn, spawns cuts in production and jobs, which depresses spending and housing prices in a vicious self-feeding cycle. It also continues to wreak havoc on financial institutions and force more government bailouts, with all the attendant distortions to the financial structure and the economy.

Households are beginning to mount the saving spree we’ve been waiting for and cutting their debts. This consumer frugality seems likely to extend the recession into 2010 and to last for years as Americans learn they can cut out frills without reducing their basic quality of life. Expensive, discretionary purchases are being avoided by consumers.

In any event, much more fiscal stimuli are probably needed to break the vicious cycle of consumer retrenchment. We’re not relying on monetary ease to help the economy much, because conventional monetary ease isn’t working.

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