Spare the Stimulus, Spoil the Recovery

Flickr/Richard Lemarchand

We are now halfway into our own lost decade. Five years ago this month, the economy started to collapse in the largest downturn since the Great Depression. Though the recession has officially been over since 2009, we’ve had a slow and uneven recovery. Unemployment, which dropped from 8.3 percent in January to 7.7 percent in November, remains far too high. 

But 2013 could be a turning point for the economy. The housing market, which has held the recovery in check since the crash, started to show signs of life this past year. The Federal Reserve recently stepped up its monetary policy, pledging to continue its efforts to stimulate the economy until unemployment falls to 6.5 percent. No less important, the public rebuked the politics of extreme austerity in November, handing President Obama a second term. Government actors played an important role in keeping the economy going in 2012, and will need to do the same to sustain the recovery into the new year.

Housing got as bad as it was likely to get in 2012, hitting a bottom over the summer. By September, it started to take off. Permits for new residential housing grew over 10 percent that month, with estimated housing starts going up even more. With construction and housing purchases moving, analysts expect construction employment to follow suit.

For most of the last four years, the Obama administration has kicked the can, hoping the recovery would boost the housing market. This past year, the administration started to coordinate better in using housing as a driver of recovery. In March, the administration significantly expanded the Home Affordability Refinancing Program (HARP),which allows people with underwater mortgages to refinance. However, recent studies have found that a lot of the relief homeowners should receive through HARP is being captured by Wall Street, which isn’t passing along the full savings of record-low mortgage rates to consumers. One way to make sure that these savings are passed through in 2013 would be for the government to refinance mortgages itself by setting up a series of public banks that would allow for refinancing at ultra-low rates, further boosting the economy.

Both housing and general economic conditions were boosted by the Federal Reserve’s aggressive actions in 2012. At the end of 2011, the Federal Reserve seemed stuck, with its governing board split, over whether to attempt additional, untried techniques at boosting the economy or instead pull back. By the end of the year, the Fed had taken large steps to boost the recovery, committing to keep rates low until inflation was above target or unemployment had finally gotten down to a more reasonable rate.

But if government policy helped in 2012, will it kill the housing recovery in 2013? At the end of the year, a special tax credit that prevented written-down mortgage debt from being treated as taxable income will expire. Put in place by Representative Brad Miller, a Democrat from North Carolina, it was designed to help with banks and homeowners working out bad mortgage debts without leaving the homeowners with a huge tax bill. Short sales—where the selling value of the house doesn’t cover the mortgage bill—increased significantly in 2012, and will continue to be a major way the economy deals with bad mortgage debt. But unless Congress acts to extend that tax credit, these sales will become major tax liabilities that will prevent the housing market from picking up.

Despite these encouraging signs, there remains an overall chicken-and-egg problem with the housing market: Income growth continues to be flat, so people may either lack the savings or job security to purchase a home. In particular, young people—many of whom have shielded themselves from the sour economy by living at home—will need to start purchasing homes to help this market really take off. 

Either way, housing will be influenced by the overall economy, and government spending and taxes will be a major factor in how this economy performs. And the  “fiscal cliff,” better termed an “austerity phase-in,” is the major factor here. The term is important, as the “fiscal cliff” isn’t a series of runaway spending that happens immediately, but instead a series of austerity through tax hikes and spending cuts phased-in during the year. If this comes to pass over the 2013 year it would trigger another recession. Like the recession of 1937, caused by legislators trying to balance the spending of the New Deal with cuts, if this austerity comes to pass for a large part of the year, it would be a major, self-imposed disaster for the economy. If played well, it could require those who have benefitted the most to pay a fairer share of taxes while also boosting unemployment benefits and continuing necessary short-term tax cuts.

The current bill that passed the Senate has no major spending cuts and extends many credits designed to boost the economy, such as the earned-income tax credit. However, the payroll-tax cut from 2010 is expiring, and it isn’t being replaced with any measures to counteract it. So there will still be weaker consumer spending from higher taxes going into the new year if this bill passes.

The Senate bill resolves the tax issue, but it delays the major spending cuts until March. These will coincide with the debt-ceiling debate, which will be the subject of a major fight between the president and the Republican party. If those spending cuts go into effect in 2013, it will significantly hurt a weak recovery.

These three fronts of the economic recovery all depend on each other. Government-imposed austerity would cause consumers to retrench, killing the housing recovery. Monetary policy is more effective if regulators are serious about using policy levers to make sure ultra-low rates benefit homeowners and the government runs a larger deficit to invest in our economy. Better coordination and a more sustained response will determine whether or not 2012 was the year where the economy was set for a major upturn, or was instead just another wasted year waiting for a recovery.

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