The presumption of economists in defining the difference between a recession and a depression is the level of reduction in GDP. They commonly believe that GDP must become a negative number before either term may be applied. The media's frequently used definition of recession is two consecutive quarters of decline in GDP.
None of these definitions are exactly true. They are based on supposed historic reference, however, it is important to note that prior to the 1930's, all economic downturns before 1930 were called depressions.
The present economic condition of the US and indeed most of the world is in a unique and poorly defined condition. Some economists insist that because there has been no true decline in GDP into negative territory, there is no recession. Other economists say there is recession because GDP has been significantly lowered from the year before, and although not in negative territory, they see a decline, nonetheless, hence their definition of a recession in progress.
I disagree with all of them.
A depression is not simply a set of statistics relative to GDP. It is also the general condition of the US economy, reflected in consumer confidence, home sales, foreclosure rates, bankruptcy filings, unemployment, business failures, bank loan deficits, new home construction levels and manufacturing.
Economic depression as I define it is a broader picture and though GDP is an important measure of economics of the nation, it may not reflect the true condition of the economy moving forward.
For example, in 2003, the banking industry made business loans equal to 23.7% of GDP. However, in 2007, the loans equaled 60.27%. At such a rate, business is in effect, borrowing to make GDP happen, and as a result, when businesses fail, as they are highly likely to do when they have borrowed too much to sustain themselves, the GDP is compelled to decline, dramatically. So while we may not yet be seeing negative numbers in GDP, they are inevitable.
The crisis brought on by the banking and mortgage industries, has created the spark that is igniting an economic depression unlike that of the 1930's. But that is not the only factor, even though we're bombarded by media reports every day about the "housing crisis". The business lending crisis, where loan defaults equal 34.4% of total lending to corporations (non-farm, non-financial) is yet another, and probably equal factor in future GDP decline.
This factor is the result of loans made to businesses without sufficient analysis of the ability of the business to succeed or repay the debt. Like mortgage lending, banks sold business loans in a speculative secondary market. While this is now at an all-time low, the truth is that there is no current new regulation to stop this practice in business lending. Moreover, the damage done is yet to be measured as some of the businesses who received loans in 2007 have not yet defaulted, but are likely to do so in 2008 and 2009. In the meantime, business lending is at a low point, with a severe credit tightening for business loans. Few new loans being made means that there's little in the pipeline to balance the deficits of those businesses that will default on their 2007 loans. Additionally, that credit tightening means that business growth is negative.
We're seeing evidence of this in states like Delaware, New York and Nevada, where the number of new incorporations is at an all-time low, and conversely, the number of tax defaults is at an all-time high. More than 30 other states currently report dramatic declines in business tax filings or new incorporations.
This depression is here, today. We have already begun to see the impact. For example, General Motors is closing plants and sees problems in future sales. Other companies, large and small, are seeing impact of high oil costs in their bottom line, and making the tough decision about closing. In April, four airlines shut their doors. Twenty-three states are facing major budget deficits and are likely to see continued crises in their capital budgets as new taxes to make up short-falls are impossible.
Incomes have remained relatively consistent for a long period, and are not keeping up with current economic conditions. Every cost of living increase, such as new government fees, toll increases, gasoline prices, food costs and more, are cutting deeply into the ability of the poor and middle-class. Even wealthy Americans are seeing the impact of higher costs.
In regard to business lending, one of the problems moving forward is that the current model almost requires that the borrower have a 750 credit score or higher. Only 15% of Americans have such a rating at present. Most entrepreneurs - those seeking to start up new businesses - have lower scores, in general. Minorities, women and veterans have lower scores as well, and their ability to borrow is not an easy one normally. CRA, intended to help even the lending playing field for these groups is being defeated by a credit scoring model in banking, putting further economic pressure on these groups. With tight credit, new businesses, including essential retail operations for low-income communities, cannot get started and so we will see added economic pressure on low-income areas.
Later in 2008, or early 2009, Wall Street will finally catch up with the economic condition of the nation. Even though the markets are already down nearly 2000 points from their all-time high at present, we may expect a sudden short-fall in the New York Exchange or a series of sudden drops of more than 150 points per day.
Normally, a depression is cured by war. I pose the question... What if the US did not have two wars in progress? What then? I believe we'd already be in a full-swing depression worse than the 1930's. However, even these wars we're presently engaged in are not truly curing the economic woes of the nation. Why? Because most of the spending is not, as in WWII, in domestic manufacturing, but in construction and other projects in Iraq and Afghanistan. Other wars that cured economic ills have resulted in massive US production of arms, ammunition and productions for war. We have no massive increase in domestic employment as a result of present war operations. Though some manufacturing production is increased, the number of warriors needed to fight these wars is considerably lower than the 2.5 Million needed in WWII. Less men (and women) at arms requires less equipment, munitions and related services, even though those cost of these are much higher than during the World Wars by comparison.
I am not suggesting that we should continue the Iraq war to maintain our economic condition and prevent a full-blown depression. Rather, I'm stating we're in a full-blown depression and that when the war ends, we must have a back-up plan in place. This should include large-scale domestic capital projects such as a national Mag-Lev rail network, rebuilding the highways that are already at breaking point; improving mass-transit infrastructure and so on. We should also have in place a strong program to help rebuild business lending.
That program is found in the Business Credit, Education and Evaluation Act.
The Act will create the infrastructure to bring business lending back to merit-based lending, where the loans are made considering the merit of the business plan and the skills of the borrowers to plan out their operation. The program would resolve many of the problems with business lending and restore confidence to the banks, borrowers and investors alike.
By restoring the merit to lending, and providing analysis of business plans, the act will help banks make better, safer loans. While these will not have the high yields in the secondary markets, they will be much safer, solid investments with little risk of creating bubbles that create havoc when burst.
The Act will also help businesses by making it possible for someone who does his or her homework, and puts a serious effort into proper planning, to obtain credit on the basis of their hard work and in-depth knowledge of what they're doing. It helps them by requiring that they think about every aspect of what they intend for the business, knowing full-well that the business plan will be reviewed and potentially, may make or break the lending decision.
While some might say this puts pressure on the business, it is considerably less pressure than the probable failure post-lending if no planning is done early in the life of the enterprise. Which is better: A bit of work on the front-end, or bankruptcy and financial collapse on the back-end? The Act answers this question.
Congress and the states already appropriate considerable funding for business education programs, such as SCORE, SBDCs and community college programs, all intended at little or no cost to help entrepreneurs write the plans. Today, with the Internet and all these free or low-cost resources, there is no excuse for a business owner not to write a plan.
Though the Act is not the cure for economic depression, it is one of the medictions needed in the process of a cure. Just as in 1933, Roosevelt's economic reforms included creation of the SEC and FDIC, all intended to build confidence, the Act would establish confidence first, and process secondarily.
It is good business to make good planning for business in America. The Business Credit Education and Evaluation Act is good business.
- Robert Angelone, Ph.D.
Chief Economist and Director
