It's been a brutal summer for the economy.
sector, like a balloon batted in the air one last time by the
government credit, resumed its inevitable fall. Economic growth
slowed to a lead-footed 1.6 percent, and job growth is even more
anemic. Meanwhile, consumers are cranky, the trade gap is gaping.
Most signs point to a slow and steady recovery, but what if the
pessimists are right, again? What if the United States isn't in the
slow-lane to recovery, but rather on the precipice of another
decline -- a double dip?
To see where this re-recession might begin, my colleague Dan
Indiviglio and I imagined five financial earthquakes, each with a
single epicenter: housing, consumers, toxic assets, Europe, and the
debt. The following five scenarios are listed in order of
1. Housing's Mini-Bubble Pops
Perhaps nothing poses as a big of a concern to the U.S. economy as
its housing market. It's unclear how the government's efforts to
stabilize the market through a buyer credit, ultra-low mortgage
rates, and mortgage modification programs will pan out. Did it just
create another mini-bubble that's beginning to pop now that the
support has been withdrawn?
Here's the scenario. Weak home sales and continuing foreclosures
result in climbing real estate inventory. This has two effects.
First, it makes new homes even less attractive which further
reduces construction jobs. Second, it puts downward pressure on
home prices, which makes it harder for struggling homeowners to
sell their home to avoid foreclosure and also keeps strategic
default rates high, exacerbating the problem. Lower home values
encourage Americans to save more and spend less, since their wealth
is effectively reduced. The Dow drops and credit markets tighten
even further, suffocating private investment just as homeowners
bunker down and slash spending. Growth turns negative.
2. You Break the Economy
You, the American consumer, are reloading savings after a
debt-fueled decade. But as any general will tell you, when an
entire squad reloads at once, it leaves everybody vulnerable. It's
the same with the economy.
Here's the scenario. Consumer sentiment continues to fall slowly,
and spending turns negative again. Small businesses hold off to
replenish their inventories or add new workers. Wages and hours
freeze, and unemployment takes a leap toward 10 percent in October.
Congress is paralyzed, because it's only weeks away from the
mid-terms. The stock market sees business revenue trending flat,
joblessness rising and Congress doing nothing, and it sparks a
300-point sell-off. Americans frightful for their savings cut back
spending even more the next month, and overall growth turns
3. Toxic Assets Return
If you closely followed the bank bailout, then you know it wasn't
originally billed as simply throwing money at the banks. Instead,
the Treasury intended to purchase the toxic assets from banks,
which were the source of investors' uncertainty concerning bank
stability. But the Treasury couldn't figure out a way to do this
quickly enough to make it effective. As a result, the banks were
largely stuck with these bad assets. We just don't know how bad,
Here's the scenario. The residential real estate market's problems
continue. Even once foreclosures begin to decline, we see waves of
defaults, as modification program participants re-default at rates
of 30% to 50%. Commercial mortgage-backed securities continue to
deteriorate, as some businesses struggle with weak consumer demand.
Home and commercial real estate values keep declining, and so do
the value of the assets that back them. Banks with exposure to
these toxic securities see another round of losses, and investors
question their stability. The market plummets, credit freezes, and
growth turns negative.
4. Europe Falls Apart
Europe seems to have avoided an all-out collapse of confidence in
its ability to pay back its debt. But things can change, and fast
fast. Indeed, the Greek debt crisis went from ignorable wire
stories to front page news in a matter of days.
Here's the scenario. Slow growth in weak Eurozone states like
Greece, Spain, and Italy turns negative and spooks investors, who
demand higher returns on government debt. Europe's bond rates
spike. Countries announce further austerity -- tax increases and
spending cuts -- which strangles our biggest export market. The EU
central bank responds by announcing a plan to write down troubled
debt, which dings some Americans banks.
In a flight to quality debt, the dollar appreciates. This hurts our
exports even more. As the trade deficit gapes open and
manufacturing's good run dead ends, the stock market plummets,
taking household wealth down with it. Families looking to restore
balance sheets cut back on spending, and the American producer
loses the American consumer and the European buyer. Growth turns
5. Debt Finally Catches Up to Us
Interest rates on U.S. debt are low today for one big reason.
Investors trust the United States, at least more than they trust
other countries. If the people giving us money suddenly have as
little faith in America as Americans, that could change, and
Here's the scenario. The IMF recently said the United States has a
25 percent chance of seeing dramatically higher interest rates in
the near future. But the bond market can strike without warning, as
it did in Europe earlier this year. If uncertainty with our
political process gets reflected in our interest rate, we'll have a
harder time affording debt, 55% of which has to be rolled over in
the next three years. Pension and mutual funds with government debt
would be written down, causing Americans to save even more of their
paychecks. We'd be left with two bad choices: tax cuts to juice
consumption or tax hikes to please our lenders. But at that point,
it would be too late to avoid a double dip.