Sarah Bloom Raskin: Downturns and recoveries - what the economies in
Los Angeles and the United States tell us
Speech by Ms Sarah Bloom Raskin, Member of the Board of Governors of the Federal
Reserve System, at the Federal Reserve Bank of Sand Francisco Business and Community
Leaders Luncheon, Los Angeles, California, 12 April 2012.
* * *
Good afternoon. I appreciate this opportunity to speak with you today.
I'm not sure when you last found yourself in a planetarium. At the start of my most recent
visit, I was handed a brochure that said "Sit anywhere. All seats provide equal viewing of the
universe." I took the brochure but instead of contemplating the stars, I contemplated my job
as a governor on the Federal Reserve Board. And it occurred to me that the brochure was
wrong. Completely wrong. All seats do not provide equal viewing of the universe. Some
seats are better than others. It's not just that the Big Dipper is clearer than Ursa Minor from
certain seats. If you want, for example, to see the economy, you don't necessarily want to
always be sitting in Washington. That is not a seat that tells you everything you need to know
about the economy. You have to break out, set free, and hightail it out of the Beltway to Los
Angeles. It's critical to appropriate policymaking that we get a multidimensional view of the
so-called economic universe.
From that perspective, it is an understatement to say that these are profoundly challenging
times for millions of Americans. Many families have suffered significant declines in their net
worth over the past several years, especially as the value of their homes and other assets
has plummeted. Many households have faced job losses or large reductions in the number of
hours worked, events that have reduced family income and well-being. While I'm not happy
to bear witness to households trying to navigate these difficulties, we would be poor
policymakers if we consistently avoided the seats that give us this view.
In short, I'm very pleased to be here, but I'm here on a mission. It's a quest to understand
what the seat from Los Angeles tells us about the economy, and more generally, how the
path of the economy in a recovery may depend on the path of the economy in a recession.
To rewind and review: The U.S. economy recently endured a financial crisis rivaling the one
that triggered the Great Depression, and a severe recession ensued. The effects of the
recent recession were pronounced in Los Angeles. Although the recession was declared to
have ended nearly three years ago, the recovery - both at the national level and here in Los
Angeles - has been extraordinarily slow compared with other recoveries. Should we be
surprised by this sluggish pace of recovery? Let's compare the view of the recent national
economic downturn with a view of the economic downturn in Los Angeles. And then, moving
from recession to recovery, let's ask how the contours of this recovery differ from the
contours of other recoveries. More generally, does the path of a recovery depend on the path
of a downturn? Let's see what the experience of Los Angeles can teach us. Of course, I note
that this perspective is my own perspective and not necessarily that of others in the Federal
Reserve System.
The economy in the United States and in Los Angeles
The overall U.S. economy had started to contract by the beginning of 2008 and entered the
severe phase of the recession during the late summer of that year with the near-collapse of
the financial system. By any measure, the cumulative decline in economic activity was large.
Nationally, employment decreased by nearly 9 million, while the unemployment rate climbed
from roughly 5 percent to 10 percent. As measured by real gross domestic product (GDP),
aggregate economic output contracted 5 percent during the recession, and the purchasing
power of household after-tax income declined by about the same amount. This recession
was the most severe economic downturn since the Great Depression, when the
unemployment rate is estimated to have soared to above 20 percent and real GDP is
measured to have plummeted by more than 25 percent. For comparison, the only other time
since then when the national unemployment rate rose above 10 percent was the "double-dip"
recession of the early 1980s. But even in that episode, real GDP contracted less than
3 percent and cumulative job losses were less than 3 million.
The recent contraction in the housing sector has also been the most severe episode since
the Great Depression. National house prices have fallen 33 percent in nominal terms since
their peak in 2006. In contrast, home prices dipped only 2 percent in the early 1990s
downturn, and they did not decline at all in the early 1980s recession. The recent drop in
housing market activity also has been dramatic. Home sales plunged more than 50 percent
from peak to trough, while housing starts plummeted more than 75 percent. Indeed, the
decline in housing starts associated with the recent recession was nearly as large as that
which occurred during the Great Depression.
Here in Los Angeles, the recent recession was even deeper than for the nation as a whole.
The unemployment rate, which was about the same as the national average prior to the
recession, rose to a peak of nearly 13 percent. Moreover, the number of jobs in Los Angeles
fell by a cumulative 9 percent, nearly half again as much as the decrease in national
employment. Those of you with a longstanding connection to the local economy certainly
recall the prolonged downturn of the early 1990s, which followed a real estate crash, cuts in
federal military spending in the region, and a sharp contraction in local industries such as
aerospace manufacturing. However, the increase in the unemployment rate was even larger
during the recent recession than in the 1990s episode. In fact, Los Angeles's peak
unemployment rate in 2010 was the highest ever recorded in this city in the almost four
decades during which local-area statistics have been published. In the Los Angeles
metropolitan area, the contraction in the housing sector has been even more extreme than
for the nation as a whole. Home prices have fallen nearly 40 percent from their peak, while
the issuance of building permits for the construction of new homes dropped nearly
90 percent.
At the national level, the economy has been recovering for more than two and a half years.
But the pace of this recovery has been slower than the pace of prior recoveries. Over the
past 50 years in the United States, real GDP has typically expanded 10 percent cumulatively
during the 10 quarters immediately following the trough of a recession. By contrast, real GDP
has only risen 6 percent over the 10-quarter period since the bottom of the most recent
recession. Indeed, it was only in the third quarter of last year that real GDP finally returned to
the level that it had attained prior to the recession. However, measured on a per capita basis,
households' real disposable personal income still was below its pre-recession peak at the
end of last year. Moreover, as of March of this year, employment at the national level had
risen by only 3-1/2 million jobs, less than half of the number of jobs lost during the recession,
and the unemployment rate was still significantly elevated at 8.2 percent.
Even though general economic activity and labor market conditions have improved modestly
in the past two and a half years or so, house prices have continued to trend down, albeit at a
slower pace than in 2007 and 2008. And single-family housing starts have shown no
noticeable increase since their low point in the middle of 2009, although multifamily
construction has been rising with the expanding demand for rental apartments. The general
stagnation in housing activity during the current recovery is very unusual since previous
recoveries typically have been accompanied by a sharp increase in residential construction.
The pace of economic recovery has also been sluggish for small businesses. These firms
continue to report weak sales, although some recent indications suggest that sales have
finally started to improve lately. Nevertheless, small business owners generally report that
they remain cautious about overall economic prospects.
The Los Angeles economy has had farther to climb than the nation as a whole in order to
achieve a full recovery, and it also has been slow-going here. The unemployment rate in the
Los Angeles area has been declining, but, still at almost 12 percent, it remains well above
the national average. The housing market in Los Angeles has remained depressed, similar to
conditions nationwide. House prices in the Los Angeles area have continued to decline, and
single-family construction has been flat, although multifamily construction has picked up.
Nationally, some economic news has been encouraging and may be suggesting that the
pace of the recovery is picking up. In the past six months, the national unemployment rate
has come down about 3/4 percentage point and employment has increased by about
1 million. In Los Angeles, employment expanded by 1 percent over the six months ending in
February (the latest available data), and the local-area unemployment rate also declined
about 3/4 percentage point.
However, the national economic recovery clearly has a long way to go. The share of
unemployed workers who have been without a job for more than six months is still more than
40 percent nationwide, a level well above that seen in earlier recessions. Being unemployed
for such a long time can have negative effects on workers' skills and their attachment to the
labor force, thereby possibly reducing the productive capacity of our economy. Here in Los
Angeles, the issue of workforce skills is all the more concerning because 13 percent of the
city's residents are reported to have less than a ninth-grade education, a share of
loweducation workers that is about twice the national average.
How surprising is the texture and pace of this economic recovery? Perhaps it's not so
surprising given the nature of the downturn that preceded it. Economic studies have found
that the aftermath of a financial crisis is usually associated with substantial declines in output
and employment and that it takes much longer to return to pre-crisis levels of economic
activity.1 Recent research by staff at the Federal Reserve has shown that the current
recovery from the financial crisis has been even slower than would have been expected.2
This unusually weak recovery can be at least partly explained by the large drop in house
prices and severe slump in housing activity that played such a major role in the recent
recession. Even though, technically speaking, the housing market contraction preceded the
financial crisis, the financial crisis undoubtedly magnified the depth of the housing bust as the
erosion in the net worth of households and the severely strained balance sheets of financial
institutions led to a sharp tightening of mortgage credit.
The drop in national house prices erased $7 trillion in household wealth. Home equity was a
large share of the total assets of low- and moderate-income families prior to the recession,
so the drop in housing wealth has hit many families particularly hard. Because wealth is one
of the key factors that households consider when deciding how much to spend, the drop in
housing wealth is expected to reduce household expenditures - the so-called wealth effect.
This restraint on consumer spending is especially severe for households who owe more on
their mortgage than their house is worth because such "underwater" households have been
unable to take advantage of low mortgage rates by refinancing. With more than one out of
every five mortgages nationwide estimated to be underwater in 2011, the resulting restraint
on consumer spending and its effect on slower economic growth is appreciable.
The heavy load of housing-related debt that many households are still carrying may be
affecting consumer spending even more powerfully than would be suggested by the drop in
house values alone. For example, recent academic research has found that highly indebted
households cut their spending on goods and services more severely in response to a drop in
home values than do less-indebted households hit with the same reduction in home values.3
This result suggests that consumer spending may not act powerfully to revive the economy
until Americans' financial situations have improved. Alternatively understood, this research
finding suggests that monetary policy alone may be insufficient to promote a more robust and
sustainable improvement in household net worth.
Besides the substantial direct losses in the wealth of households through losses in home
equity, other housing-related issues have likely been holding back the economic recovery.
The collapse of house prices coincided with a sharp increase in mortgage defaults and
foreclosures, leaving financial institutions with large holdings of residential real estate, or
REO. As these properties were put up for sale on the market, they contributed to the
alreadybloated supply of vacant homes available for sale and put further downward pressure on
house prices. In Los Angeles, for example, more than one out of every four homes sold in
2011 were REO properties. And the inventory of mortgages that are more than 90 days
delinquent or somewhere in the foreclosure process amounts to more than five times the
current stock of REO, illustrating the large "shadow inventory" of properties that might be put
up for sale sometime in the future.
Concerns about future defaults and foreclosures have caused lenders to tighten their lending
standards considerably - raising down-payment requirements, requiring extensive
documentation, and charging substantial fees to all but those with the highest credit scores.
This marked change in mortgage credit standards has restricted access to mortgage credit
for many potential borrowers, limiting both home purchases and refinancing. In addition, it
doesn't take extensive forays into many neighborhoods here to see that the foreclosure
process imposes less quantifiable but heavy costs on homeowners and communities.
Monetary policy and other Federal Reserve actions
How should the Federal Reserve respond to a recession with these contours? The Fed's
accommodative monetary policy response has been intended to ease the effects of the
recession and support a recovery in the context of its dual mandate to foster maximum
employment and stable prices. As the economy descended into recession, the Federal
Reserve promptly and aggressively pushed the federal funds rate down to near zero. The
Fed then substantially expanded its holdings of longer-term securities and more recently
moved to lengthen the average maturity of its holdings to put downward pressure on
longerterm interest rates.
These actions were intended to help bring down both short-term and longer-term interest
rates, thereby reducing borrowing costs for households and firms. Reductions in interest
rates usually expand credit and encourage firms to invest and households to borrow for
durable goods purchases, thereby stimulating aggregate demand. A more accommodative
stance of monetary policy also boosts the economy by raising the prices of equities and other
assets, and therefore supporting household spending through the wealth effect that I
mentioned earlier. In addition, a more accommodative stance of monetary policy can also
help by contributing to a somewhat lower foreign exchange value of the dollar, thus
promoting the competitiveness of our goods and services in overseas markets.
The Federal Reserve's policy actions have indeed contributed to lower interest rates. For
example, the yield on 10-year nominal Treasury securities has come down from more than
4-1/2 percent prior to the recession to around 2 percent recently - a historically low level. As
we had hoped, the influence of these policy actions has been felt quite broadly throughout
financial markets. For example, the rate on a 30-year fixed mortgage has declined from more
than 6 percent in 2006 to its current level of below 4 percent, also a historic low. Moreover,
interest rates on consumer auto loans have decreased. And corporate borrowing rates have
also come down. The 10-year bond yields paid by investment-grade nonfinancial companies
have decreased from roughly 6 percent prior to the recession to below 5 percent currently,
again a historic low. Riskier firms have also found the climate for borrowing to be hospitable.
Yields for high-yield corporate bonds have fallen from between 8 and 9 percent prior to the
recession to near 7 percent, contributing to the robust pace of issuance of these securities
over the past few years.
Partly as a result of these actions, business spending for investment in equipment and
software has been relatively robust in the past several years. In addition, real spending on
consumer durables such as motor vehicles has begun to pick up. Moreover, foreign trade
has been an important factor contributing to demand for U.S. products. Here in Los Angeles,
net container flows through the ports of Los Angeles and Long Beach rose 16 percent in
2010 and continued to rise last year, though at a slower pace. In contrast to the upturns in
business equipment investment, consumer durable purchases, and foreign trade, other
sectors of the economy have not fared as well. Despite historically low mortgage rates,
purchases of new and existing homes have not risen much above their lows seen several
years ago. One reason for the absence of a significant pickup in home purchases has been
the substantial tightening of underwriting standards for mortgages. In addition, households'
concerns about their future prospects for employment and income have likely deterred many
potential homebuyers from committing to mortgage payments that might be difficult to make
if they lose their jobs.
Housing has played a central role in magnifying the recession and delaying the recovery. In
Los Angeles, there is huge demand for information on foreclosure recovery from
organizations that serve families going through the process of losing their homes. Residents
here want financial institutions and recipients of grants from the Neighborhood Stabilization
Program to understand the most effective ways to use funds from that program to acquire,
rehabilitate, and repurpose real estate owned by financial institutions and vacant properties.
We have seen much interest by financial institutions, nonprofit housing providers and
advocates, local government, and academics in understanding new approaches to REO
disposition and financing mechanisms.
Turning to the business sector, credit conditions for many small firms have not improved in
this recovery. In 2010, the Federal Reserve Bank of San Francisco organized a statewide
small business task force that meets twice per year to assess barriers and opportunities for
credit-worthy small businesses in California. Last year, it held a conference to help identify
ways that the Community Development Financial Institutions (CDFI) Fund can work with
community banks to serve the needs of small businesses that may not qualify for bank loans
and to identify additional bank sources of capital for small business borrowers that have
needs that exceed CDFI lending capacity. The San Francisco Fed also served as a technical
resource for an initiative to help street vendors - which comprise 30 percent of the small
businesses in the central city area and East Los Angeles - to access business development
services, city certification, and microfinance capital.
Conclusion
In summary, the contours of how this recovery is proceeding seem related to the factors that
characterized the downturn. The financial crisis was unprecedented since the Great
Depression, and the recession was extraordinarily deep, even compared with other severe
recessions in the postwar period. Consequently, we have had much more ground to make up
relative to other economic downturns. The recent recession also lasted longer than most,
and long recessions tend to be followed by slow recoveries. However, the current recovery
has been even slower than would be expected given its characteristics. An important factor
explaining this slowness has likely been the severe contraction in the housing market, which
has been the largest since the Great Depression. Not only have the enormous loss of
housing wealth, heavy debt burdens, and tight credit conditions restrained household
spending, but the accompanying wave of mortgage defaults has also had considerable
repercussions for homeowners, lenders, communities, and the pace of this economic
recovery.
Here in Los Angeles, the housing market contraction and economic downturn were even
deeper than those experienced nationwide. As a result, Los Angeles - like the rest of the
United States - also is suffering through the slow pace of recovery typically associated with a
long recession, a financial crisis, and an extraordinary contraction in housing activity. In light
of the economic hardships that have been endured in Los Angeles and nationwide, the
Federal Reserve remains fully committed to doing everything it can to promote maximum
employment in the context of price stability.
Thank you again for the opportunity to speak with you today.