The Recession in the United States: A Progress Report


Dean Baker
The Hankyoreh (South Korea), July 1, 2008

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Analysts around the country and around the world are still debating whether the U.S. economy will go into a recession in 2008 and what impact it will have on the rest of the world if it does. The answer to the first question should be easy, the U.S. economy is almost certainly already in a recession. The answer to the second question will be much more difficult.

The May employment data released last week showed the economy losing jobs for the fifth consecutive month. This has never happened in the United States except during periods associated with recession.

Over this five-month span the economy as a whole has lost 330,000 jobs, with the private sector shedding almost 400,000. The construction and manufacturing sector have been hardest hit, which is always the case in recessions, but few areas other than health care have continued to add jobs during this period. This job loss has been associated with an increase in unemployment of a full percentage point, from 4.5 percent last year to 5.5 percent in the most recent data.

The labor market should always be central in any economic snapshot, both because it is what matters to most people, who get most of their income from working, but also because it directly affects consumption, which accounts for 70 percent of GDP in the United States. In an economy that is losing jobs, with wages not keeping pace with inflation, there will be considerable downward pressure on consumption.

But the underlying story in the U.S. economy remains the housing market, with house prices now in a free fall in many cities. Nationwide, house prices are falling at close to a 20 percent annual rate. In the areas most affected by the housing bubble, primarily cities along the two coasts, house prices are falling at close to a 30 percent annual rate.

This rate of price decline will destroy more than $4 trillion in real housing wealth over the course of a year, more than $50,000 for every homeowner in the country. This will have a huge impact on consumption, both because people consume based in part on their housing wealth and also because many families have gotten in the habit of borrowing against their homes to pay for their consumption.

With wealth disappearing at such a rapid pace, tens of millions of families will realize that they suddenly have to save more to support themselves in retirement. In addition, families that might have borrowed against their home to pay for a car or vacation, or even just normal living expenses, will lose their ability to do so.

The plunge in house prices also will lead to more defaults on mortgage debt. The analysts who are claiming that the U.S. financial crisis is now largely over do not understand the crisis. The system may have weathered the first wave of mortgage defaults, which was concentrated in the subprime portion of the mortgage market, but the second wave promises to be much larger.

By the end of the year, there will be more than ten million homeowners who owe more than the value of their house. In some cases these homeowners will owe several hundred thousand dollars more than the value of their house. This will give them an enormous incentive to default on their mortgage and simply return the house to the bank.

More than 1 million homes were in some phase of the foreclosure process in the first quarter of 2008. This number is likely to grow rapidly over the course of the year. With the number of foreclosures soaring, and the loss on each foreclosure increasing, it is virtually certain that more major banks will be pushed to the edge of insolvency. Even Fannie Mae and Freddie Mac, the two government-created mortgage companies, are likely to see their finances stretched near the breaking point.

Adding to the bad news are soaring energy and import prices. Higher energy prices will hit the U.S. economy much harder than other countries because the United States is so much less energy efficient. The rise in import prices is due to an inevitable correction from an over-valued dollar. The high dollar led to an unsustainable deficit, which is now pushing the dollar down.

This natural correction process has the downside of leading to rapidly rising import prices. Higher import prices in turn drain consumer purchasing. The inflation resulting from higher import prices is also pushing up interest rates, which is yet another factor weakening the housing market and hurting banks’ balance sheets.

In short, the U.S. economy is facing bad news right now on a number of different fronts. There is little doubt that it will be facing a recession, and quite possibly a very severe recession. Insofar as other countries tie their economies and their finances to the U.S. economy, they will likely also experience severe economic problems. Those countries that were smart enough to look to other markets for their exports and other outlets for their capital will manage to avoid seeing their economy sink along with the U.S. economy.


Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer ( He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site.