Pearlstein: Recession?

Steven Pearlstein
Washington Post Columnist
Wednesday, January 16, 2008 11:00 AM

Washington Post business columnist Steven Pearlstein was online Wednesday, Jan. 16, at 11 a.m. ET to discuss whether the economy is entering a recession.

Read today's column: Caught in a Downdraft and Starting to Panic

About Pearlstein: Steven Pearlstein writes about business and the economy for The Washington Post. His journalism career includes editing roles at The Post and Inc. magazine. He was founding publisher and editor of The Boston Observer, a monthly journal of liberal opinion. He got his start in journalism reporting for two New Hampshire newspapers -- the Concord Monitor and the Foster's Daily Democrat. Pearlstein has also worked as a television news reporter and a congressional staffer.

The transcript follows.


Bernardsville, N.J.: As the markets and the economy struggle and with new reports coming out about rising inflation in the wholesale and fuel/energy markets, do you foresee a possibility of another encounter with "stagflation" in the near future?

Steven Pearlstein: Yes, that's been my prediction for nearly two years, that the way this ends is with stagflation. In a weird way, its a way for Americans to adjust to the lower standard of living they should have had all along, but was masked by the credit and housing bubbles and the artificially high dollar and the willingness of the world to finance a massive trade deficit. So we'll lose a bit by having slow or no growth, and we'll lose a bit because our currency will be devalued and inflation will eat into living standards. And at some point, say two or three years down the line, things will come back into a more healthy balance.


Lexington, Va.: The official unemployment numbers do not reflect the effect of the economy's slowdown on the undocumented workers. If we could take into account the smaller amount of money transfered out of the U.S. by these workers, could we get a better estimate of the possibility of a recession?

Steven Pearlstein: I suspect that might have a bigger impact ont he economies of Mexico and Guatamala than our own.


Key Largo, Fla.: I own a Restaurant, I have watched my expenses escalate in double digit figures over the past year. How can the government say "excluding the volatile energy and food sectors inflation is moderate for 2007" when 59.9 percent of my expenses of running the business are food and energy?? I guess it's just another day in paradise!!!

Pat, Key Largo, Fla.

Steven Pearlstein: They don't say that. The report the full number, and the full number is used to calibrate Social Security increases and federal wages. It is just that, in making monetary policy, is is often useful to look at the core because it is a better guage of longterm trends because of the volatility of food and fuel prices. In this case, however, even Bernanke has acknowledged that looking just at core is not useful because there has been a secular increase in the price of food and fuel that will feed into the price-setting mechanisms and the psychology of consumers and producers.


Arlington, Va.: Truly excellent article this morning! As a blunt realist myself, I appreciate the frank candor of your words. It doesn't paint a rosy picture by a long shot, but it's about as honest an assessment as I've seen in a while. (I hate the often optimistic denial of so many economists.)

Personally, I've seen this recession coming for a long time. I blame it on a number of factors: the ever-increasing costs of the Iraq war, the housing meltdown, and the fact that prices for EVERYTHING are going up while incomes are not.

That last bit worries me the most, because I think, with prices of everything from milk to home heating bills (I thought of saying Metro fares, but figured that'd be a cheap shot) increasing so dramatically, it really raises the question of how our society can continue to function when we're shelling out so much money just to survive, and still unable to make ends meet. It'll only get worse when taxes inevitably go up, because we're going to have to make up for all these years of Bush's tax cuts.

Plus, I think the problem also involves one of human nature: this society has so much debt and so many problems that require more manpower than we're capable of to fix, yet nobody wants to pay for it.

Am I being too nihilistic/cynical, or am I actually being realistic?

Steven Pearlstein: Realistic. But let's not get histrionic here. There are people at or near the poverty line for whom this is going to be a very bad event. But for many Americans, suffering a slightly lower standard of living for a couple of years will mean going out to eat less, waiting another year to buy the latest TV, cutting back on cable options, taking a driving vacation rather than a flying one. It may mean waiting a couple more years to buy rather than rent. Those are important to people, I realize, but its not the end of the world either.


Freising, Germany: There's an interesting article today about foreign investment in U.S. banks.

It seems that some people, Saudi Prince Alwaleed bin Talal for example, are still believers in the health of U.S. banks and banking system.

What's your opinion on this? Is this the cat's whiskers, or are these investments just delaying an inevitable downturn?

Steven Pearlstein: Not sure what the expression "cat's whiskers" means. I suspect this new investors will see the value of their investment decline before it increases. They may be winners in the long run, but not the short and medium run because the financial sector has farther to fall. They are buying prestige and visibility with these investments, which have non-monetary value to them.


Maryland: Hi Steven - I'm curious about how much the individual players in these areas - finance, real estate, wall street, etc. - are actually suffering because of this recession. The little guys like us are suffering with higher energy costs, higher grocery costs, tight credit, declining property values, higher taxes, etc., etc. Are the big guys finally suffering too (and I guess it would be interesting to find out what they consider suffering)? If so, then maybe this recession is a good thing.

Or maybe they all pulled their money out a year ago and transferred it to the caymans...

Steven Pearlstein: Well, let's not throw everything together. Little guys, as you put it, are suffering from higher energy costs and grocery costs, tigheter credit, declining property values and even stagnant wages. Whether they are suffering from higher taxes or not is questionable -- if so, they are getting more local services as well. But they aren't suffering from higher federal taxes. As for the big guys in finance, many of them have seen a big decline in their pay this year and some have even lost their jobs. But they made so much during the good times that their suffering is only relative, and they still get most of the good things in life. They're just less wealthy than they thought -- that is, have less money in the investment account.


Voorhees, N.J.: How is real estate market? are we in recession? When will real estate market will pick up?

Steven Pearlstein: Bad and getting worse. Yes. Not this year.


St. Croix, Virgin Islands: I have been quite depressed watching my mutual funds slowly recede, and then take a nose dive since October 2007. I am 2 years from retirement and wondering if I need to cash out now, move my funds into European stocks, or do you believe the U.S. stock market will rebound by 2010?

Steven Pearlstein: You've sort of missed the window of opportunity on that, although there are likely to be further declines. Having some money in euro-or yen-denominated assets is a good idea. Putting money into something whose principal value doesn't decline and earns a little interest is a good idea. If you buy a bond, however, make sure it is for a duration such that you can hold it to maturity, if necessary, and not be forced into a situation where you have to sell it when the bond market is down.


Gainesville, Fla.: Just now ENTERING a recession? Out here in the reality based world we've been struggling with it for three years.

My Question...

Will the government bail out the greedy unregulated bankers or put the money in the hands of the desperate people who will spend it?

Steven Pearlstein: The government won't bail out the greedy bankers, and it may put a bit of money in the hands of the small buy as part of a stimulus program. But it won't be so much that it will make a huge difference (except, perhaps, for the very poor or those without a job). The idea of economic stimulus is to raise "aggregate demand" for goods and services by giving a little extra to lots of people who will spend it.


Alexandria, Va.: It seems that a lot of wealth was created by the increase valuation of all kinds of assets, from single family housing units to large corporations and now we often see headlines about firms on Wall Street losing billions of dollars in deals that involved the run up in these valuations. I have two questions about this phenomenon. The first is how large are these numbers relative to a particular firm and the flow of money in our economy and second; where did the profits from selling these steeply appreciated go? Is there any measurement that can be made, and generally understood, of the money supply relative to these profits and losses?

Steven Pearlstein: Very good questions, and questions too many economists, including those at the federal reserve, haven't focused on sufficiently. It turns out that there is a stronger connection, going up and down, between asset prices and real economic activity than most of the standard models show. Traditionally, economists tried to calculate the "wealth effect," that is how much extra spending does each additional dollar of wealth generate. But that is a rather cramped way of looking at things. It turns out that when you have an asset boom, it generates all sorts of other spending and investment on both the household and, in particular, on the business level that the "wealth effect" doesn't pick up. That's what really turbo-charges the booms and the busts. You see it in things like corporate takeovers and real estate investments and new product introductions, many of which won't work out but in the meantime, wind up generating lots of income and activity.


Anonymous: Atten: S. Pearlstein. Re: Your column on "Recession".

It is apparent to most students of the economy that the high price of gasoline is a major contributing factor to the cause of any recession. "Why doesn't the U.S. Government use the Sherman Anti-Trust Act, to break up the cartel's stranglehold on prices and the economy? The procedure of questioning witnesses, under oath, would reveal the vast conspiracy being used for price control.

Sincerely: Cyrano.

Steven Pearlstein: The answer is because the cartel is a cartel of governments, and governments can't be prosecuted under the antitrust laws. That's the legal explanation. There are political ones as well. But I agree with you (and have written this myself): We should make clear to any member of OPEC that if they don't stop fixing prices, we will seize their assets in this country and bar their officials from visiting, as we did with the top members of the dimaond cartel for many years.


Alexandria, Va.: OK, why is it so important to know exactly when the economy is in a recession? Isn't it enough to know that times are tough? Isn't this excessive score-keeping?

Steven Pearlstein: Yes, it doesn't matter a whole lot whether GDP growth is +0.5 or -0.5. To most of us, that feels the same.


Washington, D.C.:"So can anyone explain to me why our top elected leaders think that they're better off calling each other names and pushing proposals they know can't be enacted, rather than sitting down and hammering out a similar program that could be acted on when Congress returns next week and signed by the president when he arrives at the Capitol later for the State of the Union address?"

Because there's no money or votes in getting things done. Lobbyists and interest groups have the money and they don't pay out for legislation that gets them 50 percent of their goal. Plus by playing an all-or-nothing game, lobbyists are able to stay in business because they have to "keep on fighting for X," asking for more money from donors, getting paid higher salaries, even if a compromise could actually get them most of what they want.

Then there's the voters. Look at the flak Obama is getting for not proposing a "truly universal health care plan" because he doesn't include a mandate (which Hillary Clinton, by the way, opposed in 1993 when moderate Republicans were offering it and probably could of actually passed). But the Clinton and Edwards plans have no chance of passing since we've nearly doubled the debt in 8 years, have a looming entitlement crisis, and the need to implement ways to combat global climate change. Oh, the insurance industry is pretty good at lobbying, too. But it gins up the liberal base that thinks providing health insurance is the answer to so many ills in society, so unrealistic proposal after proposal is written up. They can tout it to their base, but it will never get acted on. And then politicians get to come back 2, 4, or 6 years later saying "Send me back and we'll get Plan X passed because we'll force the other side to accept it!" even though they don't actually have the 60 votes in the Senate, but that's neither here nor there. Moderates and independents play less a role since they don't vote/donate as regularly, especially primaries. Plus, gerrymandered districts leave politicians with little incentive to moderate their views and work on common sense solutions.

Oh, and name calling gets you on the news. Yeah, the Fourth Estate's sound-bite culture and focus on every little gaffe has given politicians incentives not to say anything beyond a set of talking points, which they will repeat until networks have nothing to air but that. The only time they say something controversial is when they want the free media (see the Huckabee "cross" ad, Swift Boat Veterans, etc.) Obviously someone like McCain is the exception, but let's just remember that George W. Bush is sitting in the White House right now, not him. And George didn't get there by speaking off the cuff!

But I'm betting you already knew this...

Steven Pearlstein: Many good points, but I think you underestimate, at this point, thedistaste the voters have for partisanship in the face of real problems.


Madison, Wis.: Your article today was excellent, as usual. My question is: How much of this panic is the result of bad luck (investors caught in a random business cycle) and how much is negligence caused by blindness caused by simple greed?

Steven Pearlstein: I always avoid the greed thing. We're all greedy (why else would we drive across town to save $100 on a TV set?). But what's happening now is not the result of bad luck. It is the result of the bursting of a credit and aset bubble that were allowed to grow too big because of negligent regulation.


Washington, D.C.: Hasn't the Fed in general been too slow to raise interest rates, after the economy recovered from the initial shock of 9/11? While these historically low interest rates helped fuel the housing boom, it appears they also contributed to the subprime credit crisis and the unprecedented devaluation of the dollar. With inflation now rearing its ugly head, won't the Fed have to administer tough medicine to the economy after the upcoming November elections?

Steven Pearlstein: The Fed is in a bind whenever there is stagflation. And as Paul Volcker taught us, the best approach is probably to keep the inflation in check and let the economy sort out the rest on its own, perhaps with a little help from fiscal policy.


Rockville, Md.: Why is everyone saying "recession" when we are not even close to the definition:

'In macroeconomics, a recession is a decline in any country's gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year. However, in the United States the official designation of recessions is done by the business-cycle dating committee of the National Bureau of Economic Research (Feldstein, 2007). The American National Bureau of Economic Research defines a recession more ambiguously as "a significant decline in economic activity spread across the economy, lasting more than a few months."'

Steven Pearlstein: We're in a period that, in hindsight, will probably be classified by the NBER as a recession. There is nothing inconsistent with saying that now and the definition you site. By the way, they define a recession less numerically and more descriptively than two quarters of negative GDP growth.


Rockville, Md.: And, to my mind, recessions ought to be as regular as winters and just as much of a problem. We should be used to them, ready for them and quick to get over them.

We seem to see a recession as the end of the world. Or am I really off base?

Steven Pearlstein: No, you're correct. Only because of the origins of this one, the asset bubble, it won't be as quick a recovery as usual. Example: the slow recovery from the bursting of the Internet and telecom bubbles, which were smaller by comparison.


Mt. Lebanon, Pa.: All the toffs and swells are testifying in front of Schumer's committee this morning. I've been watching on C-SPAN 2.

The usual baggage on how to prevent/defeat recession: faster writeoffs, more free lunches for big business, big tax cuts, more corporate subsidies, cut the regulation, more big mergers, five year restatements of earnings are sucking out the profits, yada yada yada.

"You just don't understand our problems out here. Cabana boys in the Caymans want a pay raise.. and we just don't know where the money is going to come from. We won't even go into the shortage of Monte Christos and kobe steaks out here. Please Congress, can't you help us out a little? It's not like we coming hat in hand all the time looking for freebies."

-- Big American business testimony

Have you been watching. It's enough to make you reach for a Kleenex. Sniff.

Thanks much. HLB

Steven Pearlstein: Funny.


Washington, D.C.: Today's articles and others refer to credit hedging (as opposed to interest rate risk hedging) by hedge funds -- actually outright shorting. Did major subprime lenders (e.g., Countrywide, Indymac, Washington Mutual) in 2007 as their businesses were teetering consider or engage in credit hedging by buying credit default swaps or taking positions with ABX index?

Steven Pearlstein: Not that I know of.


Boston: I have much smarter friends in the hedge fund world who, until last year, bemoaned the lack of volatility in the global financial markets. Would the flood of capital in the system (for example in the sovereign funds) and the rise of highly engineered financial products like the credit default swap market have artificially absorbed more normalized volatility? Would that be like a submarine operating with a faulty sonar--we didn't know where the risks were because we weren't getting the correct feedback from the market in the form of volatility? Way above my head but curious for your thoughts...

Steven Pearlstein: Its an interesting theory. Could be true. I suspect the lack of volatility had other causes as well, however.


Anonymous: I am a new respondent but have read the column for a long time. I believe that you are a natural born teacher turned columnist. Would you please explain at greater length and in more detail the last three paragraphs of today's column. The nest shoe to drop you call credit default swaps but I would like a more detail understanding and how they could trigger a financial chain reaction.

Steven Pearlstein: This is a hard one, and I worked long and hard on those three paragraphs last night. Let's just say there is this huge financial market you don't even know about where banks and hedge funds and big investors make bets with each other, in the form of contracts: A pays B $100 to "insure" that $10,000 worth of junk bonds at Company C don't default. If they do default, then B pays A $10,000. Now what makes this interesting is that A doesn't actually have to hold the junk bond (or the CDO, or the syndicated bank loan, or the municipal bond, all of which can be the subject of credit default swaps). It can buy the insurance, or place the bet, whether it owns it or not. Which is why the market is so big, because there can be, theoretically, an infinite number of insurance policies on every bond or loan. The reason people do this is to gamble, or to hedge investments in the security in question, or to hedge investments in other securities that tend to correlate with the one being insured. They have become an important tool in very complex, computer driven trading and investment strategies. And so if they don't work -- if the counterparty suddenly collapses and the insurance policy or bet you thought you had is no longer operative -- then there can be bad consequences.


Rockville, Md.: In the past, where have smart investors placed their money during periods of stagflation?

Steven Pearlstein: Mattresses. Foreign currencies. High dividend paying stocks in stable industries, like electric utilities. Commodities.


Washington, D.C.: Hi Mr. Pearlstein,

Unfortunately (fortunately?) for my husband and I, we would like to buy a townhouse in the DC area. Our credit is excellent, and we are willing to put 20 percent down. Since we may be headed into a recession, is this a huge mistake? Thank you.

Steven Pearlstein: If you are likely to live here a long time, just do it. If not, you might consider renting for a year, looking around, and waiting for prices and rates to drop a bit more. A lot of sellers haven't accepted that the price they thought the house was worth was a mirage.


Southern Maryland: I work in Northwest DC and have a 401K with my job. I felt so rich last summer, mid-July when Dow Jones hit 14,000. Now it's making me sick just looking at the figures. It makes me physically ill to see the money I've lost. Any chance it will turn around and start going up again? I'd like to retire in a year or two and this is my 'old age pension.'

Steven Pearlstein: Next year isn't going to give you much relief, I'm afraid. But as long as you don't need to cash out the money all at once, you can hang on and it will eventually come back. Or you can take some gains now and put it into cash or eurobonds or gold stocks.


Washington, D.C.: Normally, I respect your commentary but I think you are making a real reach with this comment.

"We should make clear to any member of OPEC that if they don't stop fixing prices, we will seize their assets in this country and bar their officials from visiting,"

If we were serious about this, most them would just withdraw their assets from the US. How do you deal with impact of the resulting capital flight?

Secondly, demand is driving the price up. Who said we were entitled to cheap fossil fuels? They just ruin the environment, keep us dependent on anti-American states and contribute the global warming. They are doing us a favor (indirectly), we should take as an incentive to move to alternative fuels.

Steven Pearlstein: We're not entitled to anything. But price fixing is illegal, and one way a monopolist or a cartel fixes price is to restrain supply. OPEC countries do this, along with free-riding non-members like Russia.


So. Md again: To follow up on Arlington, Va.'s comment -- my mother and most elderly people live on a fixed income. BG&E doubled their rates for electricity last year, meaning more money is going for basic utilities and leaving less for food and medicines. Yes--it is a struggle just to survive today. I make more money now than I ever made in my life (support staff making less than 6 figures, probably piddling to you rich liberal Democrats) but I have to budget and bend nickels just to make ends meet. I drive a 10-year-old car. God forbid I should need a new one--car payments at this point would be a catastrophe.

Steven Pearlstein: People on low fixed incomes are getting badly squeezed, whther they are Republicans or Democrats.


Arlington, Va.: Regarding Bernardsville, N.J.'s question and stagflation:

Greenspan often said he was trying to avoid deflation as experienced by Japan for many many years, I believe. What will prohibit or inhibit our transition from stagflation to deflation? What are the signs, indicators and values that tell us we are a period of stagflation, of deflation? What do you look for? Thank you!

Steven Pearlstein: There will be asset deflation -- that's probably good, since asset prices (real estate stocks, bonds) were unjustificably high. But the risk of overall price deflation, Japan style, I don't see yet. Nobody else I know of does either.


Albuquerque, N.M.: I'm not unsympathetic to the plight of people in mortgage distress but I have to ask: if the relief efforts are thinly disguised attempts to preserve the insane prices reached by housing in California etc, how will this be different than the attempts of the Japanese banks to keep propping up the values of their loan portfolios of mortgages made on the inflated Japanese real estate of the 1980s? We all know how well that worked for everyone concerned. A follow-up question: if we follow the Japanese model, could we be looking at a decade-long malaise similar to what Japan experienced in the 90s? A third question: the Japanese Nikkei peaked in 1989 (approx) at 42,000 (approx). It hasn't been above 16,000 since then. Can the U.S. stock markets avoid a similar fate if the underlying economic syndrome in Japan 1989 and USA 2007 are the same?

Thanks for the excellent columns! P

Steven Pearlstein: We have not make the same mistake as Japan by not dealing with bad loans quickly and taking the appropriate write-downs. That's what Citi and others are doing. So we're not really falling into that trap.


Silver Spring, Md.: For the person retiring in two years:

The money that you will need in 2010 "should" already be in something pretty stable, like cash. But don't forget that most of your retirement money will not be tapped until long after this recession is over, like in 2020.

Retirement savings can look like one big lump of money but as retirement approaches, it requires more sophisticated management.

Steven Pearlstein: Good point.


Albany, N.Y.: Can you tell us how one should go about investing in euro-or yen-denominated assets? Thanks for your columns..very insightful.

Steven Pearlstein: Its not so easy. You can buy stocks in foreign companies, You can see if your broker will sell you euro or yen-denominated government bonds or corporate bonds. There are ETF funds that do this for you as well, and mutual funds.


Austin, Tex.: Steven, I currently work in acquisitions of commercial real estate. Our equity partners are quite squeamish at the moment and with good reason it seems. Should I be looking for another line of work?

Steven Pearlstein: You might look for a fund that is preparing to go bottom fishing for depressed commercial real estate. Otherwise, its going to be a slow year. I suggest learning to paint or play the piano.


Rockville: Are there any government programs to reward people who have lived within their means, did not buy outrageously priced homes, and pay off their credit cards each month? Give me a break.

Steven Pearlstein: Good behavior is its own reward. Would you rather be one of those people looking at foreclosure. I doubt it.


Canada: Dear Steven, I would appreciate your thoughts on market and real estate corrections in China and India. Those economies really seem to not have felt the agonies occurring here even though the markets and prices are really in a bubble there as well. Thank you.

Steven Pearlstein: There are real estate bubbles in both places. In those instances, there are some good economic fundamentals behind rising real estate values. But there is also a speculative quality to it and it will come acropper at some point.


Louisville, Ky.: I've heard that holding investments with certain foreign currencies may be the best way to protect an investment fund. You yourself mentioned today "foreign-denominated securities." Am I right to assume that this strategy differs from simply holding securities in international companies or international holdings?

I am curious how holding foreign-denominated investments might offer better or at least different protections from dollar investments in foreign securities.

Steven Pearlstein: If you buy a stock in a foreign company, and that stock trades principally on a foreign exchange, then it is denomiated in the foreign currency. So if, during the time you hold it, the dollar goes down against that currency, you will get more dollars back even if the price of the security doesn't change. And if it goes up, you get two bumps up -- one from the price appreciation of the stock, one from the currency convension. Of course, if it goes down, or if the dollar strengthens against the currency during the time you hold it, you can lose money both ways. That said, betting against the dollar is something a lot of people are doing right now.


Rochester, Minn.: Out of curiosity, where would you attribute blame for the fine mess we're in?

Steven Pearlstein: As I said, Wall Street and the regulators are a good place to aim your ire. But remember, too, that recessions happen with some regularity.


Los Angeles, Calif.: With inflation taking off, it seems like the little in the way of rate cuts that are being implemented by the Fed now will have to be offset by equally higher (than average) rate increases in the future. Nor is there any reason to believe that they'll work (e.g. lower dollar equals higher oil prices and even higher inflation). How high might they go? For those of us who remember the crazy 70's and early 80's, high interest rates seem a terrifying possibility, completely destroying home values.

Steven Pearlstein: Luckily, we don't have 18 percent inflation, so I don't think you have to worry about a repeat of the late 70s and early 80s.


DC: As a patriot, I have a problem with Wall Street taking on sovereign wealth funds of dictatorships as partners. It's unrealistic to say that they won't have influence, if only because so much public policy is tailored to meet the demands of the squeaky wheels there. Do you see national security implications here?To me, this is much more serious than a foreign company taking over administration of a port authority. It irritates me most because the only reason its happening is that these finance institutions were allowed to be too thinly capitalized, so that the greed-buckets who run them could take their winnings off the table. Compliant regulators are complicit in the end result of Russia, China, and the gulf gaining power over our country, just so the rich men could get x percent richer. Sickening, they should be pilloried.

Steven Pearlstein: I share some of your sentiments about the Wall Street types who let this bubble develop and didn't do their jobs in terms of managing risk. But I wouldn't worry too much about soverign wealth funds taking small positions in big banks. There were similar cries when the Japanese started buying up Hollywood studios and Rockefeller Center and Pebble Beach, and look how things turned out for them.


Steven Pearlstein: That's all we have time for today, folks. "See" you next week.


Editor's Note: moderators retain editorial control over Discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions. is not responsible for any content posted by third parties.

View all comments that have been posted about this article.

© 2008 Washingtonpost.Newsweek Interactive