Is Another US Recession in the Works?

Democratic Presidential Candidate Elizabeth Warren has been calling out financial malfeasance for a large part of her career. As a Harvard Law Professor, she first gained national attention in 2004. During an appearance on The Bill Moyers Show, she called out then Federal Reserve Alan Greenspan for acting at the behest of banks when he was encouraging Americans to borrow against the equity in their home.

Her concern was the fact that her data indicated that Americans were overextending themselves, and the banks were encouraging this behavior. In short, she equated the growing mortgage debt akin to gambling in Las Vegas… and in Vegas, the house always wins. Over the next few years, Warren became more vocal about her concerns on what she saw as increasing predatory lending by banks. 

Back then, her concerns were often marginalized, and that’s when they were paid attention to at all. And then on September 15, 2008, investment bank Lehman Brothers imploded, setting off a chain of events that, as Rolling Stone writer Matt Tiabbi noted, “almost punctured a hole in the universe.”

Recently, Warren published an article in which she looks at some recent economic data, and has noticed some of the same precursors that led to The Great Recession. It’s worth looking at some of these to see if they do, in fact, pose a threat.

A leading bellwether of a healthy economy is how its manufacturing sector is performing. According to MarketWatch, for the period ending June 30, 2019, production in America was down 1.2% after a 1.9% decline in the first three months of the year. Manufacturing itself fell at a 2.2% rate in the second quarter, after a 1.9% drop in the first three months of the year. This information, supplied by The Federal Reserve, indicates that by data and definition, this sector is indeed in the first stages of a recession.

Ian Shepherdson, chief economist at Pantheon Macroeconomics, acknowledges as much but is not concerned, “The sector is in recession. That’s not news, it’s a consequence of China’s cyclical slowdown and the trade war. We expect another tough quarter in Q3, but by Q4, we think a trade deal will have been done and China’s economy will be turning up.” Adding insult to injury is the fact that for the first time ever, the average hourly wage for manufacturing workers in America is below the overall average.

While much of the economic data being projected by almost everyone in America appears solid, the same claim was made repeatedly in the few years leading up to 2008 implosion. However solid the numbers may seem, perhaps it’s best to view the state of the economy as solid as The Flying Wallendas performing a high wire act without a net. In other words, maybe precarious is a better word choice.

A striking similarity to 2008 is the amount of debt that Americans are taking on just to keep up with the simple cost of living. In fact, it’s more alarming. According to a report from the Federal Reserve Bank of New York’s Center for Microeconomic Data, household debt is now $869 billion higher than 2008’s $12.68 trillion peak. The presumption is that much of this debt is around healthcare, childcare, education and normal living expenses, not refinancing your home or taking on debt to build a wrap-around porch.

Once the dust had settled from the financial crisis and mortgage lending was put on ice, banks and financial lending institutions were forced to find other avenues of revenue. As the real estate sector lay cold and flaccid, they turned their attention to automobile loans. Since 2009, car debt has grown 75%, to about $1.3 trillion dollars. In 2018, there were $584 billion in new auto loans and leases appearing on credit reports, the highest level of auto loan debt in the almost 20 years that this data has been collected. 

Much like the mortgage loan boom before it, the target demographic of auto loans isn’t the one with the best credit. According to a report by the US Public Interest Research Group and Frontier Group, auto loan rates rates are soaring, “particularly among the most vulnerable borrowers. And lower-income people are being subjected to a range of shady practices in auto lending, like subprime loans and racial discrimination.” That sounds strikingly familiar.

While 75% growth is very unusual, it’s not what’s alarming Warren and raising flags with others. It’s the fact that 7 million Americans are three months behind on their auto payments. Equally alarming is the fact that 71 million Americans – 30% of the country – have all of their debt being serviced by a collection agency. For many, including Warren, this alone indicates that the American economy is faltering.

But wait, there’s even more debt. Having more than doubled since the financial crisis, student loan debt is now the second highest debt, behind mortgages. It’s currently about $1.5 trillion dollars. There are many reasons for the increase in student loan debt (state budget cuts forcing state universities to raise tuition, straight up increased tuition, etc) but the simple fact is that increased tuition is placed squarely on the doorstep of students. 

It also can’t be ignored that the amount of credit card debt in America now matches its 2008 zenith.

However, it’s not just individuals – corporations are strapping themselves with more debt too. The leveraged loans industry – loaning money to companies already gravely in debt – has become a “systemic risk” to our financial system, according to former Federal Reserve Chairperson Janet Yellin. If that sounds vaguely familiar, it’s because it was this type of leveraged lending that contributed to the mortgage-backed securities model that contributed to the 2008 crisis.

According to Elliot Ganz, chief counsel for the The Loan Syndications and Trading Association, “People are jumping to conclusions by focusing on credit risk, but not looking at much lower systemic risk, which does not support those conclusions.” But Professor of Finance at the University of Pittsburgh, Shawn Thomas, has a more apprehensive thought by recommending that regulators “keep a close eye on leveraged loans.” 

Breathing the spirit of the Trump administration into the topic, his Comptroller of the Currency, Joseph Otting, has boldly said that banks can “do what they want” with regard to leveraged lending, as long as they have sufficient capital.

Nonetheless, this $1.3 trillion dollar leveraged-loan market that played a significant role in the 2008 downturn has become so troublesome that even the International Monetary Fund has rung the alarm bell on the industry.

Perhaps most alarming is the US Treasury yield curve. This upward slanting curve is an indicator of market demand as investors demand higher yields for bonds with longer maturities. In short, it serves as an indicator of market confidence.

In March of this year, that upward slope inverted, indicating that investors wanted to lock in rates today rather than risk long-term rates going lower as a result of a stumbling economy or recession. It’s worth noting that the US Treasury yield curve has inverted before each recession in the past 50 years.

If that inversion history holds true and the United States is on course for a recession, it can take anywhere from 12 to 24 months to slip into a recession.

There appears to be many indicators that America is walking down a similar path as it did a little over ten years ago in the lead up to The Great Recession. Once again, it’s Elizabeth Warren sounding the alarm bell and largely being ignored. One could be cynical and say it’s a political ploy for the Presidential Candidate to push her economic plans for the country… and of course, that’s possible. But, even a cursory search will quickly reveal that it’s not just Warren sounding the alarm: it’s the IMF, Former Fed Chairperson Janet Yellin and a growing number of economists and financial reporters.  

At this moment in time, it’s safe to say that a course correction is called for to offset America’s current trajectory. But that seems unlikely. In which case, it will make the words of philosopher George Santayana, from his The Life of Reason: The Phases of Human Progress, far too apropos:

“Those who cannot remember the past are condemned to repeat it.”