A conversation with the chief economist and co-founder of Moody’s Economy.com
Question: What has fundamentally changed post-crisis in terms of the financial system?
Mark Zandi: Well, we won't be spending like we have in the past. For 25 years, from the early 80's to the mid part of this decade, consumers spent very aggressively. They borrowed heavily and used that to finance spending. Wealthier households thought they were really wealthy and didn't need to save and so they spent also very aggressively.
I think after this crisis, this great recession, that has changed in that consumers are going to be much more cautious going forward and they'll save more. Higher income, wealthier households because they know they're not wealthy and that savings values are going to rise as quickly as they thought. Low and middle income households because they'll have no choice, they just can't borrow to finance their spending. So, to see change an inflection point with respect to households and how they spend their money and how aggressively they spend their money.
Question: How will the Millennials be affected by the recession?
Mark Zandi: Actually, there's been a huge change in their saving behavior. If you look at their saving rates, people in their 20's and early 30's firmly negative, firmly negative, right up until early 2008. Since then it's positive. And not inconsequentially so. I mean, a measurable saving. So I think even younger households have changed. They're thinking about the world has changed and they're going to behave differently going forward. In part that's on their own volition because they realize and understand that economies don't move in a straight line and that they need to be prepared for things when things don't do well. But part of it is being forced upon them because they are just not able to get that credit card or get that big auto loan, or get that mortgage like they did in the past. I think people are starting to think and are starting to worry about things like, are my taxes going to go up? Whose taxes are going up? Spending by the government on Medicare and on Social Security. Am I going to be able to get Social Security and Medicare at 65? Am I going to get the same benefits as I've gotten in the past? So, those are big questions that I think people are now really starting to ask themselves and it does have political implications. There are many, but that would be one key implication.
Question: What can we learn from the spring stimulus package?
Mark Zandi: Well, in my view, I think it worked. I don't think it's any accident that the recession ended just at the same time that the stimulus – now, I'm talking about the $787 Billion package passed last February. But that stimulus is now providing its maximum benefit. So, the stimulus worked in that it brought this recession to an end and it's providing a little bit of juice for the economy into the various parts of recovery. Now, this stimulus probably isn't going to be enough to push the recovery into a self-sustaining economic expansion and that's where we are right now. It's a little bit tricky and so we may need to see more – the government may need to provide more help to make sure that that transaction does actually occur. The intent of the stimulus was to end the recession, get a recovery going, and in my view, it worked.
Question: You wrote in a recent paper. “It’s no coincidence that the great recession ended just as the stimulus package began providing its maximum economic benefit.” How do you know? (Steven Landsburg, The Big Questions)
Mark Zandi: Well, it's a good question. I mean, we can look at individual aspects of the stimulus package and then look at the parts of the economy to which that stimulus would have an impact. So for example, the Cash for Clunkers, we know that that had a huge effect on vehicle sales and helped turn around vehicle production and employment in the vehicle sector. The First Time Homebuyer Tax Credit, the housing market stabilized this summer. Housing prices actually have risen a little bit in the last few months. Now there are many reasons for that, all of them policy related, but one of the key policy aspects that helped the market was the First Time Homebuyer Credit.
Consumer spending stabilized, and consumers got tax cuts, Social Security recipients got checks, so I think it helped there play a role. Without help from the feds, states would have been cutting. Let me just give you a statistic. In the year ending in the second quarter of 2009, state and local tax revenues fell by $120 billion. On a percentage basis, we've never seen anything like that, $120 billion and in that same year; aid from the federal government to state and local government increased by $110 Billion, so almost a complete offset. Not complete in some states, but localities have been cutting programs and jobs and raising taxes because they still have a budget hole, but could you imagine what they'd be going through had they not gotten that help.
You have to think about what the world would have looked like without the stimulus. You've got to construct a counterfactual, but in the case of state government, I don't think that very hard to do. You can ask any governor and they'll pretty much tell you that the stimulus was very important to keeping their budgets together as well as they were kept together.
Question: After 2006, what was the thinking among regulators and financial professionals concerning a scenario in which housing prices fell significantly in many areas of the country? (Arnold Kling, Econlog)
Mark Zandi: I think though, if you go back to '06, there's a broad based belief that house prices would not decline, at least across the nation. There would be regions of the country, California perhaps, and New York and maybe Florida where we see some price declines, but nothing that would encompass the entire national housing market and get outright price declines.
I mean, I can remember -- we do a lot of house price forecasting for our clients and in '06, at some point, we forecasted that national house prices were going to decline in '07. Not by a lot, but b a little bit. A couple, 3 percentage point decline and that was a big change and created a lot of angst among a lot of our clients saying, "How can that possibly be the case?" So, of course, it was a couple of 3 percent and it ended up being 30% plus. So, I think there was this general view, based on historical experience that this just couldn't happen. At least not to the scale that it obviously ultimately did occur.
Now, I have to say, unfortunately, because the models were based on looking at house prices relative to people's incomes and house prices relative to effective to apartment rents, the models wanted to say bigger price declines in some big markets. But I didn't even believe it. I had a hard time digesting what the models were telling me. And I felt like, if I came out and said prices were going to decline, that was a big enough statement and I didn't have to say they were going to decline by 23%. Because then you lose credibility. And that's also part of the problem in this period because for a number of years, good economists were arguing that house prices were getting inflated, it was speculative that in all likelihood we would at least see them go flat or decline. But if you say that say, in '05 and then prices continued to rise by double digits, and then you say that again in '06, and then prices rise again in double digits. Then you lose credibility and no one listens. And so that became the problem.
And that's not a typical of the bubble, but that's exactly what happened and why a lot of us lost credibility because we had been arguing that this wasn't sustainable, but we started arguing that too early.
Question: How did we miss an $8 trillion asset bubble? (Dean Baker, Beat the Press)
Mark Zandi: Well, a number of things. I think at the root of it was a very new and complex process of financing mortgage lending and other lending altogether. The process of securitization, which at its core I think has value and is a good thing. It provides for the more efficient allocation of savings into investment, but I think the problem is no one really understood the process from start to finish. You had the originators making the loans who were focused on what they did. You had the investment banks buying the loans and packaging them into securities, and the focused on what they did. You had the rating agencies looking at the securities and deciding, how is this going to look, and they were focused on what they did. The regulators were focused on individual aspects of this process. But no one was looking holistically and saying, "Is this going to work? Does it make sense?" And at the end of the day, we made a lot of bad loans because the process didn't make sense.
Question: Were financial regulators or industry executives equally to blame? (Arnold Kling, Econlog)
Mark Zandi: I think industry executives, they were looking at it only in the broad sense, and they were only focused on their aspect of the process, so they really didn't consider everything in its totality and regulators the same way.
Now the other problem regulators had was there was a general view in regulatory circles that the market would figure it out. In a sense the regulators were thinking the CEO's had it figured out and that they didn't need to do much oversight or really consider what the CEO's were doing. The CEO's in fact, weren't -- because of the way the securitization process was structured, no one really was focused on the entire system, and regulators didn't understand that. But they thought the market was working properly and the CEO's would get it right. And of course, that was wrong.
Question: Do you believe that bonds could one day be like stocks where analysts present their opinions rather than the market relying on the ratings of few agencies? (Dan Indiviglio, The Atlantic Business Channel)
Mark Zandi: Well, I think to some degree that happens now. I mean, all the folks that work at various investment houses, buy side analysts, do spend a lot of time and energy trying to understand the risk characteristics of bonds and determining whether they are good investments or not. So, that happens already. They take the ratings as one other opinion in their decision-making process, whether to make an investment.
I think, going back to securitization-- that was complex. That was more difficult for analysts at these investment houses to evaluate in part because they didn't have all the information and data and in part because the securities were really very difficult to understand and so they didn't have the same level of understanding and they didn't do the same kind of due diligence as they did for say, a municipal bond or for a corporate bond, or a sovereign bond. But I think that's going to change going forward if there ever is another structured finance deal that's done, you'll see a lot more analysis put into it.
Question: What if ratings agencies disappeared? Would Wikipedia or Google do a worse job? (Tyler Cowen, Marginal Revolution)
Mark Zandi: I think there's a function for rating agencies because in a sense, there is a lot of despaired information and bringing it altogether is very costly and doing good analysis is difficult and you need scale to do it. Some bond houses are gaining that scale and doing that on their own. There's the PIMCO's of the world and other big bond houses that have the skill necessary to put together the staff to do the kind of analysis that needs to get done. But many other investors don't have that scale and the rating agencies, in a sense, provide that for them. And so, there are scale economies in that kind of analysis and in a sense the rating agencies provide that.
Also, there's a lot more esoteric kinds of bonds and securities that are issued and it always will makes sense to have, I think, something like a rating agency providing an opinion as to the quality of that particular bond or that security. So, I think there's an economic reason for rating agencies, so I think they will always be around, obviously the role is going to change as a result of events, but I think there will always be a role for them.
Question: How did you get into economics?
Mark Zandi: Well, it happened in 4th grade. I did a project on: Why was Detroit the center of the vehicle industry? This was a 4th grade project. I remember -- it was a group project and I enjoyed it tremendously and I didn't now what an economist was in the 4th grade, but I knew that I wanted to do something like that. And so from that time on, I sort of focused on things related to business and economics. So, I remember that day and I remember that project and I remember how much I enjoyed it and I thought I was good at it. I thought I had insight and so from that day forward I was headed towards being an economist.
Question: How should economics be taught at different levels of school?
Mark Zandi: I think it's not taught properly at high school. If I were teaching in high school, I would focus on personal finance issues. When I got out of high school, I could make a pretty good omelet, but I didn't even know what a mortgage was. And I think that's a mistake. And I think that's one of the reasons why we are in the mess that we are in. Why all those millions of bad loans were made because people really did not, truly did not understand what they were getting into. So, I think the high school curriculum should change and home economics should be more about the economic than the home. I think. That would be my view.
And then I think in universities, it tends to be – the teaching seems to move towards the highly theoretical. Very mathematically oriented and it kind of loses touch with the reality of what's happening in our economy and in the real world. And I think that's to the detriment of the profession and it's relevancy to our everyday lives. So, I think it's important that universities, at least, make an effort to get back to more practically oriented kinds of economic analysis. Or, at least do economic theory that they can ground in terms of something that is practical. I think we've lost that and are losing that and there are very few economists that can really step out of the theoretically world and make an impact on what's happening to people's daily lives.
Question: What keeps you up at night?
Mark Zandi: What keeps me up at night is the fact that businesses seem to be still very, not panicked, but they're very, very cautious. Unusually cautious. And I guess it's understandable because many a business people suffered near death experiences in the last year and just aren't stepping up and the longer they wait to step up and begin to invest and begin to hire, the more likely this recovery that we are now in unravels back into a recession. And if we get back into recession, I don't think that's going to be easy to get out. People's wages will start to decline and we'll be engulfed in a deflationary cycle. You've already used up most of our policy ammunition, the funds rate target is at zero, and we have a $1.4 trillion budget deficit. So, we have to guard against that and it worries me that businesses haven't gotten their groove back. At least not yet.
Recorded on November 10, 2009