Why It's Stimulus Time Again

When the financial crisis lifts, a bleak job market will need some overdue attention

Next stop for bailout-happy policymakers? The stressed-out U.S. consumer.

A weakening jobs picture could be the next target for officials who have spent weeks trying to shock the financial markets out of their daze. House Speaker Nancy Pelosi said Monday that Congress will discuss a recovery package that would fund infrastructure improvements and extend unemployment benefits. Also on Monday, Democratic presidential candidate Barack Obama unveiled a five-point plan for helping the middle class.

The prospect of further government spending at a time of substantial budget deficits is hardly music to taxpayers' ears. The United States has committed over the past month to spending hundreds of billions of dollars to shore up the crumbling financial sector. The Bush administration this year has sent out billions of dollars worth of tax rebates as part of a $168 billion stimulus package Congress passed earlier this year.

Yet despite the mounting bills and the limited effectiveness of the spending to date, economists say policymakers have little choice but to send out more cash, in the name of stabilizing the job market and boosting the economy as a whole.

"Investors have been reluctant to admit that this cycle, unlike 1998's credit crisis, is imbedded in the real economy," Merrill Lynch investment strategist Rich Bernstein wrote last week. "The government can come up with any number of refinancing and liquidity plans, but households are likely to increasingly default on mortgages and other debts if cash flow is not stabilized via employment."

The employment picture is deteriorating rapidly. The United States has lost 760,000 jobs in the past nine months, according to the Bureau of Labor Statistics, while weekly initial jobless claims have hit a recent 478,000 from the low 300,000 range in early 2007.

Those are numbers that go hand-in-hand with recessions, noted Northern Trust economist Asha Bangalore. "Projections of weak economic growth," she added, "suggest that a higher level of jobless claims in the months ahead is nearly certain."

In fact Microsoft, founder Bill Gates said Monday he believes the unemployment rate could hit 9%, up from 6.1%. Any substantial rise in joblessness will put more pressure on house prices and further undermine the mortgage markets that governments around the world are trying desperately to shore up.

After the Binge

The economic stumbles come after a debt-fueled consumption binge tied to the surge of house prices in the first half of this decade. Consumer spending as a proportion of gross domestic product rose to 71% in 2005 and 2006 from less than 65% in 1980 and a 25-year average of 68%, according to Royal Bank of Scotland data.

To finance that spending, consumers and businesses took advantage of former Fed chief Alan Greenspan's expansionary monetary policy and borrowed heavily, laying the groundwork for a massive expansion of the financial sector. Low interest rates, together with deregulation, allowed the likes of now-defunct Lehman Brothers and Bear Stearns to post record profits and ply top staff with multimillion-dollar bonuses.

But outside the booming financial sector, job growth was soft and wages were stagnant. The median U.S. family's income was actually a shade lower in 2007 than it was at the end of the high-tech boom of the 1990s, according to census bureau data.

"Since 2000, a lot of economic growth has been illusory," said Len Blum, a managing director at investment bank Westwood Capital. "Now that the asset bubbles have been popped, you start to realize we really didn't make that much progress in our economy."

Indeed, consumer outlays are now falling, as households try to work off their debts. Along with the surge in mortgage delinquencies that precipitated the financial crisis, the spending slowdown is also taking a toll on employment.

What's more, the news in the job market seems to worsen by the day. General Motors said Monday it will close plants in Wisconsin and Michigan, costing 2,500 jobs. Financial firms have cut 65,000 workers in 2008, as the so-called shadow banking system has cratered, forcing the feds to cough up billions in bailout cash for the likes of Fannie Mae, AIG and others.

Narrowed Options

The scope of that rescue will narrow the government's options in stimulating demand, says University of Wisconsin economics professor Menzie Chinn. Chinn says the best way for the feds to stimulate the economy is to support infrastructure spending via aid to cash-strapped state and local governments, because that will increase economic activity more than a tax cut would.

But officials will be constrained, he adds, by the huge budget deficits the United States has run in recent years even when times were flush. While the foreign central banks that have been the biggest buyers of U.S. debt are likely to continue purchasing Treasury securities, he says, they'll demand stiffer terms as debt issuance rises with the cost of the bailouts - and that means higher interest rates.

"We really need the biggest bang for the buck," he wrote," given that we have borrowed so much already."