The Great Recession deeply affected our country in general, and its states and localities in particular. But my most vivid memory of it occurred in -- of all places -- India. In the fall of 2008, a few months after retiring as publisher of Governing, I had just returned to New Delhi from a lengthy hiking trip in the Himalayan Mountains of Sikkim and Nepal. Eager to catch up on the news from back home, I skimmed through an English-language newspaper and was stunned by the main story: Our stock and bond markets had fallen off a cliff.
The financial bubble had burst like a bomb. The investment bank Lehman Brothers had entered into what would be history’s largest bankruptcy, starting off a global collapse in asset values of close to $10 trillion. It was a catastrophe so severe that we have taken almost a decade to recover.
Are we facing another such disaster? No one knows for sure, even people who are supposed to be well-informed. At a moment of economic and political turbulence, with financial markets zig-zagging and the world’s largest economies locked in a trade war, there is reason for worry.
Topping the list of concerns is the staggering level of federal debt. According to the Treasury Department, the deficit in fiscal 2018 was $779 billion, in a year of solid economic growth and robust employment. That was an increase of $113 billion, or 17 percent, over the year before, most of it due to the large tax cut the administration pushed through Congress just before Christmas in 2017, largely for the benefit of wealthy taxpayers and corporations.
The net result is a national debt of almost $22 trillion, which equals 78 percent of the entire economy’s annual output. Since the current administration took office, the debt has increased by around $2 trillion. But the White House doesn’t seem to recognize this. Larry Kudlow, the director of the National Economic Council, told an interviewer last year that the tax cuts were promoting economic growth and “throwing off enormous amounts of new tax revenues” to the point where “the deficit is coming down, and it’s coming down rapidly.” Kudlow later explained to skeptical journalists that he was talking about the future: “The economy is so strong right now it’s going to produce lower deficits. I probably should have said future deficits.” Probably.
The one key element in the crash triggering the Great Recession a decade ago that I thought was missing from this current worrisome picture was the role played by mortgage-backed securities, increasingly risky home loans that were bundled together and sold off to investors. I was wrong, though, because those highly leveraged securities have been replaced by collateralized loan obligations (CLOs), or loans to corporations -- most of them fast-growing but highly leveraged -- needing quick cash. Just as happened a decade ago, the quality of the loans has diminished as the CLOs have been sold off by banks to private equity firms, insurance companies and other lenders who can avoid the regulations imposed on the mortgage industry in the wake of the market collapse.
Admittedly, the economy has been performing well even in the context of jittery financial markets, mayhem in the top ranks of an administration, and a president who often appears to be impulsive and clueless. The employment reports from late last year were stunning: a significant increase of 312,000 jobs, another 58,000 that had been undercounted in previous months, and an unemployment rate below 4 percent for half a year. Whether that can continue for long at the federal level seems highly problematic.
But amidst all these negative signs, there is also reason for modest optimism, and it is coming from the state level. A recent survey by the National Association of State Budget Officers concluded that “state general fund spending is expected to grow 4.3 percent in fiscal 2019” over the past fiscal year, which also saw robust growth. General fund revenues last year grew by 6.4 percent, led by a whopping 9.8 percent jump in personal income taxes. Perhaps most encouraging was the increase in cash reserves, “with the median rainy day fund balance as a share of general fund spending expected to rise to 7.3 percent in fiscal 2019 from a recent low of 1.6 percent in fiscal 2010.”
I know it’s hard to be optimistic when Washington is in such disarray, the federal debt burden has grown so fast and economic forecasters seem certain that we will experience a recession in 2020, if not before.
But I rely on two positive trends for optimism. First, it’s a good sign when states can harness the political will to feed their rainy day funds. The bigger these funds are, the more effective a buffer they will be in harder times. Second, there seems to be a growing consensus at all levels of government that we need to make significant investments in infrastructure, particularly for improved transportation and cleaner energy production. The report from the state budget officers noted that “states invested nearly 9 percent more of their own funds in transportation,” with the largest increase coming in California, which is pursuing an ambitious 10-year building program that will ultimately cost $54 billion.
So maybe when the rain comes, we will be able to build some bridges.