The Economy and the Credit Markets: Seeking the New Normal

Published on May 29, 2009

The rate of U.S. economic growth has been disappointing, but some signs of stability have been emerging, according to Carl Tannenbaum, ’84, vice president in the risk specialist division of the Federal Reserve Bank of Chicago.

Tannenbaum made his remarks during his lecture on “The Lessons of Recession: The Road Ahead for Banks and the Economy,” at the 57th annual Management Conference 2009 at the Gleacher Center in Chicago.

While there are “a few green shoots” in the credit markets and the economy, he said Americans might nonetheless expect “some challenging months and quarters” ahead.

Economic indicators reveal a generally discouraging economic landscape. The GDP declined more than 6 percent over the last two quarters – the worst since the 1980s. Unemployment stands at 8.9 percent with little signs of abating. Banks are approaching lending very cautiously, while consumers are busy decreasing their spending and building up their savings. This last trend is good news for individuals, but bad news for the economy, which depends on consumer spending to grow, Tannenbaum said.

In addition, businesses and industries aren’t seeking new credit from banks because lending is extremely tight. “While some have hoped that bank lending would step forward to support a recovery, credit providers are actually pulling back,” according to Tannenbaum.

“As a consequence, we’re not seeing the level of business investment that we will need to see in order to keep productivity growing at a rate enjoyed over the last 15 years. Without that productivity growing, we won’t see the sort of economic performance and rise in standards of living at the level we’ve become accustomed to.”

As for consumer credit, home mortgages are currently “much more difficult to qualify for than they were a year ago,” Tannenbaum said. Financial institutions now look at credit more carefully, which “they should have been doing all along.” And unfortunately, government programs aimed at dealing with foreclosures haven’t yet met with much success.

“We’re still seeing a recidivist rate of 60 percent or more,” he said “Within six months of rewriting a loan, the majority fall back into delinquency.”

Tannenbaum also reflected on what contributed to the economic collapse and ways to prevent it from happening again.

Investors, he said, should have been “asking a lot more questions about the assets they were buying.”

In addition, credit rating agencies “should also have been asking better questions. Some of the triple-A-rated CDOs floating around out there were formed from very questionable raw material.”

At the same time, financial models built during the past decade performed very poorly under duress. “Those financial companies that were able to see that their models were no longer capturing what was happening on the ground and turn them off the fastest are the ones faring the best,” he said. “The whole industry of financial modeling, the techniques, their applications and their oversight are now open for review.”

Finally, Tannenbaum joked that the “cottage industry of producing lessons learned” may be one of the few growth areas in the United States.

                                                                                                        — Mary J. Paleologos