The fiscal cliff “catch-22”

An overview of events leading up to the fiscal cliff  

The bank crisis of 2008 was the result of a loss in the value of mortgage backed securities held by banks when the “housing bubble” burst.  The housing bubble peaked in 2006 and by 2008 the value of mortgage backed securities had dropped in value to the point where a systemic collapse of the banking system in the United States was a possibility.  

The chart below shows the impact of the bank crisis on GDP as we slipped into recession in the third quarter of 2008. Technically we remained in recession until the third quarter of 2009 when GDP finally moved higher than the previous quarter.  

The recession had an immediate negative impact on unemployment. The U6 unemployment number is the Bureau of Labor Statistics broadest classification of unemployment.  The chart below shows the impact of the recession on the U6 unemployment number during the recession period reflected above.

In an effort to prevent a recession resulting from the bank crisis Congress passed the Economic Stimulus Act of 2008. The Act provided for tax rebates to low- and middle-income taxpayers, tax incentives to stimulate business investment, and an increase in the limits imposed on mortgages eligible for purchase by government-sponsored enterprises (GSE). Total stimulus provided by the bill was approximately $150 billion for 2008.

The Economic Stimulus Act of 2008 did not work to avert recession and on Feb. 17, 2009, in response to high unemployment and the recession that had started in 2008, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (ARRA). The ARRA was broad in scope and involved a number of tax incentives and credits. Additionally, the ARRA extended unemployment insurance benefits, provided direct cash payments to qualified recipients, provided funding for work projects, subsidized health care for the unemployed and increased food stamp benefits.         

The ARRA, along with monetary stimulus provided by the Federal Reserve with quantitative easing — normally referred to as QE1 — was effective in pushing GDP higher in the third quarter of 2009.  There is a general consensus that the ARRA and QE1 were necessary and effective measures that brought an end to the 2008-09 recession.  

Although the recessionary slide was halted in the third quarter of 2009, since that time we have not been able to shift private sector sentiment to the degree needed to create real economic growth. Absent the massive injection of government money (borrowed money) back into the economy provided for by ARRA we would have remained in recession.  Unfortunately we now find ourselves at a point where we simply can’t borrow any longer to provide the artificial economic prop that has held recession at bay for the last three years.       

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