Will the American economy hit a recession? A quick look at the credit crisis and the housing bubble

For all the talk about housing bubbles and credit crises, the main factor that will decide whether America hits a recession, and how long it will be stuck in this recession, is consumer spending. Private expenditures account for just about 70% of the American economy -- seventy percent!

Of course, the housing bubble and credit crisis are important in this way, because they directly affect the level of consumer spending. Therefore let's look a little more closely at credit and housing and how they might impact consumers.

1. Credit. In an economy like the one we have right now, our extraordinary consumer spending is made possible through the extension of credit to more and more Americans. Innovative ways of extending credit, such as the so-called 'subprime loans,' have collapsed. This collapse is the 'crisis,' which has spawned two major consequences. It has: (a) drained financial banks, like Citigroup, which has lost about $15 billion the last two quarters, of much needed cash; and (b) made them skittish about lending to controversial debtors. Because our economy's growth was systemically dependent on the extension of this questionable credit, it is unclear how our economy can avoid a long recession without the help of the controversial credit practices. Or put another way, perhaps the recession will last as long as it takes for new innovative credit practices to emerge. Problem is, by then we might be so desperate to get out of the recession, we might rush to employ even more questionable credit practices. Did I say economics is tricky?

2. Housing. Housing affects consumer spending in the obvious way (more houses bought means more consumer spending): People who own homes, especially those who have recently bought a new home, need to furnish them -- that is, buy things! People who rent have less incentive to make expensive household purchases.

But more important is not the rate of home-buying, but the value of existing homes. This value represents 'home equity' and much of the wealth of households all over the country. So it is a problem not just for the individual but for the economy as a whole that, as is reported today, "Sales of existing homes fell in March while the median home price declined, as a severe slump in housing showed no signs of abating."

All that said, what we think we know at this very moment is basically drawn from theory and logic and common sense. What we really need are data, and data only come with time. In the meantime, at the top of this post are four statistical pictures (data we do have) to help get a grasp of the economic reality around us.

They are taken from the Financial Times, from the April 21 article "Road to Ruin? America ponders the depth of its downturn" by Krishna Guha.

The first graph (top left) deals with quarter-by-quarter GDP growth. We see it was lowest in Q3 and Q4 of 2001, this country's most recent recession, and that recent quarters are trending in that direction.

The second graph (top right) compares America's savings rate with its disposable income, and we can see that, relative to disposable income, Americans are saving less and less the past few years, and we didn't save much before that to begin with.

The third graph is really the picture of a bubble -- we can see house prices climbing, climbing, climbing, and then peaking and falling downwards around early 2007.

The final graph deals with vacant homes. Look, for instance, at how much higher the vacancy rate is right now compared with 2001 (the most recent recession with which to compare). The percentage of abandoned homes is currently approaching 3%. In contrast, in the recession of 2001 abandoned homes accounted for less than 2%.

So will the American economy hit a recession? It already has; we are in the middle of it. How long will it last? The answer to that is a question: How quickly can we get lending and borrowing (credit) and personal consumption flowing again?