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Freund offers view on the state of the economy.

"One of the strengths of capitalism is its resilience. Just as good times don't last forever, neither do bad," Pace University professor and Chief Economist Emeritus of the New York Stock Exchange William C. Freund told delegates to the Congress of Cities in San Antonio.

Freund, who directs Pace's Center for the Study of Securities Markets, shared his optimistic outlook for the American economy, both short-term and for the next three to five years, at a general session.

"Clearly, what we have been through is not just an ordinary recession," he said of what has been called the Great Recession.

The current downturn differs from other post-World War II recessions, he added.

"In this Great Recession, it has not just been one element, not just housing, although I hardly need tell you that housing has been in a turmoil. It hasn't just affected the stock market, although the stock market did decline some 60 percent before the recent upturn," Freund said.

Investment advisors usually tell clients to diversify, the economist said, but diversification hasn't helped this time, because this recession has affected so many markets.

Problems with sub-prime mortgages and credit default swaps, or insurance policies that debts would be repaid, were big triggers.

Some of these products were very useful and well designed, but the problem was that there was so much borrowing against them, or leveraging.

"The investors were more concerned with the return on their money, rather than with the return of their money," he said.

Many investment firms hired quants, or mathematicians and physicists who built models of risks.

"What they forgot was what happens when everybody wants to sell at the same time and there are no more buyers.

"The motto was 'make money now, worry about risk later.'"

Assets have shrunk, but the liabilities and debts have remained outstanding.


"The inventiveness of unregulated investment banks and other financial institutions was truly astounding," Freund declared.

Freund predicted that about 200 banks will merge or fail this year.

The Federal Reserve and other central banks have poured funds into the banking system, essentially nationalizing financial risk. These actions, together with the stimulus program, have gone a long way to moderate the collapse, he said.

"We have learned a lesson since the Great Depression of the 1930s ... that old Keynesian lesson, namely, when some portion of demand dries up, you have to fill the void. If you don't, you reach a new lower level of equilibrium which is called underemployment equilibrium, and you stay there until ... there is an injection of purchasing power either by the private sector or by the government."

Freund said the worst is now over. The economy has bottomed out and some positive factors are emerging. The third quarter saw a turn, in part from inventories that had been drawn down excessively and had to be restored.

"The economic expansion ... which we are now undergoing will be tepid. The housing market has probably not yet quite reached the bottom."

Also, unemployment will continue to rise.

Official unemployment statistics are somewhat misleading, Freund explained. When part-time workers who would rather work full-time and discouraged workers who have dropped out of the work force because there are no jobs for them are factored in, the figure is more like 17 percent.

Moreover, the average work week has declined from 40 to 33 hours. The first impulse of employers who need more manpower will be to lengthen the work week rather than hire additional employees, he said.

Freund predicted that the unemployment rate, which always lags behind the Gross Domestic Product (GDP) expansion, will remain essentially unchanged in 2010 and probably begin to decline to about 8.5 percent in 2011 and 7.5 percent in 2012. A more normal rate would be about 5 percent.

He said it will take a long time for unemployment to reach normal levels and consumers will continue to try to save more.

One more shoe to drop is commercial real estate, he said, noting retail and office vacancies.

"I do not expect a sharp bounce back on a 'V' pattern, as we've had in the past."

Freund said the Obama Administration has more or less done the right things and the President is surrounded by very competent economists.

"What I think we will see ... is what has been called a 'new normal' in the years ahead."

The next three to five years will see slower growth, greater consumer savings, less spending out of income, above normal unemployment rates, a weaker dollar internationally, lesser willingness to bear risk on the part of investment and commercial banks and others, and greater government regulation, especially of banks and financial institutions deemed too big to fail.

Cities and states will experience slow growth or even declines in tax revenue. Cities will have less money coming from their state governments, as their budgets are under pressure also. Foreclosures will add to their problems.

With limits on tax revenues and cost pressures continuing to affect their budgets, cities will have to limit some social and welfare benefits, he said.

Municipalities need access to the bond market to finance their long-term capital projects and will therefore have to close budgetary gaps to maintain investor confidence in their debt instruments.

Cities are labor intensive and need to develop new ways to economize and obtain productivity gains as well as seek regional cooperation and public/private partnerships. Freund encouraged delegates to lobby for more federal grants, especially for Medicaid programs.

Freund expressed some major, longer-run concerns, including the federal debt.

Freund said it is not difficult to make longer term projections because there are only two factors that determine a country's long-term economic growth, the rise in its labor force and its. productivity.

"It is primarily productivity growth that allows a country to enjoy a rising standard of living."

The United States has had very good productivity growth in recent years and that productivity growth will continue to fuel economic growth longterm, he said.

The era may be over, Freund said, but the age of the Internet has barely begun. A revolution in high-tech fields will continue to drive economic growth. He sees big profit opportunities in alternative energy sources, biomedical advances, health care and information technologies.

"Computers are really doing amazing things. Computers and bio-tech and telecommunications will be as important in the 21st century as autos were in the 20th and railroads in the 19th."

Freund foresees much greater government regulation of banks, insurance companies and other financial institutions. Governments will limit leverage and strengthen capital requirements and will probably appoint a regulator to review risks and anticipate weaknesses.

"Despite the fact that we've been through a serious recession, the world is not coming to an end," he said.

"I think there are glimmers of hope. Our economy is not shrinking any more. Corporate profits are beginning to rise. The stock market certainly has done pretty well in the last few months."

He told attendees that local officials have the ability to adjust to bad times temporarily.

"Though we will have subpar growth for a few years, the American economy has shown an ability to adapt and respond to challenges. We'll continue to benefit from entrepreneurship and a competitive spirit. In American, we have a great sense that everything is possible.

"Above all, I believe that with good productivity growth, our economy will continue to grow, though we are likely to face a sluggish few years ahead," Freund concluded.
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Author:Turner, Laura
Publication:Nation's Cities Weekly
Geographic Code:1U2NY
Date:Nov 23, 2009
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