"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. …