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Directions for the Road to Economic Recovery

Mark Zandi, the chief economist and cofounder of Moody’s, believes the worst of the U.S. recession is behind us.

That’s the bad news. The good news is that the pain of this recession is so deep and so broad, he argues, that lessons may linger long enough to push the next meltdown well into the future.

Zandi’s predictions defy political pigeonholing. Although an economic adviser to 2008 Republican presidential candidate Sen. John McCain, Zandi was also an outspoken supporter of President Obama’s $787 billion stimulus package and even suggested that government spending could have been bolder to avert the worst effects of the recession. Zandi, author of Financial Shock: Global Panic and Government Bailouts—How We Got Here and What Must Be Done to Fix It, spoke with AARP Bulletin Today about indicators to use for monitoring economic recovery and what the government can do to reduce the risk of future calamities. (Read an excerpt from Financial Shock.)

Q. Why are some people calling our economic crisis the Great Recession?

A. The Great Recession is a good way to describe this. It’s the worst downturn since the Great Depression, though they’re not in the same league. This qualifies as the Great Recession because of its severity, its length and its breadth across industries, regions of the country and the globe.

Q. Are we in recovery?

A. Well, we’re still in a recession. In the United States, we’re a year and a half in. It began in December ’07, and the global economy followed us in fairly quickly. The U.S. recession should be over by the end of the year. The global recession should be over by early next year, with a bit of luck and some continued good policymaking.

Q. What gives you the sense that things are turning around?

A. The panic that pervaded consumers, businesses and investors has faded to caution. People were literally panicked—running for the bunker—at the end of last year and early this year. Thus the free fall in spending, investment, investment activity. Everyone is still very nervous but not panicked. And that is reflected in more stable consumer spending and business investment; the stock market has improved a bit.

Q. What accounts for the change?

A. Most fundamentally, this has happened because of the aggressive response by the Federal Reserve and fiscal policymakers. The Fed has acted to lower interest rates and engaged in credit easing. We’ve gotten stimulus from Congress. There’s been a very strong effort to shore up the banking system and the financial system more broadly. The auto industry got help. There have been efforts to mitigate foreclosures and quell the foreclosure crisis. The panic has faded in large part because the policy response has been so significant.

This has occurred not only in the United States but globally as well. Every major economy has lowered interest rates, and almost every nation in those economies has implemented various types of fiscal stimulus.

Q. What signs will suggest further recovery?

A. Confidence is key. It’s still very low. But the numbers aren’t falling—they are improving. So we need to see a clear, definitive increase in consumer and investor business confidence.

We need to see better retail sales, some evidence that the fiscal stimulus, the tax cuts are having some benefit. We then need to see continued improvement in the job market. The best measure would be the unemployment insurance claims. They’ve peaked and are coming down, but they are still very high. We also need to keep our eye on the financial system. Things are vastly improved—particularly, the banking system is in much better shape.

Q. Americans seem frustrated because a lot of banks that made sketchy loans got bailed out.

A. I don’t think anyone got bailed out, frankly. I mean, everyone’s suffered. Maybe a few hedge funds that bet against the housing and mortgage markets did fabulously well, but generally speaking everyone has gotten creamed in this downturn, including those in the banking and finance industry.

Q. In your book you candidly note that in July 2008 you thought the “worst might be over.” What went wrong?

A. The answer is the policy response, and that’s ironic because here I’ve been arguing it’s good policy that quelled the crisis. But it was also very bad policymaking that turned a garden-variety recession and a modest financial crisis into a complete panic and the Great Recession.

Q. Elaborate.

A. There was a string of mistakes made last September, beginning with the takeover of Fannie Mac and Freddie Mac. The mistakes extended to allowing Lehman to go into bankruptcy; to Congress initially voting down the Troubled Asset Recovery Plan; to the secretary of Treasury saying TARP funds would be used to take troubled assets off the books of troubled banks and then doing an about face; to the way bailing out AIG steered even more money to banks.

Now, in all fairness, this was all happening very quickly, and it was difficult to put this into a broader context and thus make good decisions. But clearly in hindsight a lot of the decisions that were made were not good ones, and they precipitated this very serious downturn that we’re engulfed in by destroying public confidence.

Q. What do you think of the Obama administration’s talk of regulatory reforms?

A. Regulatory reform is vital to restoring confidence in the financial system, which is a necessary condition for a well-functioning economy. It has to be done. The most important aspect of the reform is to institute a systemic risk regulator, a single institution, namely the Fed, that can look at risk across the entire financial spectrum, at every institution. The risk regulator needs to look at the entire financial system and ask, “Is this an appropriate level of risk? Is leverage getting too high? Are people borrowing too much?” And if so, the regulator has to have the courage of conviction and weigh in against it. One of the reasons why we got into this mess is that there was no single regulating body that could or would do that.

Q. And how about creating a consumer protection agency for financial affairs?

A. The most controversy has centered around that. I think it’s a good idea. Clearly the current regulatory framework failed in this regard. A lot of people got loans and got into other financial products that they really didn’t understand. People do need some help and protection, just like the FDA helps with regard to the safety of our pharmaceuticals. There needs to be an institution that watches over financial products because that’s so important to so many people’s lives.

Q. Is the bubble and collapse cycle par for the course?

A. Well, it certainly has been. Every decade or so we have a pretty serious financial crisis because we have a tendency to start forecasting with a ruler. If prices of something have risen one year and then the next, we all believe they’re going to rise like that, ad infinitum, into the future. So then we do silly things, we have bubbles and they burst and we have crises. It happens every 10 years or so—probably because it takes that long to change over management and for a new generation to come in and think that they are better than the previous one, that they’ve got better tools and techniques and data and so forth. That’s part of human nature.

Q. So we’re good for 10 years?

A. The next crisis is more likely to happen in 20 or 25 years, because more than one generation has been affected by this.

Q. What advice would you give to a 60-year-old thinking about his retirement today that might be different from what you would have said before the crisis began?

A. I wouldn’t count on large returns on my investments to make a big difference to my wealth over the next 20 years.

Q. In other words, don’t expect 7 percent per year?

A. Yes. I mean, people were expecting more than that; even two years ago embedded in people’s thinking was 8, 9, maybe even 10 percent. Five, 6, maybe seven percent is possible. But I don’t think I’d plan on it.

Q.What else?

A. Don’t stay in the bunker. If you’re going to be in short-term CDs, they may make sense at the moment, but interest rates will rise, and you’ll have an opportunity to get higher-yielding CDs.

It also means you probably don’t want to stay in the United States. You probably want to look for investments in other parts of the world because that is where the action’s going to be. You want to do that in a cautious way, with well-respected mutual funds that are very cognizant of your tax situation and your risk tolerance and charge reasonable fees for their services.

Michael Zielenziger writes about business and the economy. He lives in the San Francisco Bay area.