Why an Individual Mandate is Necessary for a Healthy Market for Health Insurance and Should Be Ruled Constitutional

March 25th, 2012

It’s been a long time since my last post. I’ve been inspired to share my thoughts again because this week the Supreme Court is hearing arguments concerning the constitutionality of the “individual mandate” in the Patient Protection and Affordable Care Act. I believe strongly that the constitutionality of this mandate should be upheld on both legal and economic grounds. As a PhD economist, I believe strongly that we can’t have effective universal access to insurance if we don’t have (near) universal participation, either through an individual mandate or a government provided healthcare system.

I apologize for the length of the post but there is a lot to be considered to fully understand the issue. The first part of the post provides a summary of some key facts about our current healthcare and health insurance system. The second section summarizes why the individual mandate is necessary for a private health insurance system to work. The post closes with arguments why the mandate should be declared constitutional. I believe that if the Supreme Court finds against the constitutionality of individual mandate, it will take judicial activism to new heights, raise serious questions about the Federal Government’s power to tax, and would eliminate one of our country’s best options for universal access to health insurance.

Current Situation:

·         Our current system currently provides access to health insurance coverage to people who are:

        Employees of companies or government entities that provide health insurance for the employees and their family members

        People who have recently lost jobs that provided health insurance, who have access to insurance through COBRA and HIPAA (plans mandated by Health Insurance Portability and Accountability Act of 1996)

        People who can demonstrate that they have few health risks

        People who qualify for Federally-provided insurance, such as Medicaid or Medicare.

·         People who are self-employed, employed part-time, or are unemployed  who are viewed as being high risk based on pre-existing conditions cannot get access to health insurance of any kind if they unless they are extending coverage from a former employer through COBRA or HIPAA or qualify for government funded care.

·         People may be forced to change their insurance coverage if the change jobs

·         Currently roughly 50 million people (1/6 of the US population) do not have health insurance

·         Uninsured people consumed $116 billion worth of health insurance they didn’t pay for, the costs of which are shifted on to taxpayers, insurance companies and those who pay for healthcare

·         The US spends 17% of its GDP on healthcare, which is nearly 50 percent more than the next closest developed countries, The Netherlands, Germany and France which spend approximately 12 percent. The healthcare results don’t appear to be commensurate with the expense. For example the US ranks 29th worldwide in healthy life expectancy, 30th infant mortality (and the rate is more than twice that of Sweden and Japan), and ranks last in preventable mortality, just below Ireland and Portugal, according to the Commonwealth Fund’s analysis of World Health Organization data. Overall, according to “The World Health Report 2000, Health Systems: Improving Performance” the U.S. healthcare system ranks 37th in the world (see New England Journal of Medicine - January 14, 2010; 362:98-99). The US is the only developed country that doesn’t have near-universal health coverage.

·         Our mediocre healthcare system performance is not due to the lagging technology or lack of facilities or trained physicians, but rather most likely due to a lack of access and utilization of our healthcare system due to a faulty insurance system.

·         Based on discussions with health insurance senior managers, between 10 and 20 percent of our insurance premiums under the current system go to administrative expenses associated with determining who is eligible for insurance. If these administrative expenditures could be avoided and the savings were applied to providing care for those who are uninsured (particularly in the form of preventive care), we could largely cover the healthcare cost of the uninsured without an increase in our current total insurance expenditure.

The Economic Rationales for an Individual Mandate:

·         One of the key objectives of Patient Protection and Affordable Care Act (ObamaCare) is to allow everyone to have access to health insurance. Two key provisions are the requirement that insurance companies provide access to insurance without consideration to-preexisting conditions (mandatory issue) and a mandate that individuals purchase health insurance or at a minimum contribute to the cost of insurance if they can’t afford the full cost of insurance (mandatory enrollment). People who do not purchase insurance would be subject to a fee. It is this second provision, known as the “individual mandate,” that is the subject of the current legal challenge.

·         We cannot have effective universal access to private sector provided health insurance without the individual mandate. If insurance companies are required to issue health insurance policies without considering pre-existing conditions, one of the biggest incentives for people who are currently to buy insurance will be removed: the threat of not being able to get insurance if they get sick.

·         If there is mandatory issue with no mandatory enrollment (the individual mandate) the result will be that many people who currently perceive themselves as healthy will choose to save money by waiting to get insurance until they either are sick or view themselves as being at high risk of getting sick. This is a problem that economists refer to as “adverse selection” and has been long known to be a source of market failure in insurance markets. As relatively healthy people opt out of purchasing health insurance the expected cost of insuring those purchasing insurance will go up due to the higher proportion of sick or at risk people in the risk pool. The result is that insurance premiums will need to go up to cover the increased costs. As insurance premiums go up, even more low-cost, relatively healthy people will opt out of insurance, further raising the cost of providing healthcare for those who still choose to be insured. The end result will be very high priced insurance that will only be purchased by the most sick or at risk people in the population.

·         There is already a model that illustrates the dilemma for people who are seeking mandatorily issued insurance and have preexisting conditions: the HIPAA mandated insurance policies. These are policies that an insurance company must issue to individuals who have had continuous insurance coverage after their COBRA insurance coverage period expires (COBRA insurance is the extension of their employer-provided plans that people are allowed to buy for a limited amount of time when they lose their jobs). HIPAA policies typically roughly cost twice what employers would pay for the same individual. Sample monthly HIPAA insurance policy rates for providing HMO coverage for a single individual in 2011 are listed below (Source: Health Net, figures rounded).

        Age 19-24: $530/month

        Age 25-29: $620/month

        Age 30-34: $790/month

        Age 35-39: $860/month

        Age 40-44: $910/month

        Age 44-49: $960/month

        Age 50-54: $1,130/month

        Age 55+:    $1,320/month

·         Many of those who are unemployed, employed part-time and many who are self-employed will find these rates to be unaffordable and will take their chances. The reason these rates are so high is because the insurance companies (correctly) assume that people with no pre-existing conditions will seek insurance policies in the open market that can deny coverage for pre-existing conditions. As a result, those willing to participate in these HIPAA programs are inferred to have pre-existing conditions that make them likely to be expensive to insure. Without the individual mandate rates and with the Patient Protection and Affordable Care Act’s mandatory issue requirement for insurers will likely to be in the same range as those outlined above for HIPAA policies, because insurance companies will (I believe, correctly) assume that most of those opting for insurance will be at high risk of requiring expensive care. The end result will likely be higher premiums and a smaller percentage of the non-employer insured population with health insurance than we have under our current system.

·         Broadly speaking we have three choices for healthcare insurance:

1.       The status quo in which insurance companies can deny coverage to those with pre-existing conditions.  This system results in high administrative costs and a large number of people who are unable to get insurance. The uninsured will be less likely to get preventative care and more likely to require expensive treatments that they will be unable to afford, ultimately imposing costs on those who are insured.

2.       A mandatory issue requirement for insurers with a mandate that individuals get insurance. This system will result in all people having access to “relatively” low cost insurance (likely less than half the rates listed for the HIPAA policy above). It will encourage some people to get insurance who would have opted out otherwise, which has the benefit of expanding the risk pool. With greater coverage, more people will obtain preventative care which will reduce the need for expensive emergency room treatment and other treatments for conditions that could have been mitigated with preventative care. In order to maintain the system, health insurance coverage for low income individuals will need to be subsidized. It is likely that reduced insurance administration cost savings could cover much of the cost of that subsidy if a mechanism could be designed to require insurance companies to do so.

3.       A mandatory issue requirement for insurers with no individual mandate. This system can reduce administrative costs but will lead to high priced coverage. This policy would significantly lower the proportion of the population with insurance among those who don’t have employer provided insurance compared to the status quo. WE CANNOT HAVE UNIVERSAL ACCESS TO HEALTH INSURANCE WITHOUT AN INDIVIDUAL MANDATE UNLESS WE WANT TO HAVE VERY EXPENSIVE POLICIES THAT ONLY THE SICKEST PEOPLE WILL PURCHASE IF THEY CAN AFFORD IT.

·         Prohibiting the individual mandate would eliminate the possibility for near-universal coverage short of a government run single payer system, which would leave the US as the only developed country that does not provide health insurance access to nearly all of its population. It also would mean that the country would have to continue to rely on employer-provided insurance since employers will be the only group to have a large enough risk pool to be able to offer low cost insurance. The result is that people will be less likely to become voluntarily self-employed, start new businesses, and will tend to stay with undesirable jobs in order to keep their health insurance. Of the three options, the second with mandatory issue and mandatory enrollment seems to be by far the most sensible of the options with private insurance. There was a time when conservative politicians and conservative think tanks such as the American Enterprise Institute and the Heritage Foundation agreed with me. NYTimes.com-02/15/2012

The Case for Constitutionality of the Individual Mandate:

·         The Commerce Clause refers to Article 1, Section 8, Clause 3 of the U.S. Constitution, which gives Congress the power “to regulate commerce with foreign nations, and among the several states, and with the Indian tribes.” Since healthcare expenditures account for 17% of the US GDP, clearly regulation of the health insurance industry falls within the legitimate purview of the constitutional power of the Congress. Also, given the arguments presented above there are arguably significant potential economic and social benefits from the mandate.

·         As summarized by Paul Gigot of the Wall Street Journal: “The Commerce Clause that the government invokes to defend such regulation has always applied to commercial and economic transactions, not to individuals as members of society. This distinction is crucial. The health-care and health-insurance markets are classic interstate commerce. The federal government can regulate broadly—though not without limit—and it has. It could even mandate that people use insurance to purchase the services of doctors and hospitals, because then it would be regulating market participation. But with ObamaCare the government is asserting for the first time that it can compel people to enter those markets, and only then to regulate how they consume healthcare and health insurance. In a word, the government is claiming it can create commerce so it has something to regulate.”

·         The argument for Congressional regulation of markets comes from the failure of markets to function efficiently. As pointed out above the markets will not function efficiently without some form of mandatory participation due to the adverse selection problem, which will result in only high cost insurance that will be purchased by only the sickest people if they can afford it. If Congress can act to restrict the behavior of monopolist in order to promote market efficiency arising from monopolistic behavior (such as setting prices excessively high),  then there is a rationale for compelling behavior on the part of individuals in order to improve the functioning of the health insurance market.

·         One source of economic inefficiency comes from cases in which the actions of one party have a negative impact on others who do not voluntarily participate in those actions. For example, if someone doesn’t purchase car insurance and gets into an accident that harms another driver, that other driver is harmed unless they can be compensated for the costs they incur. If the uninsured driver cannot compensate the accident victim because the he or she is uninsured, then the action of the uninsured driver (the decision of the driver to not obtain insurance) has a negative impact on others (the uncompensated victim). As a result many states compel individuals who drive to purchase car insurance. The constitutionality of this type of legislation has not been challenged because an individual can opt out of buying car insurance by deciding not to drive.

·         In contrast to the car insurance example, opponents of the mandate argue that people cannot opt out of health insurance since it is required of anyone who is alive. While this is true, the decision by one individual not to get health insurance can have a negative impact on others if they get injured or sick and are unable to pay for the care that they receive. Since healthcare providers cannot deny treatment to those in need of urgent care, they are forced to absorb the costs of many uninsured patients. In response, they will be compelled to raise their prices in order to cover these costs. As such we have another case in which the action of one party (the decision of the driver to not obtain insurance) has a negative impact on others (those who pay for their healthcare). As long as healthcare providers are compelled to provide urgent care to those who need it regardless of their ability to pay, the decision not to purchase insurance does financial harm to others and should be subject to regulation. PEOPLE CANNOT CURRENTLY OPT OUT OF OUR HEALTHCARE SYSTEM. As such it should be possible to compel people to purchase health insurance. If laws were amended to allow healthcare providers to deny health coverage to people who don’t have insurance (or sufficient credit to cover the cost of care) then it would be possible for people to opt out of our healthcare system and then individuals should be allowed to decide not to purchase insurance. However, doing so would mean that those who chose to gamble or couldn’t afford the insurance would be allowed to die if they got seriously injured or sick. This position seems to be advocated by many libertarians, such as Ron Paul, but poses ethical challenges for many of us.

·         From a financial point of view the individual mandate is not fundamentally different from a healthcare tax imposed on all US citizens that allows people to get a 100% rebate on the tax if they purchase health insurance. The right for the federal government to tax its citizens has not been questioned constitutionally. Finally, Congress has imposed a number of financial mandates on U.S. citizens. One example is that people are required to buy into a federally-run retirement insurance account called Social Security. More abstractly, any expenditure by Congress funded by tax revenue amounts to citizens’ being forced to purchase something that they probably wouldn’t have purchased voluntarily. Ruling the mandate unconstitutional would raise serious questions about the right of our federal government to charge taxes and/or offer tax credits for desirable behavior.

We may have different views about the effectiveness of the Healthcare Reform Act. In particular, there are many changes that could be enacted that would lower the cost of our healthcare system that were not addressed in the Act (such as tort reform and modifying the fee for service healthcare compensation system). However, the constitutionality of individual health insurance mandate should not be in doubt. It is not the Supreme Court’s responsibility to determine whether the mandate or the law as a whole is desirable or effective. They should only determine whether it is allowable under the U.S. Constitution.  If the Supreme Court finds against the constitutionality of individual mandate, it will take judicial activism to new heights and would eliminate one of our country’s best options for universal access to health insurance. This would leave us stuck with the least comprehensive and least cost effective health insurance system in the developed world.

A Modest Proposal for TARP Funds (revisited)

January 26th, 2010

When I was giving a final exam to my UC Davis MBA pricing students in December of 2008, I came up with an idea about how Troubled Assets Relief Program (TARP) or similar funds could be used to help mitigate the problem our economy was going through with mortgage foreclosures. I wrote it up and sent it to folks in government I hoped would listen and two others whom indicated interest. Not surprisingly the people in government to whom I send it at best sent me a form response. However, I received a very favorable response from many of the other interested parties who reviewed it. I’ve decided to post my modest proposal on my blog because I believe that we are still facing substantial headwinds in the housing market and that such an approach could still be useful.

More than 2.3 million American homeowners faced foreclosure proceedings in 2008. That was an 81% increase from 2007. In 2009 the number of U.S. residential properties receiving at least one foreclosure filing jumped 21% to a record 2.82 million according to RealtyTrac, an online foreclosure marketplace. Some 6.2% of mortgages were at least 60 days delinquent at the end of the third quarter of 2009, up 16.7% from the previous quarter and 73.8% from a year earlier. Furthermore there are some substantial waves of Option ARM and Alt-A mortgage adjustments that are expected through 2012 (see below).

Mortgage Rate Resets 2007-2016

A major source of this problem is that the current loan owners and servicers are either unwilling or, due to securitization, unable to take the necessary steps to restructure the loans in a way that will adjust principle and interest rates in a way that will result in affordable and fixed monthly payments for homeowners. Last year the White House introduced a loan-modification effort, called the Home Affordable Modification Program. According to the latest Treasury Department report, some 759,000 struggling borrowers have received temporary mortgage payment relief under this program but just 31,400 (only 4%) have succeeded in obtaining permanent changes.

My modest proposal is not as Draconian as Jonathan Swift’s proposed solution to the Irish famine of the 1700’s, in that I don’t suggest that we fatten up financially stressed homeowners as serve them to their mortgage owners as compensation for their defaulted loans. Now that banks are repaying their TARP funds, I would like to make the case that these or similar funds should be devoted to stabilizing the housing market directly by purchasing qualified stressed homes at currently appraised values, which would be resold to the original owners with reasonable financing.

The process would work as follows.  A homeowner who is upside down in their own home would get their house appraised and apply for a homeowner refinance program.  To qualify the home would be one that is owner occupied and for which the owner could afford a fixed mortgage for 80% of the currently appraised value.  I would not recommend requiring that the owner be delinquent in their payments to qualify for this program. I’d also suggest that less emphasis should be placed on credit rating at this point and focus on the potential borrower’s ability to pay a suitably refinanced loan.

If homeowners qualify, the Department of Treasury would offer to purchase the home at the currently appraised value using the TARP or other designated funds.  The homeowner could then take this purchase offer to the lender as an offer for  a short sale.  The lender would have the option of accepting the short sale or accepting a deed for the property. 

If the lender declined the short sale offer, the lender would get the deed to the property and the Treasury Department would agree to purchase a comparable home of equal or lesser value and sell it to the original owner, conditional on the upside down homeowner’s turning the deed of the original property over to the lender.

Once the home was purchased, the Treasury Department would sell the newly acquired home to the original owner and offer financing of a 30 year fixed loan for 80% of the currently appraised property value.  In order to create an attractive loan that could be resold, a 20% down payment would be required on the property.  If the purchaser could not afford it, designated funds would be used to make the 20% down payment in exchange for 20% equity stake in the home. Under such a circumstance, the homeowner would have the option at any time of buying out the government’s stake at its fair value at the time of the proposed buyout.

This down payment requirement or government equity stake may at first seem unappealing to troubled homeowners, but if the house has depreciated in value by as little as 17 percent, it provides a higher potential for capital gains than they would have if they were to keep their current mortgage.

There may be a concern that this policy’s adjustment in the principal might reward homeowners for a poor investment when the property appreciates in value. If so, one could require that the first twenty percent of any post-purchase appreciation revert to the government to compensate it for assuming the risk of the down payment and reduce the likelihood that a homeowner would profit from selling the property at a price that was below the original purchase price. This would also encourage more homeowners to put more skin in the game. Furthermore, it would create new relatively low risk loans that could be resold to financial institutions, the sale of which could be used to recapitalize the program.

This proposal has several advantages. First, it will increase the expected value of many troubled mortgages by greatly reducing their risk of default. It does this by substantially reducing the homeowners’ monthly payments, especially for those who have had adjustable rate mortgages that have, or will soon, reset to higher rates. This would enable more homeowners to keep their homes. It will also reduce the incentive of homeowners who are upside-down in their homes to walk away from their mortgages because they owe substantially more than their property is worth, a major contributor to the high redefault rates. Buying the mortgage backed securities directly wouldn’t accomplish this because of the difficulty in reworking the terms on securitized loans when the authority to do so is not well established.

This proposal will take currently risky mortgages off the banks and compensate them at a fair market value, which would be greater than they could expect to receive if the property were to foreclose. Further, it will have the political appeal of directly assisting homeowners and slowing the supply of defaulted properties on the market which has been putting downward pressure on housing prices.

The Best Government Money Can Buy

January 22nd, 2010

Yesterday the Supreme Court struck down decades-old limits on corporate political expenditures, potentially reshaping future elections by permitting businesses and unions to spend freely on commercials for or against candidates. I think this was a terrible decision for the future of our political system.

I believe that unless you can vote, you should not be allowed to engage in, fund, or facilitate campaigns for political candidates or contribute to organizations that engage in these activities. Applying the 14th Amendment, which requires states to provide equal protection under the law to all people within their jurisdictions to businesses, unions, and lobbying firms, is wrong. Businesses and unions are not persons, and therefore 14th Amendment protections should not apply to them.

This ruling in effect makes it possible for a company whose stock I own to utilize its (and effectively my) funds to support a political candidate that I do not support. The same may be said if I were a union member about the use of my membership dues. From the point of view of shareholders or organization members, the only “ethical” justification for these organizations using funds in this way is if the funds are an investment that will advance the well-being of the organization. For all intents and purposes these contributions are bribes and this ruling is just legalized bribery by businesses and unions.

The ruling will vastly increase the influence of lobbyists in our legislative process. According to Lawrence Noble, former general counsel of the Federal election commission, a lobbyist can tell lawmakers “we’ve got a million we can spend advertising for you or against you - whichever you want.” I believe that this is bad for the political process and will lead to legislation catering to lobbyists and special interests.

I can hardly wait to see what comes out of this.

“Gentleman” Ben Bernanke - Should He Be Time’s Person of the Year?

December 30th, 2009

A couple of weeks ago something that I think is pretty cool happened: one of my former PhD Macroeconomics professors was named Time Magazine’s Person of the Year. I find it interesting that a Fed Chair, who may have some difficulties in getting his reappointment confirmed by the Senate, would be given this kind of recognition. The question arises, “Is this a reasonable choice?”

I’d like to make the case that it was. If not for the actions that he spearheaded following the failure of Lehman Brothers, a number of key financial institutions would have gone belly up, which would have caused a collapse in our financial system. As unpopular as the TARP was, the funds were necessary to keep speculators who were driving down the stocks of financial institutions by short selling at bay (see The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History by Gregory Zuckerman to see the types of tactics that were being used to profit by driving our largest financial firms out of business). When TARP funds were allocated to the financial institutions, it essentially put a floor on their stocks and sent a big signal to short sellers that they would not be able to drive them into bankruptcy.

Low interest rates have been also highly desirable due to the large number of creatively financed “prime” mortgages that are resetting and will continue to be reset through 2012. The low interest rates are allowing those loans to be reset at low rates, which will reduce the number of foreclosures and increase the money that these homeowners will have for consumption of other items. There are those who feel that these low interest rates will expand the money supply to an extent that we run a great risk of inflation in the near future. I’m not concerned about inflationary pressure until the banks start lending again for reasons I will explain in another post. I also think Bernanke is sensitive to the potential for inflation and will lead the Fed to take the steps necessary to keep inflationary pressure to acceptable levels.

I don’t believe that he has done a perfect job however. I was deeply concerned with the inability of the Fed models to anticipate the fact that the problems in the mortgage market would spread seriously to other sectors of the economy. A modest level of disaggregation of the numbers would have seen how much of the economic activity between 2003 and 2007 was driven either by massive home construction, home improvement expenditures, and purchases enabled by borrowed funds obtained by refinancing homes that had appreciated unrealistically in value. I don’t really consider myself to be a macroeconomist, but I saw the problem coming and I went on record in the summer of 2007 with my prediction that the economy was going into a recession in 2008.

I was also frustrated by the continued focus on inflation through the summer of 2008 in spite of all of the indicators that we were in a recession. This may have been driven by the observation that commodities prices were rising through the summer or 2008 (remember $4.00 a gallon gasoline prices, anyone?). However, if attention were paid to what hedge funds were doing, it would have been easy to see that they were driving up commodity prices by encouraging the purchase of commodity futures contracts to protect investors from the potential declines in the value of the dollar.

I’m not sure about why the Fed made these mistakes. There may have been political pressure to suggest that the economy was stronger than it was. Alternatively, the Fed may have been jawboning to stave off a recession by suggesting the economy still had some strength to it, realizing that a Fed statement that the economy was in a recession would have accelerated it. Regardless, the failure to act sooner allowed the situation to get worse.

Fortunately, when the seriousness of the economic downturn became obvious Bernanke, who has done extensive research on the Great Depression, led a drive to implement many of the monetary and fiscal actions that I believe were necessary (although distasteful) to keep a serious recession from turning into a depression encore.

The reason I think he deserves the “Person of the Year” recognition comes from his key role in averting an economic disaster. At the very least, I think he deserves an award for “Comeback Player of the Year.”

Overall, I think I agree with Republican Senator Bob Corker’s assessment from the Committee on Banking, Housing, and Urban Affairs Confirmation Hearing:“Did Bernanke get all the calls right? Absolutely not. Did he make many mistakes? Absolutely… But I think that the experience that Chairman Bernanke has had over the last year and a half makes him by far, of the people that I know, the most well equipped person to lead the Fed over the next several years.”

The federal government: spender of last resort

December 30th, 2009

Unfortunately, it looks like we are in a situation in which we have to rely on the federal government to be the spender of last resort, which requires greater deficits. Unless the spending is on investments that will make some or all of the debt self-liquidating, this will mean higher tax burdens in the future or “printing money” causing inflation which devalues the debt obligation by making the dollar worth less. Both of these will put a damper on long-run economic growth. I recommend that the government focus its spending on activities that will be self-liquidating.

There are two ways that debt can be (at least partially) self-liquidating. One way is by improving productivity or otherwise lowering production costs which will help generate more economic activity and more tax revenues in the long run. The other way government debt can be self-liquidating is by accelerating expenditures that would otherwise have occurred in the future, allowing for long-run spending to be reduced. Sadly, things such as spending on government services such as police and military personnel or tax cuts that enable increased consumption, while they may be desirable, do not pay for themselves and will add to our long run debt.

When will the economy recover?

December 30th, 2009

We have gotten into this serious economic downturn because of our excessive reliance on debt: consumer debt, governmental debt, and trade deficits. The consumer debt is particularly troubling since consumption accounts for roughly 2/3 of our GNP. Two things happen when lenders are no longer willing to issue credit to consumers. First, consumers can no longer borrow to fund consumption which means that they must consume within their means. Second, they must pay down their debt (which in aggregate statistics looks the same as increasing savings), which means that they will only be able to consume at level that is below the level that would be sustainable without their debt burden. This second reduction will be temporary but will continue until consumer debt is reduced to an acceptable level, at which point banks will resume a normal pattern of lending.  

Given our economy’s reliance on consumer spending, I don’t believe it will get well until the consumer can resume spending at a sustainable rate. That won’t happen until they deleverage by either paying off their excessive debts or by defaulting on loans. At current rates of deleveraging, that could take five to ten years.

In the meantime, our economy’s slide has been to a large extent stopped by substantial fiscal stimulus in the form of spending on government projects, extending unemployment benefits, the federal government’s subsidizing state spending and employment, and consumption subsidies like cash for clunkers.

Business spending has also recovered somewhat after a period of paralysis from Q4 2008 to Q2 2009 caused by the great economic risk and uncertainty that we were experiencing. Businesses are spending again, but primarily on things that will improve their operating efficiency rather than on investments that will expand capacity. I expect the bump in business spending to subside after businesses have made up for the spending that was deferred during the period of fear.  I expect it will soon return to the (reduced) level that will be needed to sustain the lower level of operations. Sadly, that does not bode well for employment in the near term.

Ultimately, I believe that a financially healthy consumer will be needed for a sustainable economic recovery. It troubles me to think that will take a quite a while.