look at the attached documents
Recessions and Oil A recession in the US is officially designated by the National Bureau of Economic Research, the NBER. The NBER is a private nonprofit made up of prominent researchers in economics. They define a recession as, "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” This definition is somewhat bulky and vague. More simply, a recession is typically defined as two consecutive quarters of negative economic growth as measured by GDP, but the NBER uses monthly data so it doesn’t necessarily have to wait two quarters (6 months) to declare that an economy has entered into recession. Domestic production and employment are key gauges in determining the health of an economy for the NBER. They rely on data from the Bureau of Economic Analysis, BEA, which tracks and measures GDP (economic output), and the Bureau of Labor Statistics (BLS) which measures unemployment, as we’ve already discussed during the semester. Although the NBER is a private nonprofit, it works closely with these and other government agencies in order to disseminate key findings and research to government and industry so as to help them make well-informed decisions and policy. The NBER is funded through grants by government and private foundations, investment income (financial assets they hold), as well as individual and corporate donations. The Business Cycle and Recessions An economic downturn is part of what economists term the business cycle: fluctuations in economic activity that an economy experiences over a given period of time. Business cycles consist of expansions (periods of economic growth) and contractions (periods of decline). This is recognized to be somewhat inevitable. Crises of all sorts can spark a downturn in the economy: unexpected attacks (e.g. 9/11), build up in debt (the subprime mortgage-backed securities of 2008), or natural disasters and pandemics, as we’re currently in the middle of. In the 70s they were sparked by concern over the rising price of oil (and thus all other goods) and workers' power as organized labor began to wrest more control from employers/capital. During expansions, businesses are hiring, people are spending on both consumer goods as well as durables (i.e. cars, household appliances, jewelry, etc.); i.e. consumer confidence is high. At the same time, people may be building up debt as well. For workers that would like to undertake larger purchases (of a car, a home, expensive appliances) debt financing is an attractive option compared to spending current income. On the other hand, workers that do not receive a living-wage or a stable source of income may borrow as well to meet their daily necessities. As wages stagnated and failed to keep up with inflation from the 80s onwards, consumer debt filled the void (until they had to pay it back). Consumer debt (credit card debt, student loans, auto loans, mortgages) accrues as people are confident that the economy will continue to expand, wages and benefits will rise, and they can therefore service their debt into the future. Businesses, especially big corporations, also begin to borrow more with expectations of growth being higher than debt payments, and therefore an ability to service their debt and grow bigger. In businesses’ case, this is called leverage: borrowing to expand returns on investment. Businesses receive credit scores just like households do, and some businesses are known to be more reliable borrowers than others. The more reliable borrowers pay lower interest rates as the likelihood they pay their loan(s) back on time is much higher. Firms that are known to be riskier (and therefore have worse credit ratings) must pay a higher interest rate for the higher probability they may default. What Do Businesses Use Borrowed Money For? But sometimes, and in recent decades especially, corporations use both their free cash flow (the amount of money a firm has on hand after spending on operations) and borrowed money in unproductive ways, like buying back their own stock to increase its price, borrowing to pay out dividends (oil major Shell secured $12bn in credit to safeguard its dividend payments to their wealthy investors), and as a result of both of these policies, increasing the short-term profits and capital gains (increase in a company’s stock price) in order to appear healthy and prosperous. This short-term appearance of doing well increases the pay of a company’s executives; executive pay is usually based on the performance of the company’s stock, short-term profits, and some of their pay is in stocks and stock options, making the movement of stocks particularly important to the pay packages of CEOs and their managerial underlings. But none of these uses of borrowed and other money increase productive investments, e.g. hiring new workers, building new facilities, expanding research and development (R&D) of new products/services, etc. This leaves the company vulnerable in the long-term. Although the firm looks great through its increasing stock price and CEO’s salaries/bonuses, in reality the lack of ACTUAL PRODUCTIVE investment in its real workforce or infrastructure not only hurts actual workers, but it compromises the firm’s ability to pay back all of its debts when a crisis hits. Investments in real productive activity would create a stream of steady income for the firm which could be used to pay off increasing debt. Without such investments, a firm must rely on the value of their stock to use as collateral or justification for extending old loans or getting new ones. When the stock price plunges (along with the rest of the stock market) this makes the firm’s position much weaker. Eventually they may need to restructure their debts with their creditors (banks, bondholders, etc.) or even ask for government help as many big corporations and financial institutions did back in 2008 (and many times before, like during the Great Depression, the railroads in the 1970s or Continental Bank of Illinois in the 80s, just to name a few.) Expansions Lead to Contractions At a certain point in an expansion, due to reasons specific to the time and place (such as the build-up of debt, consumer and/or business, discussed above), the economy begins to contract. Businesses may lose revenue from sales and be forced to lay off employees due to lack of cash flow; default or restructure (e.g. chapter 11 bankruptcy) their debt with creditors and bondholders; and maybe shut down completely. These employees that are laid off can no longer service their debt, whether credit cards, mortgages, car loans, etc. and will suffer from the lack of income. This causes a vicious cycle. In the case of mortgages, if enough people are unable to pay their loans, the property value may tank, and this can cause a general crisis in the housing market. For the majority of people, their house is their only wealth asset to build long-term wealth and many people borrow against their homes with home-equity lines. As their home’s value falls, the cost of their loan increases, because the loan is now secured with a less valuable asset (the home) while the nominal price of the loan stays the same. As many people collectively default on mortgages and see the value of their homes decline in specific neighborhoods, this can affect the value of surrounding homes and threaten homeowners that otherwise were making good on their loans. This happened in 2008 with the rash of foreclosures that shuttered houses in neighborhoods all across the country. Homeowners that saw their neighbors foreclose and the houses put up for sale also suffered. As many houses are foreclosed on and they are put up for sale, the supply outstrips the demand, especially and particularly during a recession when nobody (but the rich and real-estate speculators) is able to buy a home and/or acquire a mortgage. This extra supply and lack of demand puts downward pressure on the price of homes, which in turn decreases the value of all homes in a neighborhood, not just the ones previously occupied by debtors that could not pay their mortgage. This decrease in home values hurts all homeowners and the real-estate industry more generally, as pay for people in the industry is based on both sales of houses (commissions) and those houses’ prices. The 2008 crisis occurred as a result of the financial system’s unscrupulous and illegal behavior, and the laws that worked in favor of high finance. It was exacerbated by the fact that workers and their standards of living were falling since the 1970s. Workers pay remained stagnant over the last half-century while productivity (the amount of output produced with a given amount of inputs) increased. Where did the extra value that was created go? To corporate profits that got funneled into the unproductive investments we outlined above. Over the years, the failure of the financial system (or parts of it) affect the rest of the economy and drag “Main Street” down with “Wall Street.” That is, the reach of finance has become so broad and its importance so critically intertwined with the production of real goods and services that even though it represents less than 5% of workers, the financial sector earned 40% of domestic corporate profits in recent years. When sectors of finance engage in speculation, i.e. unproductive gambling on the price of stocks, bonds, or other financial securities (like derivatives), instead of extend loans to businesses that actually produce value in the form of usable goods/services, it funnels money to activities that do nothing for society. In other words, it is socially useless. One such activity happened when banks and other financial institutions extended mortgages to unsuspecting borrowers who had poor credit and no understanding of how these financial transactions worked. Banks and other finance firms then packaged many of these “bad” mortgages with other mortgages of better quality into one financial security called a Mortgage-Backed Security (MBS) and then sold this financial instrument to investors with the promise that it was a “safe” investment. It was understood that the investors’ income would come from the interest and principal payments by the mortgage holders every month. If one borrower could not pay, then the investor was protected by the other mortgages that were packaged into the MBS where the borrowers could pay. This “diversified risk” according to the advocates of this scheme and made MBSs a ‘safe’ investment. Of course, it was not and many of the mortgage holders could not pay back their loan once interest rates rose. Many of the investors in these MBSs were pension funds that managed workers retirement income. When the MBSs lost their value, the workers who had their retirement funds invested in them were the big losers. This created a systemic crisis, one that compromised the entire economic system of the US and the globe. The Great Recession was largely a result of this scheme, as well as the unsustainable build-up in other forms of debt at the