Financial Fiasco: Can America Recover This Time?

When it comes to predicting the financial future, economics can sometimes feel more like divination than science.

In light of the current crisis on Wall Street and yesterday's stock market losses, some experts fear the worst and even claim that, for the first time in recent American history, future generations could be worse off economically than their parents.

"For many U.S. households this may result in a new reality, with declining economic prospects for the next generation," said economist Ross Gittell of the University of New Hampshire.

But other economists doubt this dire outcome.

"It's possible, but I think it's unlikely," Steven Fazzari, an economist at Washington University in St. Louis, told LiveScience.  "There are stronger aspects of the economy that will eventually turn us around. Once we get out three to five years, things will start to look much better."

The sometimes speculative science of economics depends at times on too many variables to definitively predict outcomes.

"It's like looking into a crystal ball," said Radhakrishnan Gopalan, a professor of finance at Washington University.

Ultimately, the future will be decided not just by financial fundamentals, but also by the decisions of individuals, lawmakers, politicians and corporations. It also depends on the extent to which the nation collectively learns from our economic past instead of letting history repeat itself, experts say.

Public perception

Whether or not we're in for the worst, many Americans are definitely worried about their financial futures.

A majority of Americans (56 percent) now rate their personal financial situations as only fair or poor, according to the Pew Research Center. And economic optimism is swiftly receding. In January of this year, 60 percent of people surveyed said they expected their finances to improve over the next year, but that number declined to 55 percent of people in March, and to 51 percent in July.

Overall, only 10 percent of Americans rate the state of the national economy as excellent (1 percent) or good (9 percent), while 89 percent rate it as only fair (39 percent) or poor (50 percent), according to another Pew survey done in July 2008.

And economists agree that the average American will likely feel the effects of what's happening on Wall Street.

"I think people are going to live a more austere lifestyle," said David Sicilia, an economic historian at the University of Maryland. "We're going to travel a lot less over the next 10 years. It's probably going to hurt the service industry a lot."

Predictions

Assessments of how severe this crash is, and how long an ensuing recession might last, vary widely. While some experts are in full-fledged panic mode, others say this is a bit of an overreaction.

"I always look at stuff like this as Chicken Little and the sky is falling," said Dian Griesel, founder and CEO of the Investor Relations Group (IRG), an investor relations and corporate communications company. "I think we have a major correction taking place, but that doesn’t mean the sky is falling. Real estate prices had gotten high, lending had gotten loose, and this is a correction. There are still opportunities all over the place."

Yildiray Yildirim, an associate professor of finance at Syracuse University in New York, said he agrees that the future may be brighter than many fear.

"I think future generations are going to do fine," Yildirim said. "My suspicion is that we are a strong country and financially we are going to be fine. We always learn from our mistakes. In the short term, yes, people are going to be having a hard time accessing goods that they easily accessed before. But once we catch the upward trend in the next few years then everything is going to go back to normal, hopefully."

Forecasting the future is especially difficult when facing novel economic challenges.

"It is hard to predict what could happen to the economy because what is going on in the financial market is unprecedented and therefore little is known about how much worse the current financial problems will get," said Christian Pardo, an economist at Saint Joseph's University in Philadelphia.

Complex causes

There are complex causes behind the recent stock market losses and the downfall of a number of major financial institutions. In general, banks lent money to too many people who were not qualified to pay it back, and when they defaulted on their loans, the reverberations spread far and wide.

Some experts have suggested that, in part, the current situation arose because too many Americans were living beyond their means, and there just wasn't enough real wealth to back up the rampant consumerism going on.

"Our rising consumer spending during the 90s and into this decade turns out to have been unsustainable," Fazzari said. "We were financing high rates of consumer spending, but we were doing it with more and more debt. It worked for a while, while housing prices were rising, and people were pulling money out of their houses to finance other kinds of spending, but ultimately that can't continue."

To some degree, analysts say, a downturn in the economy was inevitable after so much recent growth. One of the major triggers for the crisis we are now facing was the burst of the real estate bubble, and the ensuing disaster when many people were unable to pay their mortgages. But perhaps this burst was unavoidable.

"If house prices keep going up, eventually they have to go down," Gopalan said. "In some sense this crash was inevitable. But what is unique about this crash is the scale of it — it's giant."

How do we fix it?

Experts also disagree on exactly what steps must be taken to mitigate the current disaster, but many say that increased government regulation of the financial industry is in order.

"The Fed [Federal Reserve] should come in quickly and put in checks and balances," Gopalan said. "They need to make rules about who you can lend to and how to rate mortgage packages."

Our best chances for a financial comeback could be in industries such as science and technology.

"There's the basis for continued economic growth from the technology side," Fazzari said. "We've got consumer electronics, biotechs, maybe new energy technologies. The country has some advantages going forward, but we have to clean out the financial excesses of the past years."

Lessons from history

Those who want reassurance that we'll pull through our present problems need only look to history, some say.

For example, after the terrorist attacks of Sept. 11, 2001, the American economy suffered a severe drop that had many experts fearing a major recession.

"Right after September 11th there was also this dire thinking, but really just within a few months consumer spending was booming," Fazzari said. "What's happening now is more severe, but I suspect people are going to come around. Partly it depends on how severe this crisis is, and how many people lose their jobs."

And in 1987 America experienced a massive stock market decline, dubbed "Black Monday," but afterward the country's economy was able to recover.

"1987 showed us that a huge stock market crash doesn’t necessarily lead to a recession," Sicilia said. "But I think the situation we're in now is much closer to the 1929 crash. We've had some pretty serious structural weaknesses in the economy for some time. This financial crisis could be a precipitating event that ushers in a long recession."

We have faced recessions in each of the most recent decades, including one in the mid-1970s, one in the early 1980s, and one in the early 1990s.

"If financial problems end soon, this recession could be not much worse than the 1991-92 and 2000-01 recessions," Pardo said. "The hope is that it does not become worse than the 1970s recessions and the 1982-83 recessions (the latter is the worst one since the Great Depression of the 1930s)."

Time will tell

What could separate our current situation from the Great Depression is not how bad it gets, but how long it lasts.

"Right after the First World War, there was a recession that was every bit as severe as the 1929 recession," Sicilia said. "The reason the 1929 recession became the Great Depression is because it lasted almost a decade. It wasn’t the severity, it was the length."

And many are still holding out hope that this time just won't be that bad.

"We'll look at this as as bad an event as we've had in the last 50 years, but not another Great Depression," Fazzari predicted.

If only economic forecasting were more like some aspects of meteorology. The latter science can predict pretty well when, where, and how bad a storm will be. If that were the case for economics, though, we might have been able to avert the current crisis.

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