The Top Line
The economy won’t be recovering anytime soon
“we’ve seen demand growth flatten recently with the rise of covid-19 cases,” Delta Air Lines CEO Ed Bastian told investors during the company’s latest earnings call on July 14. Delta lost $7 billion in the second quarter of this year and served 93 percent fewer passengers than it had in the same quarter last year. In early June, things had been looking up: Bookings were rapidly accelerating as customers prepared to resume travel. But in recent weeks, demand has, as Bastian notes, “flattened,” with coronavirus surges making customers less eager to fly. Delta, like its competitors American and United, had to pare back its plans to add more flights over the summer. And it’s not just airlines that have seen demand flatten in recent weeks—the once-sharp recovery has stalled across much of the economy, and perhaps gone into a modest backslide, as Americans have become more cautious about their spending.
Real-time data from the Opportunity Insights Economic Tracker, sponsored by Harvard and Brown universities and the Bill & Melinda Gates Foundation, shows that consumer spending remains far above the levels from March and April but stopped rising in mid-June and remains below last year’s levels. The recent retrenchment has been national—consumer-spending growth has stalled not just in covid hot spots like Texas and Arizona but also in states like New York that are performing much better. That suggests consumers are looking at the big picture rather than reacting to outbreaks in their own area. And the grim outlook for schools’ reopening in the fall will serve as a further drain on the economy, making it tough for parents to resume normal work schedules.
The “V-shaped recovery” that Trump economic adviser Larry Kudlow forecast as recently as July 8 is not in the cards. A double-dip recession is possible, but the most probable outcome right now looks like treading water, with the fast recovery of the late spring turning into a long, slow slog. Fewer jobs will be created, and many businesses will find themselves unable to stay afloat until conditions improve. Exactly how rough the economic recovery will be depends on many variables, but three will be key: the extent and persistence of covid outbreaks, whether and how robustly Congress extends additional economic aid to workers and businesses, and whether and when an effective vaccine is widely distributed.
It’s likely that Congress will extend the enhanced unemployment benefits that are set to expire at the end of July, albeit at a less generous level than the current $600 per week. It’s also likely that the decision on an extension will come so late that there will be delays, as state unemployment offices scramble to implement the new guidelines. “There’s going to be at least a couple of weeks where the big ongoing fiscal support provided by the federal government—these emergency unemployment payments—goes away,” says Ernie Tedeschi, a former Treasury Department economist. He notes that the other chief fiscal supports from the cares Act passed in March—$1,200 rebate checks to most adults and forgivable PPP loans to businesses—have largely been disbursed, so the economy is already getting far less aid than it was during the spring.
Even if Congress does decide to extend unemployment benefits, the ongoing uncertainty will hurt the economy: Households unsure of how much they will collect in benefits later this year may be less inclined to spend now. But assuming we do get a pretty large fiscal package—say, more than $1 trillion, including some unemployment enhancement and another round of rebate checks—the rickety execution of the aid will be a significantly smaller drag on the economy than the virus itself.
As for vaccine hopes, the stock market has been strongly influenced over the past few weeks by signs that an effective vaccine could be approved before the end of the year and in use within months after that. For the market, at least, this prospect serves as a light at the end of the tunnel—even as the government fumbles virus mitigation in a way that means more deaths and less economic activity in the short term. The assumption that we’ll have an approved vaccine soon, of course, could prove wrong.
Recent earnings announcements from major banks, whose financial health depends on the ability of borrowers to pay back loans, reflect the wide range of possible economic outcomes. To date, the economic crisis is not yet showing up on the balance sheets of major banks in the way you would expect. But they are getting ready for it to do so over the next year.
Consider the case of JPMorgan Chase. During its earnings call on July 14, the bank announced that it had enjoyed quite a good quarter, everything considered, posting $4.7 billion in profits. “In the normal recession,” JPMorgan CEO Jamie Dimon said on the call, “unemployment goes up, delinquencies go up, charge-offs”—delinquent loans the bank expects never to collect—“go up, home prices go down.” But this isn’t a normal recession, and JPMorgan isn’t experiencing the expected rise in borrower delinquency. That’s in part because household incomes and savings have actually risen during the crisis, owing to government aid and reduced consumption. (One factor that bolstered JPMorgan’s bottom line was a significant increase in the balances that customers were keeping in their accounts.) In the second quarter, the bank experienced $1.6 billion in charge-offs, up only a little from the same quarter last year, when the economy was strong.
The bank’s big credit loss came from setting aside $8.9 billion in “reserves”—that is, losses JPMorgan expects to take on loans that borrowers will default on in the future, even if they aren’t behind on their payments yet. “You’re not going to see it right away, because of all the stimulus, and in fact 60 percent or 70 percent of the unemployed are making more money than they were making when they were working,” said Dimon. “So it’s just very peculiar times.”
A similar expectation was reflected in earnings reports from Wells Fargo and Citibank. To date, defaults at both banks have been modest—in part because they have offered so many customers forbearance on their loans, allowing them to miss some payments without going into default. But both banks expect the credit environment to deteriorate in the future.
How much, of course, is anyone’s guess. JPMorgan said its projections of loan losses are built around a “base case” where we end the year with unemployment around 11 percent but with a thumb on the scale allowing for even worse economic outcomes. If the economy recovers more quickly, the bank may not need all of the $8.9 billion in reserves it set aside to cover anticipated defaults; it can reverse them later, boosting its profits in future quarters. But if the economy gets a lot worse, the bank will lose even more money on bad loans. In 2008, loan defaults were a driver of a wider economic crisis, as banks failed and credit dried up, making it harder for consumers to spend. Fortunately, we entered this crisis with both banks and households in stronger positions this time around, with more room to absorb financial shocks. But additional defaulted loans will be a sign of increased financial hardship, even if they do not cause the snowballing effect we saw last time.
A fundamental question for the economy—one that will determine how many consumers and businesses are able to meet their financial obligations, and whether JPMorgan was right to set aside billions for bad loans that haven’t even gone bad yet—is how much permanent damage will result from our temporary failures. Even if businesses are able to operate normally sometime next year, how many will fail between now and then because we proved incapable of suppressing the virus, unlike so many other countries? Business failures have permanent costs for both owners and workers: The income and productivity they lose in the short term, even if they are able to make a successful transition to new forms of entrepreneurship and employment, are gone forever. In the end, the incompetence that has let the virus rage across so much of the country may well cause economic hardships that long outlast the epidemiological ones. ■
JP Morgan’s “base case” ends the year with unemployment around 11 percent and allows for even worse.