that there was problems in the housing market. that's where it became, you know, many n. many cases it was politically too challenging to deal with it. so a great example of that is if we look at mortgage modification, right, about 25% of all the mortgages that are ak couldly directly held by banks have been modified. about 2% of those that are in mortgage-backed securities have been modified and none of the mortgages at the government-sponsored entities have been modified. and the last group is actually 56% of the market right now. so, you know, i think that there became political issues and fairness issues that came in but at i think at the start there was an underestimation of how difficult it was going to be with the market to deal with the problem. >> you wanted to jump? >> paul is right but there do tend to be moralistic paintings of what happened. as part of the sort of fairness debate is that we could have had a t.a.r.p. that exacted a lot more in the way of punishment in

terms of replacement of bank executives and bank boards. there was a lot of symbolism -- [ applause ] that would have made a huge difference, witness the audience reaction, in terms of how it wbt down with the public at large. the second is that there's still a lot of discussion about the undertone of the dead beat borrower. it's now much more complicated than that. the people who really took out the mortgages, the teaser loans, a lot of those have already been foreclosed those op those were the resets were in 2007-2008. a lot of the people are gone. the people who were losing their houses now are much more people who lost jobs or who had hours cut back or more normal -- more normal situations like medical bankruptcies, things like that. on top of that there's significant evidence in which the administration hasn't really wanted anyone to go there, and no one knows the number because there have been no investigations, of servicer force foreclosures. where the bank applied fees

inappropriately and compound them -- for example, you're supposed to apply payments to interest and principle first, they will apply the late fee first and then you've got the next month late and then more fees kick in when that 4happens. the people who represent homeowners in court say that it's actually quite significant. when the few case where's people have hired a forensic accountant, which was people don't do, they found significant abuses. so the morality tale is a lot more complicated than anyone wants you to believe. >> bearing in mind the condition of the housing market and that we're not likely to see a sort of hail mary moment that's going to solve it all in the foreseeable future, i'd like to ask each of you about how you assess the quality of the recovery we're going through that right now. we've had three months consecutive months, of joblessness over a quarter of a million. we've seen growth of 3% in the

final quarter of last year. we've seen the markets responding as if this is a real bona fide sustainable recovery. is this a recovery the kind of recovery that we're used to prior to '08? is this, on the other hand, a japan style recovery, which side of that debate does each of you fall? let's start again with you. >> i'll try to be short. i'm not a believer that we're on our way to a sustainable recovery. we also had a period at the beginning of last year where admittedly not to this degree but the numbers look better and than the strengthening faded. you know, we still have more downside on housing. the fed has been talking about a fiscal cliff that we're going to reach in january 1, 2013. they thought it would be january 2, 2012, but some of the tax breaks, particularly the lower

payroll tax rates, were pushed out another year. we're going to have unless other measures are taken we're going to have fiscal spinning fall off in 2013. if nothing else that is going to be another drag on the economy. >> now, i'd like to just stay a little bit with the discussion we've been having because i don't think wee we framed the problem right. this is washington. we want to get through policy and prescription first. but prescription isn't worth a damn unless you do diagnosis right. now, there are three explanations broadly speaking, of this problem out there. one is a republican american enterprise institute explanation which i call the government failure hypothesis. that is you blame the fed for holding interest rates too low too long in the last expansion. arou and you blame the government for interfering in the housing market, fannie mae, freddie mac. and the policy prescriptions that come from that are very clear. number two is what i call the

market failure hypothesis. that's what we've heard so far and only what we've heard so far. here you say there was a failure in financial markets. that failure was due to inadequate regulation, too much deregulation, and arrangements -- incentive pay arrangements that allowed -- that fostered loan pushing instead of sound lending. i think that's what the administration sand folks we're going to here from this afternoon were at. market failure. >> you are going to link this up to my question? >> very much. this is your dodd frank piece. that solves the problem but unfortunately the football cr l caused a deep recession and to get out of the deep recession we need fiscal policy. for them that's all you need to continue doing. they solved the problem structurally in their view but now how long do you with this fiscal still husbanmulus. now, the third piece, which is what i call the destruction of

shared prosperity hypothesis. what happened around about 1980. we changed horses. we changed our growth model, and we moved to what i call a liberal growth model where we broke the link between wages and productivity growth and in return we started driving the model up the economy with asset price inflation and debt instead of wages driving demand. now, that created demand gap but we papered over the gap. this is the study boom you're talking about. this is the reality of the great moderation. the great moderation was papering over this structural flaw by pushing assets into the economy and debt. and of course, it went on far longer than any of us expected. >> you're saying your concern is policymakers, namely this administration, are assuming we can return to the status quo enti? that your keogh oh. >> now that the thing has broken, we can't go back to

driving the economy by debt and asset price inflation. what we're doing is filling in the problem by having the sector bank sheet fill it in. that works as long as we can keep that going. that's why there's a 1937 moment, if you start to pull back on the deficit, you're going to have that shortfall. we've got to tackle the underlying problem of income distribution, where that comes from, bad globalization, a labor market flexibility agenda that undermines bargaining power. >> given that, given that joblessness is falling, so are median wages, which is your point essentially. >> this only keeps going temporarily. >> are we headed for another 1930s -- >> no, we're head for a stagnation. if we do what paul was talking about i think in the green room, about not doing 1937 all over again, then we will have a depression. >> that's essential think 1937 scenario, right, or the december

sequestration scenario we're potentially facing this year? >> i think we have a recovery worthy of the name. will it be different from the recoveries of most of my lifetime? probably. we are growing concern economy with income distribution issues that trouble me as a citizen certainly. but, yeah -- >> but not as an economist? >> also as an economist. more as a citizen but it's a real recovery. the key issue for me is it's a recovery that's founded on both the balance sheets of both the private sector and the public sector. and my biggest concern about the longevity of the recovery and the robustness of the recovery is that the mindset on wall street and also in this town is somehow that the government sector should look for the earliest and first opportunity to exit the stage, which i've,

you know, coined cainsian interruptus. it did not turn out particularly well. so a particular role for the government. observe vanlt role for the fed relative to physical authority is an enduring part of our landscape. if we accept that this is part of our new landscape, bigger government, fiscal policy taking the lead. not justsick sickicallically until we can get out the door. it won't be exuberant party but perhaps we at times have a little bit too much exuberance anyway. so i'm frightened to learn that the last 30 years of my life was but a mirage. that is a little frightening to me. i just turned 55 yesterday. i want to believe that i lived something meaningful. >> talk with me afterwards. >> we've already solved the causes of the crisis.

we're on to how to fix it now. do you share this view that this is -- two out of three say it's not a real recovery. >> is it sustainable? it's already the weakest recovery in the post-war period. without question. and for good reason. the first time we followed a financial crisis at this magnitude as opposed to a fed-engineered recession. but is it -- i'll also note that on the question about vis-a-vis japan, we are not japan. the u.s. stock market is 16% below its previous peak in 2007. japan's is still 70% below its 1990 peak. there's a very different animal there but we are suffering from some of the same problem. i'm encouraged though. i look at what's going on. we've been recovering for the better part of three years, since the trough of the recession in mid 2002009.

and time is the big healer in this one. we've had an extended period of time with home construction, less than half the rate you need to house the growing population and, as a result, we're working down this excess stock of vacant homes. pretty dramatically. home building can begin to rise to more normal levels over the next year or two and that's going to be a little extra engine of growth on the plus side. another major development, one of the key things everybody is worried about is household deleveraging. well, there's been a lot of deleveraging. the household debt to income ratio has come down at unprecedented rate as it rose a lot. but you look at what's happening in the household financing, average household debt servicing, financial obligation ratio is well below historic norms. interest rates are very low. that helps. and you're seeing credit quality improve, chargeoffs default

rates on credit card to down sharply and consumer credit after having declined for several years is now growing at a pretty good pace and that's according to consumer spending. it's not a big surprise that we're seeing some at least moderate growth in consumer spending going forward. that's sort of -- that's at the heart of is this sustainable. now, i agree with paul. there is a back cloud on the horizon here when we talk about fiscal policy and if we take this 3 1/2% of gdp cliff that's coming at the end of the year, bush tax cuts and it gets in place, employment tax cuts, all of this, then we're facing a problem. doug elmendorf had it right that we're looking at 1% gdp growth next year under current law. but i don't think anybody expects us to go through this without some major modification. the question is do we begin to do the right things in

washington next year? do we begin to tackle the longer run problem with tax reform and entitlement reform, give the market something positive to look forward to as we're taking away this year-term fiscal drag and probably getting a downgrade from the ratings agencies in the process. but at least if we're moving in the right direction, if washington -- two political parties could begin to communicate and make some progress, it's sustainable. >> you can look at it glass half full or the glass half empty. half full is america has a more efficient market clearing process than europe. you have delevered -- not you, the americans have delevered quicker than other economies and therefore returning to growth quicker. in terms of the glass half empty perspective is there a concern that there is relevering going on too quickly? consumer borrowing are back up. credit card bills are going back up. the savings rate is losing some of its gains.

is there a concern that we're heading back into -- >> i think one of the core concerns is the fact that income growth is so weak. and when you strip off inflation it's very modest. and that means that in order to spend -- and there is enormous pent up demand up there. people aren't saving as much. probably the personal savings rate needs to go back up higher. i think if we continue to see the labor market improve consistent with the last couple of months we should start to see income rising a little bit better. but in terms of this question about, you know, is the recovery sustainable, is it japan like, you know, a normal business cycle with a bad recession is usually like a 2% drop in gdp. and then the year after you grow at 4%, twice the rate you declined at. in this cycle the u.s. went down 5.1% but the average rate of growth since the recovery started is only about 2 1/2%. and what it's a reflection of is the legacies of the financial

crisis, things like the housing market that still have to be worked out and we're making progress on that. but we need to understand that the magnitude of the imbalance that built up was so big that when the housing market corrected if it unround really quickly it needed a depression. so the government cut interest rates and provided enormous fiscal stimulus and tempered how deep it became. we transformed the personal savings problem into a government savings problem which now has to be addressed which is going to constrain the rate of economic growth going forward, even if the washington gridlock diminishes. i think fiscal restraint -- or fiscal drag is going to be present on the economy. when i think about the u.s. economy and i have to do a five-year projection on the part of corporate planning, he assumption is it will continue to go at a 2 1/2% pace. how you feel about that is

whether you're a glass half full or glass half emptity person because 2 1/2% growth is probably close to trend. we are talking about growth but it's not the above trend growth you normally get in a cycle. this is an -- >> who is capturing this growth, as well. >> it's important also in terms of the japanese experience when you do the parallel. the stock market is completely different but japan basically went for you in lost decade, you know, the growth rate has been trend. right? they have declining population and you take a declining labor force and productivity. their return rate of growth is 1%. what's the return rate of growth for the u.s. economy? the u.s. has population growth, strong immigration, and innovative economy. you add those components together and the japan like experience for the united states economy is a growth rate of 2 1/2%. >> if i could add one point there, productivity growth in the u.s. for gdp over the last year has been negative.

the trend over the long run may be 2 1/2% but because capital formation in the business sector has been so depressed and because we went -- we had a huge boom inivity in the recovery we may be looking at several years.1/2%. labor force right now with the aging population is growing about 3/4%. maybe we get a little bit of rebound in labor force participation to discourage workers but there's no question that productivity growth is going to be quite -- could very well be quite depressed over the next several years which says 2 1/2% gdp growth which is pretty close to consensus gives you a fair amount of improvement in employment, okay, and one final point is that the data on employment are very much at odds with the data on income right now. employment is growing at a pretty rapid pace. income has been surprisingly

depressed. although the revisions are starting to come in upward. historically there's been an average of something like 2%, 3% points upwarder recision to income over time. >> we're going to have audience questions as well. we better get on to another question. >> i just want to very quickly, you mentioned capital spending and that's actually an important point and it ties to dr. palley's point about changed economic paradigm. one thing that's not discussed enough in the debate, there are people who talk hopefully about business innovation and businesses will spend more and that will have to take care of it. our intuitive understanding is the household sector saves and businesses spend the household sector savings and that's why you don't like that too much because the fear is it will crowd out business investment. in fact, we've had business continues to be a net saver, corporations have over $1 trillion of excess on their

balance sheets. and even in the last expansion the business sector was a net saver. that's unheard of. you know, the short term ince incentives that major corporations have these days are actually impeding the processes that would be more helpful for economic growth. >> i'm glad you mentioned businesses because if you go down the road here in washington, d.c. to the chamber of commerce or to the national association of manufacturers, you will get the perspective that regulation and regulatory uncertainty is a very big inhibiting factor to the return to the recovery. and an explanation of the lateness of the recovery. thomas, do you agree with that? is regulatory uncertainty been holding back growth? >> this is -- >> epa, shared, responsible for this? >> this is the third, fourth, or fifth order factor. i think it's a nonfactor. >> it's a first on talking point. >> i'm surely the chamber of commerce will raise this. number one thing. political body. economic policies are designed to serve the interest of their

people. this is not a supply side recession. we have massive unused capacity. our profit ratesh highest in history. profit share is at the highest in history. pushing the profit share higher has done nothing. this is a demand side of recession. in fact, in an economy you can have too high profits in is something we need to get on the public discussion. i can promise you a capitalistic economy with 0 percent will fail and it will fail, too. there is something in the middle. we have to find where that is. that's about the distribution of income. that's where we've got it wrong. in fact, we have too much profit right now, as yve pointed out, firms are save that profit. it's not coming back in the form of capital spending. this comes back to your sustainable recovery point, if this goes on too long, then the demand shortage will kick in again and you will get another ratchet down in terms of investment spending. this is a very classic mechanism that's not part of what's going

on. one last point, i do think we have to change the discussion from sustainable recovery, which is much too small a box, to shed prosperity. that's what we lack. i think we have get a sustainable recovery -- even in sustainable is questionable, everyone here, business sector people, former business sector people, said that we need the crutch of 6% to 10% government deficits, thus continuous rounds of quantitative easing. it's a pretty stretching the meaning of the word to call that sustainable. i think we probably can get by with something less than that. but how do we get shared pros r prosperity on the agenda? that's the type of recovery we should be talking about. i think we should be raising people's expectations when we talk about it in the way we are talking about it we're down seizing people's expectations and that prevents change. >> i really don't need to downsize people's expectations. to be fair to those who are viewing regulatory uncertainty plays a role here. if you look -- go back to where

we started. dr. dodd frank, you ask five people in the industry where they think this is going to turn out, how do they think the volcker rule ends, you will get five different opinions. that is uncertainty, isn't it? in your industry, peter, in yours, greg, this is lack of low visibility in terms of the regulatory environment. and that's just the states we're talking about. we haven't even mentioned the regulatory changes internationally. >> no question that uncertainty -- regulatory uncertainty and capital requirements, which i agree fully that's critical to stability in the system down the road. there is an adjustment period here that's going to be one that's not friendly to credit creation or the cost of credit. and there are elements within the volcker rule that one can debate. certainly the prop trading and the extent to which you affect market makers which are

necessary and, for example, the corporate bond market. there are 25,000 issues of corporate bonds that, as paul knows well, that day in and day out there isn't always a market there. you have to have firms of scale that are willing to buy whole for a while and sell when a buyer comes along to make the market work. if you don't have that the cost of doing business goes up substantially. >> business surveys show that regulatory uncertainty is rib contributing to the cautionary approach that businesses are taking? there is a cost to -- >> ranks surprisingly lowdown, doesn't it? i've seen surveys that -- >> that's actually where i was headed. the regulatory uncertainty shows up in surveys and it's having an impact but there are other things going on in the world right now that basically make it an extraordinarily high risk environment from business point of view. it's like, you know, businesses are not confident that the recovery is going to be

sustainable. only about four, six months ago the market pundits were predicting a 40% or 50% chance the economy was going to go back into contraction. you have europe which, if they completely lost control of their fiscal crisis would create a financial environment far worse than in late 2008. in that environment businesses are being very cautious. one thing, you know, you can see the caution when you did below the surface and the economic numbers. look at the payroll numbers we're getting the reason why the payrolls are rising is because decline in layoffs. that's a signature call that basically businesses are saying, okay, we can see our orders and we need these people to fill those orders. if you actually saw them hiring additional new people as opposed to reducing the layoffs, it would be a signal of, hey, i am more confident of what i need down the road in terms of more people to produce. i think flthere's a lot of sign in the market. a high degree of uncertainty about what's going to happen. the message i always have in

businesses when i try to talk to them is it's like when i get up in the morning to do an event like this and it's pea soup fog outside. you know, i don't want to make the drive but i don't have a choice. you have to build your business even with the uncertainty that's out there. >> what's wrong with pea soup fog? we're going to go to the audience for about 15, 20 minutes of questions. but before we do, does anybody have cheering observations to make? this has been a fairly down -- >> it's a business mall science, what do you expect? >> rigorous economic dose of pessimism most of you have been giving us. paul, where is the silver lining here? >> i'm optimist. in fact, used to tease me at pemco, i'm the house optimist and i'm still the house optimist. i think our economy is a growing concern. we have americans get up every morning and go to work, you know, support their families, have aspirations for their

children enjoy romance. plif is okay. it's not what we would like it to be. but our economy is growing, our population is growing. we're benefiting from continual technology. three months ray go i bought a iphone. i find it fascinating. i'm learning how to use it without making typos. life is okay. life is okay. >> can anybody cheer us up out mentioning apple? yve? yve? >> i'm not the person to go to for optimism. >> okay. we'll have to go to the audience for that, i think. >> we should -- antonio grampsee, optimism of the spirit and pessimism of the intellect. we have a problem and we can't dig our heads in the sand. there's certainly a way out of this. there is a map out of this. it's not on the table right now. but that's the optimistic message. let people know there is a map and demand that map. if we don't offer to it them i

get politically mepessimist tic as well as economically pest mismi pessimistic. >> those that are on this side and the far side of the room if you would like to cue up, please, share your name and organization. >> you had a comment while they're lining up. >> i was just going to -- >> sorry, peter. >> i was going to maybe go out on a him and say that the euro will likely survive. >> growing concern. >> certainly the developments there had been, i think, promising in the sense that you have both at the fundamental level, policy developments and spain, italy, and recognition among the political leadership of what needs to be done. you also have the ecb that has obviously taken from the time being the risk of bank failure off the table. certainly being very supportive. these two factors continuing, i think you've --

>> you can see sustainable -- >> taken away a major downside risk at least for the time being at least. >> okay. so we have -- we have questioners lined up. sir, could you start? >> my name is eric lowe. i'm with the fair observer. my question is for yves. the point is that because i used to work in finance i understand you to appoint about like wall street and everything. and i share the pessimism because one of the things i got from people who work -- who used to work there saying that, you know, that talk about the regulations that are not in place, it's not going to be in place because you don't have repo recorders of know inside how wall street works. it continues basically. always to come back again. so i totally agree with the one beside you talking about like the thing -- did you get your question? >> yes, it's not on the table. so how can we get the agenda on the table, would be a very good

point. >> i'm afraid -- i wish there was a simpler answer. one is -- and i don't give it very high percentage odds of success but there are peculiarly some of the groups around occupy wall street. for example, the occupy the s.e.c. group submitted a 325-page volcker rouletter. you're actually seen people -- and that was done by a very small group of people, four or five people. you're actually having citizens groups making input in the regulatory process and the media has taken over, the financial times and other outlets have taken that up quite seriously. you're getting push back from unexpected areas. the second as i hate to say it is if we had, you know, we've obviously very aggressive efforts by the obama administration, the fed, to keep the banking system healthy. if we see more problems, you know, for example, if -- for example, mayjorfail i cannot se problems not