More unemployment victims: The banks

A rising jobless rate is an aggravating factor in efforts to bail out the financial system.

By Anthony Karydakis Contributor

NEW YORK (Fortune) -- When people talk about rampant job losses, it's usually in the sense of unemployment as a symptom. But in fact, unemployment can be an aggravating cause of the financial crisis as well, especially when it's as severe as we're seeing now.

The labor-market picture has deteriorated at a stunningly rapid pace in recent months. More than 3.2 million jobs have been lost since the onset of the latest phase of the financial crisis in September 2008, with the unemployment rate spiking by nearly two percentage points during that period to 8.1% last month.

The dramatic erosion of labor-market conditions has become a hurdle for the prospects of any turnaround in the economy over the next 9 to 12 months, as it severely weakens income growth and, by extension, consumer spending. The latter, following sharp declines of 4.3% and 3.8% in the two most recent quarters, is already on course to retreat by another 3% or so in the current quarter. This would represent a cumulative decline of about 11% in just nine months, which exceeds by a very wide margin any such pullback seen in past recessions, including the more severe one in 1981-82 (during which, in fact, consumption declined in only a single quarter). Differently put, a retrenchment in consumer spending of the magnitude we are currently experiencing can only compare directly to the depths of the Great Depression.

However, the effect of the sharp spike in the unemployment rate is not limited to its impact on household spending. What has attracted far less attention is the way in which rapidly increasing joblessness directly undercuts the massive efforts underway to stabilize the banking system. In fact, the pace and magnitude of further job losses is one of the most critical (and elusive) factors in the unrelenting struggle of policymakers to resuscitate the banking industry.

The ballooning ranks of unemployed are steadily feeding the near-tidal wave of homes on the brink of foreclosure as well as delinquencies on auto loans and other types of consumer lending. This process inevitably expands the already dangerously high levels of toxic assets on bank balance sheets.

It is not by accident that the unemployment rate is a key measure of the much-publicized "stress test" that the Obama administration is currently using to evaluate the needs of banks for additional capital. In the context of a series of "what if" assumptions, banks are being evaluated as to their ability to withstand the pressure stemming from a 10.3% unemployment rate in the current cycle, as a worst-case scenario.

Six months ago, at the start of the most intense phase of the financial crisis, the prospect of a double-digit unemployment rate would have been nearly unthinkable. It is appreciably less so now, in light of how quickly the rate is rising in the last few months and how fast economic growth forecasts are downgraded globally. As recently as a few weeks ago, in his semi-annual congressional testimony, Fed chairman Ben Bernanke submitted the forecasts of the Federal Open Market Committee members, which were pointing to an unemployment rate of between 8.3% to 8.8% at the end of 2009. This particular forecast seems already outdated.

With banks coming under steadily growing strain because of proliferating non-performing assets, the cost of stabilizing the financial system is bound to escalate from earlier estimates. That's probably why Treasury secretary Tim Geithner warned recently that the cost of the bailout for the banking system could significantly exceed the initially estimated $700 billion - something which had already started becoming increasingly obvious.

Another complication is that the skyrocketing unemployment rate recently will increase the cost of the widely publicized, and wisely structured, Term Asset-Backed Lending Facility program (TALF) that the Fed activated just a couple of weeks ago for the first time since its announcement last November. The program was designed to provide low-cost funds to investors willing to buy different types of securitized consumer loans, as part of the broader plan to take some of those assets off the banks' balance sheets and help restart lending.

The program was structured as a kind of joint project of the Fed and Treasury, with the Fed standing ready to provide as much as $1 trillion of such lending and the Treasury providing $100 billion of seed money to the program. With more securitized consumer loans getting into trouble in the midst of a spiking unemployment rate, the cost of the TALF program will move quickly to an appreciably higher range for both the Fed and Treasury.

The severity of the current crisis is such that it has blunted any conventional concerns about costs associated with addressing it. Both the Fed and the Obama administration have made it clear in various tones (the Fed much more openly so than the politically more sensitive Treasury) that they are prepared to pull out all the stops to deal with the economic recession and financial crisis. Still, on some level, it must be very disheartening to Bernanke and Geithner to realize that the cost of that undertaking keeps going up every time they look around.

Anthony Karydakis is a former chief U.S. economist for JP Morgan Asset Management and currently an adjunct professor at New York University's Stern School of Business To top of page

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