Second, and Possibly Third, Stimulus on the Way as Unemployment Poses Next Major Hurdle for the Economy

By Jason Simpkins
Associate Editor
Money Morning

With gross domestic product plummeting and the jobless rate at a 14-year high, U.S. policymakers will have to author at least one more stimulus package in the months to come if they are to elbow aside the impact of high unemployment and depressed consumers.

"Investors have been reluctant to admit that this cycle, unlike 1998's credit crisis, is imbedded in the real economy," Merrill Lynch & Co. Inc. (MER) investment strategist Richard Bernstein wrote in a research note last month. "The government can come up with any number of refinancing and liquidity plans, but households are likely to increasingly default on mortgages and other debts if cash flow is not stabilized via employment."

The unemployment rate climbed to 6.5% in October – the highest level since 1994. Employers cut 240,000 jobs last month, making October the second-worst month of the year after September, during which 284,000 jobs were shed.

The economy has lost 1.18 million jobs so far this year, according to Challenger, Gray & Christmas Inc. But the worst may be yet to come, as employers last month announced plans to cut 112,884 more positions. That’s a 19% increase from September and a 79% jump from a year ago.

"Year-end job cuts are typically higher than at other times of the year, but the fact that October was significantly higher than recent years suggests that companies not only have been hit hard by this downturn, but they do not see a rebound any time in the near future," said John Challenger, chief executive officer of Challenger, Gray & Christmas.

The pace of hiring has also slowed substantially, the outplacement firm found. Retailers hired the fewest number of holiday workers since 1991, and overall retail hiring fell 19% compared with last year.

The number of people working part-time jobs has soared to 6.7 million, from 3.2 million a year ago, as employers have fewer full-time positions.

"There are now almost 2.8 million people unemployed in the last year chasing fewer jobs," said Challenger. "So far in 2008, we've had a net loss of 1.2 million jobs."

Bob Brusca of Fact and Opinion Economics in New York told The Christian Science Monitor that the pace of job losses could soon quicken to 500,000 a month – double the amount of jobs shed in October.

"The important thing is that some of the key indicators are now reading as weak or weaker than these deep recessions," Brusca said. "We have every reason to think this is as bad as a deep recession."

A new analysis by Goldman Sachs Group Inc. (GS) was every bit as dismal as Brusca’s. Goldman says that the downturn has yet to hit full swing, and that job losses could surpass 2 million in 2009, with unemployment climbing to 8%, TIME magazine reported.

"As the economy slides into a deeper recession, it appears we are closer to the beginning of the labor market downturn than the end," wrote the study's co-author, economist Ed McKelvey. "We anticipate a sharper decline in employment in coming months."

According to McKelvey “lagging” sectors of the economy – such as construction, manufacturing, financial services and retail – will absorb most of the coming losses.

But a big jump in job losses could also exacerbate the ongoing real estate crisis. In June, 45.5% of all delinquencies reported by government-sponsored enterprise and mortgage giant Freddie Mac (FRE) were due to unemployment or the loss of income [For additional details on the current state of the U.S. housing crisis, check out a Money Morning story elsewhere in today’s issue that details a new federal government program that’s aimed at slashing foreclosures on delinquent mortgages].

Motor City Meltdown

Another vulnerability is the U.S. auto sector, which is on the brink of collapse.

Ford Motor Co. (F) posted a $2.98 billion operating loss for the quarter ended Sept. 30 and let 1,500 salaried employees go in that time.

General Motors Corp. (GM) reported a third-quarter operating loss of $4.2 billion. The company said it plans to cut 30% of its salaried workforce, but in reality, job cuts at the automotive giant could be much deeper.

The reason: GM also said that, without federal assistance, it could run out of cash by year’s end

“Even if GM implements the planned operating actions that are substantially within its control, GM’s estimated liquidity during the remainder of 2008 will approach the minimum amount necessary to operate its business,” the company said in a news release.

If any, or all, of Detroit’s Big Three fail to acquire the financing they need going forward, the consequences for the U.S. labor market – and for the economy – could be devastating.

All told, the three automakers employ more than 200,000 Americans, and support millions more U.S. workers indirectly through suppliers and dealerships. Their collapse could ultimately cost the economy more than 2 million jobs total. And that doesn’t count the estimated 1 million Americans – including many retired autoworkers – who rely on the U.S. auto companies for pension and healthcare benefits.

GM, Ford, and Chrysler all asked to be included in the U.S. government’s $700 billion bailout plan, but were denied. They are currently seeking $50 billion in federal loans in the form of a package that would devote $25 billion to healthcare costs and $25 billion to aid general liquidity.

“Either the federal government provides money for a bailout and lets the industry retool, restructure, and move ahead, or the industry dies,” Dennis Virag, president of Automotive Consulting Group in Ann Arbor, Mich., told Bloomberg Television.

 A Band-Aid for the Big Three

The fate of the U.S. auto industry lies squarely in the hands of the Democratic Party – which, after last Tuesday’s election, controls both houses of Congress, as well as the White House.

So far, both House Speaker Nancy Pelosi and President-elect Barack Obama have said they would work to pass legislation to support the teetering auto industry, as well as two additional economic stimulus packages.

President-elect Obama and his newly designated chief of staff, Rahm Emanuel, have both called on the Bush administration to “fast-forward” $25 billion in low-interest loans already approved by Congress to help automakers retool. Obama has also proposed doubling that loan to $50 billion.

According to The New York Times, the president-elect pressed the issue further when he met with current U.S. President George W. Bush at the White House yesterday. Obama reportedly urged President Bush to support emergency aid for the beleaguered automakers.

Citing sources that were familiar with the discussion, The Times said that Bush indicated he might support further aid to struggling automakers – as well as a broader economic-stimulus package – if congressional Democrats passed a stalled free-trade agreement with Colombia. But that seems unlikely.

“You don’t link those essential needs to some other trade deal,” Emanuel said on ABC TV’s “This Week.”

Pelosi and Senate Majority Leader Harry Reid, D-Nev., have urged U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. to extend part of the $700 billion rescue package already passed by Congress to auto companies. But White House spokeswoman Dana Perino has been made it clear that the current $700 billion bailout plan was intended for financial institutions, not automotive companies.

Protecting the financial markets “is what Congress had in mind when it passed that rescue package,” Perino said Monday. “There was not discussion of specific help to auto companies during that debate, and so Congress' intent was to help financial institutions."

Senator Carl Levin (D-Mich.) told Bloomberg that if the Treasury Department can't be persuaded to act under existing law, Congress may include automaker assistance in an economic stimulus during a so-called lame-duck session later this month.

“If they don't agree that the current language is flexible enough, we should try an amendment during the lame-duck session and attach it to the stimulus package,” Levin said. “If the stimulus package looks like it would be vetoed, then we would have to get this done separately.”

What Would an Obama Stimulus Look Like?

Ideally, Democrats would like to pass two stimulus packages in the near future: One during a lame-duck session this month, and one after Obama takes officially takes office in January. 

Pelosi recently told The Wall Street Journal that any measure moved by outgoing lawmakers before the new Congress takes office on January 20 would be a "down payment on additional stimulus enacted later."

"Let's see if we can't do something, working together now, that gives us a two-month jump," Pelosi told The Journal. "We'll take the longer view as soon as we take over in January."

Pelosi said that a new stimulus package should include extensions on unemployment insurance, as well as middle class tax cuts. Direct tax cuts would be preferable to rebates because they would have a more immediate impact.

Obama has raised several proposals including:

  • Suspending penalties and income tax on early withdrawals from IRA and 401(k) accounts.
  • Offering a temporary tax credit of $3,000 to companies for each new full-time employee hired in the United States.
  • Extending unemployment benefits by a period of 13 weeks and temporarily suspending income taxes on those benefits.
  • Requiring a 90-day moratorium on foreclosures for homeowners.

Clinton Stretch, of tax principal at accounting firm Deloitte & Touche LLP, told Bloomberg that two other Obama tax proposals could be good candidates for inclusion in a stimulus package.

The first is Obama’s “Make Work Pay” tax credit, which would provide a partial Social Security payroll tax holiday for most taxpayers, worth up to $500 for individuals and $1,000 for married couples.

The second would be an extension of the Earned Income Tax Credit, which favors low-income workers.

Of course, the pending stimulus package could include any number of these measures, or none at all. The only near-certainty is that another economic stimulus will be on the books in the next few months.

“We are going to need to see a stimulus package passed either before or after the inauguration,” Obama said. “I want to see a stimulus package sooner rather than later.”

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