At a minimum it is clear that something other than housing deteriorated to turn slow growth into a recession. That something, in my mind, includes the collapse in automobile purchases, slowdown in overall consumption spending, and deteriorating consumer sentiment, in which the oil shock was indisputably a contributing factor.
“Causes and Consequences of the Oil Shock of 2007-8” James Hamilton
http://www.brookings.edu/economics/bpea/~/media/Files/Programs/ES/BPEA/2009_spring_bpea_papers/2009_spring_bpea_hamilton.pdfIn the above paper, Hamilton argues that the oil price bubble of the Bush administration was the crucial factor in creating our current recession.
He shows how the automobile industry, a huge employer, was devastated by (artificially) high oil prices.
Although gasoline prices were likely a key factor behind plunging sales for U.S. automakers in the first half of 2008, falling income appears to be the biggest factor driving sales back down in the fourth quarter of 2008. Here we see, in contrast to the first half of 2008, the sales decline was across the board, hitting cars if anything more than SUVs, and imports along with domestics.
The result was a significant shock to the U.S. auto industry in 2008:H1, quite comparable in magnitude to what was observed in the wake of the oil shock of 1990.
Other sectors of the economy were hit in the same way. Manufacturers need fuel. Rising production costs combined with decreased spending power hurt their profits. Transportation, farming, retail sales, travel---all were directly affected by inflated energy prices at a time when consumers had less money to spend, so much of it being diverted to pay for necessary fuel costs for cars and heating and so many earners being forced out of their jobs in the industries hardest hit----like automobile manufacturing.
Even the housing slump was, at least partially caused by the sky high price of oil, which made suburban homes suddenly less desirable—causing their prices to plummet just as folks with adjustable rate mortgages discovered that they needed to sell.
Second, there is an interaction effect between the oil shock and the problems in housing. Cortright (2008) noted that in the Los Angeles, Tampa, Pittsburgh, Chicago, and Portland- Vancouver Metropolitan Statistical Areas, house prices in 2007 were likely to rise slightly 39 in the zip codes closest to the central urban areas but fall significantly in zip codes with longer average commuting distances. Foreclosure rates also rose with distance from the center. And certainly to the extent that the oil shock made a direct contribution to lower income and higher unemployment, that would also depress housing demand. For example,the estimates in Hamilton (2008) imply that a 1% reduction in real GDP growth translates into a 2.6% reduction in the demand for new houses.
Eventually, the declines in income and house prices set mortgage delinquency rates beyond a threshold at which the overall solvency of the financial system itself came to be questioned, and the modest recession of 2007:Q4-2008:Q3 turned into a ferocious downturn in 2008:Q4. Whether we would have avoided those events had the economy not gone into recession, or instead would have merely postponed them, is a matter of conjecture. Regardless of how we answer that question, the evidence to me is persuasive that, had there been no
oil shock, we would have described the U.S. economy in 2007:Q4-2008:Q3 as growing slowly,but not in a recession
Why did speculators like Goldman Sachs and the Carlyle Group start driving up the price of oil to levels that jeopardized the United States (and world) economy in order to make themselves a cheap and sleazy buck? Because they could—thanks to Ken Lay.
Back in December 2000, Congress passed and President Clinton signed into law the “Commodities Futures Modernization Act of 2000 ”. While the CFMA attempted to resolve the dispute over jurisdiction between the SEC and the CFTC, two elements of the bill appear to have a direct impact on the markets and the financial services industry, specifically investment banks and hedge funds.
I will save the second point for a later report, as it requires further research before I feel comfortable commenting on the derivatives portion of the bill. What I do want to get to is what has come to be known as the “Enron Loophole”, a provision that was slipped into the bill literally in the dead of night by then-Senator Phil Gramm .
The provision, allegedly at the behest of Ken Lay of Enron, exempted from regulation energy trading on electronic platforms. This provision is believed to be the primary reason for the spike in electricity costs in California in 2001 and is at the heart of the debate re the speculation in oil prices today.
http://seekingalpha.com/article/81243-the-enron-loopholeDeregulation depends upon competition to work. If the price of a product rises too high, people will stop buying it. If one seller asks too much, the guy across the street will ask less. But, what happens when the product is something people
must have in order to live? And what about situations, like the one we are in today, in which huge monopolies control an entire industry? And who do you call when speculators----like Goldman Sachs and Carlyle—get together to artificially jack up the price of the absolutely essential commodity? You do not call the president, whose Poppy works for Carlyle. You do not call Stephen Friedman, Chairman of the Federal Reserve Bank of New York, since he had Goldman Sachs ties. Treasury Secretary Paulson was out for the same reason.
The speculators were doing more than just betting on prices. They had begun to buy up oil fields and other energy holdings, which offered them some degree of control over supplies. Their purchases would also allow them to share in the windfall profits that folks at real oil companies like Exxon experienced when crude oil prices shot up by as much as $20 in a single day.
(You gotta love this headline from 2008
Oil giant makes corporate history by booking $11.7 billion in quarterly profit; earns $1,300 a second in 2007.http://money.cnn.com/2008/02/01/news/companies/exxon_earnings/ )
The Wall Street Journal reported that financial speculators were snapping up leasing rights in Cushing, Ok (Ann Davis, “Where Has All The Oil Gone?” October 6, 2007, Page A1.) In August 2006, Goldman Sachs, AIG and Carlyle/Riverstone announced the $22 billion acquisition of Kinder Morgan, Inc., which controls 43,000 miles of crude oil, refined products and natural gas pipelines, in addition to 150 storage terminals. Prior to this huge purchase, Goldman Sachs had already assembled a long list of oil and gas investments. In 2005, Goldman Sachs and private equity firm Kelso & Co. bought a 112,000 barrels/day oil refinery in Kansas. In May 2004, Goldman spent $413 million to acquire royalty rights to more than 1,600 natural gas wells in Pennsylvania, West Virginia, Texas, Oklahoma and offshore Louisiana from Dominion Resources. Goldman Sachs owns a six percent stake in the 375-mile Iroquois natural gas pipeline, which runs from Northern New York through Connecticut to Long Island. In December 2005, Goldman and Carlyle/Riverstone together invested $500 million in Cobalt International Energy, an oil exploration firm run by former Unocal executives.
http://www.answerbag.com/debates/oil-speculation-responsible-high-gas-prices_1855481Obama campaigned on the promise that he would close the “Enron Loophole”. Here is a NYT piece from 2010 about plans to regulate energy speculation.
http://dealbook.blogs.nytimes.com/2010/01/14/cftc-seeks-to-curb-speculative-energy-trading/The Commodity Futures Trading Commission will oversee these transactions. Guess which company the CFTC’s Chairman came from?
If you said “Goldman Sachs”, you understand business as usual in the USA.
Unfortunately, the new rules would only affect transactions in the U.S. Since so many companies are now global, they would be free to continue their energy speculating ways in other countries.
If the U.S. plan is approved, it could open the door to overseas rivals who have long snapped at the heels of Goldman and Morgan, especially Barclays Capital, which bought the U.S. operations of failed Lehman Brothers, Deutsche Bank, Credit Suisse and Australia's Macquarie.
http://www.commodities-now.com/news/portfolio-management/1620-forget-cftc-obama-plan-is-real-commodity-risk.html
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