A top UC Davis economist says the world needs to prepare for the next economic crisis through banking reform and a better understanding of market conditions.

As for how much longer the current slowdown endures, economics professor Alan M. Taylor said it is far from over.

“It’s a very, very bad recession compared to what we’ve seen in the past 50 to 60 years,” Taylor, director of the university’s Center for the Evolution of the Global Economy, told about 75 people at the Institute of Governmental Affairs’ Policy Watch Seminar Series on March 12.

“The financial instability should have been understood,” he added, urging economists and policymakers to follow the data, not “hubristic beliefs,” when evaluating economic risk.

Job losses, consumers, stimulus

Most recoveries take 12 to 18 months, but this is different due to high unemployment rates throughout the 50 states and the credit crunch, Taylor said. California has a 12-percent unemployment rate, and Michigan, 14 percent.

He called the job losses “unacceptable” and a “manifestation of a failure” of either political leaders or the financial sector, or both.

“The problem is worse than expected,” said Taylor, adding that the economy would be in more dire shape if there had been no federal stimulus plan.

Unfortunately, he said, the stimulus funds are ending and other fault lines, like rising commercial foreclosures and continued low U.S. consumer spending, may continue to dampen the economy.

So, Taylor does not think the downturn has hit bottom yet. “We’re approaching a bottom” to the crisis, which he said is not as bad as the Great Depression in the 1930s — but close enough.

People are still paying off large amounts of debt, mainly mortgages that they found themselves overleveraged on from the 1990s, Taylor said. “The mortgage debt relative to the value of houses is at an all-time high.”

Unlike some critics, he is not worried too much about inflation, which is now about 1 percent. “In the data, there is no evidence yet” of momentum toward rapid inflation.

As for government debt and spending, Taylor said, “Countries can tolerate pretty high debt ratios,” noting that Great Britain around 1850 had a 250-percent-to-GDP ratio, and recovered enough to become a major world power. In this most recent recession, most countries went into it with “average debt ratios,” which helps matters.

On banks, Taylor took issue with their conduct both before and during the crisis. The massive government infusion of funds into the major banks was simply a “recapitalizing” of them that has failed to lead to more lending. Rather, banks are sitting on vast hoards of cash and may be hiding undeclared losses as well.

“There’s not much new lending. This is a really bad sign,” he said.

Remember the phrase, “too big to fail” when it came to companies like AIG and Lehman Brothers? With consolidations and mergers between the imperiled banks, “now we have banks that are even bigger than before,” Taylor maintained.

‘Hubristic’ attitudes

He advocates regulations and limits on how big banks can become, and greater analysis and less complacency or “hubristic” attitudes about how the financial sector affects the rest of the economy.

The Federal Reserve System, which sets monetary policy and interest rates, has a “broken transmission,” the professor said. While it can influence monetary and credit conditions, it is up to the banks to actually do the lending, he noted.

Meanwhile, Europe, as exemplified by the recent meltdown of Greece’s economy, is heading into dangerous waters, and Japan is still coping with the highest debt ratio in the world, an aging society and lagging production, Taylor said.

“If there has been an (economic) disaster in the last 20 years,” he said, “it’s been Japan. Their economy has done nothing.”

Good news, he said, can be found in emerging markets worldwide, which are still making products aimed for the U.S. consumer. This becomes a “bubble,” however, if the American consumer slows down in buying products from Asian countries like China.

For more information on future seminars at the Institute of Governmental Affairs, visit iga.ucdavis.edu.