The economic recovery, which seemed to be gathering momentum and spark during the summer, more recently has shown signs of faltering.
The normal forces of economic expansion are running up against countervailing forces that I have likened elsewhere to a 50-mile-an-hour head wind.
To a considerable extent, the factors restraining expansion are working through the financial sector.
For example, a heavy overhang of debt, an accumulation of bad loans, and doubts about the future have produced an unusual degree of caution among many key lenders, as well as on the part of businesses and consumers.
Started in the Early '80s
To better understand these forces and their implications for the current economic situation, it would be helpful to look back some years. A key element in the story is an extended cycle in commercial real estate investment.
The cycle started in the early 1980s, when commercial space was in unsually short supply. It received a major impetus from the Economic Recovery Tax Act, which was passed in 1981.
In general, that act represented a significant improvement in our tax structure and its incentives for production, saving, and investment.
An important and much-needed component of this improvement was an acceleration of depreciation allowances for capital goods.
Overgenerous Tax Writeoffs
With regard to commercial structures, however, the act went too far, producing far shorter writeoff lives for tax purposes than the economic depreciation of the property could justify.
This artificial set of incentives helped lead to an extraordinary boom in commercial construction, and the total stock of commercial buildings in the United States doubled during the decade of the 1980s despite a huge increase in vacancy rates.
But the tax change was not the only reason for this development. A similar pattern can be seen in a number of other countries around the world.
Failure of Foresight
In many cases, lax credit policies by financial institutions also contributed to the surge in commercial building.
These institutions were searching to exploit new powers or to find new, profitable lending outlets as securities markets captured significant portions of their traditional lines of business.
Moreover, lenders and developers apparently failed to appreciate that there might be some limit to the shift toward financial services and other office-intensive categories of employment.
The accumulation of vacancies over the first half of the decade, along with the provisions of the Tax Reform Act of 1986 that reduced the rate at which property could be depreciated and limited the deductability of "passive losses" on such property, had a stark impact on this market.
Prices of commercial real estate peaked in 1985; the prices of the office-building component have fallen by a fourth since then.
After the Fall
The boom and bust cycle in commercial real estate left its imprint on our lending institutions.
In the early phases, the surge in the appraised value of collateral was a prime reason for a major increase in commercial mortgage lending by depository institutions and other financial intermediaries such as life insurance companies.
After the market for commercial real estate turned down, many of those loans became nonperforming or had to be written off, putting significant pressures on lenders' capital positions.
Moreover, commercial real estate is not the only area in which asset-quality problems have emerged. You are well acquainted with the difficulties that a large number of businesses have had in meeting their obligations - especially those businesses that substituted debt for equity.
Clearly, many businesses as well as households took on considerably more debt in the 1980s than they could comfortably service under less buoyant economic circumstances.
Consequently, commercial banks have experienced mounting delinquencies and losses on business and consumer loans, in addition to those on real estate loans, over the past year or two.
That aggressive lending faded rapidly in the circumstances is understandable. While some tightening of credit standards by banks and other lenders was clearly a healthy trend, the contraction continued well beyond that point.
Depository institutions endeavored to reduce their commercial real estate exposures. The natural inclinations of lenders were reinforced by the reactions of appraisers and bank examiners as the property boom of the early 1980s reversed.
Tightening of Credit
The endeavor to protect capital positions and mounting asset-quality problems led to a general pulling back of normal lending outside of commercial real estate categories as well.
With credit now restricted for a broad range of real estate and non-real related firms, we have encountered the development referred to by many as a credit crunch - a situation where many creditworthy borrowers face significantly stiffers terms and standards and some find credit simply unavailable, with potentially adverse implications for the economy.
The tightening of credit supplies, engendered largely by banks endeavoring to protect their capital positions, has coincided with a dramatic slowdown in the rate of overall economic growth.
The relationship between these two phenomena and their meaning for the economy, however, is not as straightforward as it might first appear.
A Fall in Loan Demand
Most of the slowdown in credit growth is related to a slackening of credit demand rather than a constriction of credit supplies.
Moreover, some of the fall in demand represents an implication of shifting incentives for carrying debt, rather than a response to a reduction in actual or intended spending.