Why the Economic Recovery May Be Disappointing

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Susan Walsh / AP

Federal Reserve Chairman Ben Bernanke testifies before the Joint Economic Committee on Capitol Hill on May 5

Federal Reserve Chairman Ben Bernanke told Congress on Tuesday morning that the economy is likely to pull out of the recession and start growing later this year. This in itself isn't news — Bernanke has been saying the same thing for months. What's news is that people are starting to believe him.

Talk of "green shoots" is everywhere. The stock market is up 34% since early March. Credit market conditions are easing too, if less dramatically. Housing sales are picking up in some of the hardest hit markets, though prices are still dropping. Measures of business activity and consumer sentiment are returning to levels last seen before the great global financial panic of last fall. (Read about the impact of swine flu on the pork market.)

But let's not get ahead of ourselves. So far, all we've seen is a slowing of the breakneck economic decline that began in October. There are differing spins you can put on this truth. "People like to talk about green shoots," New York University economist Nouriel Roubini said during a recent visit to TIME. "All I see is a lot of yellow weeds." On the other hand, a slowing in the pace of decline during a recession has in the past almost invariably segued into the end of that decline, recession maven Lakshman Achuthan of the Economic Cycle Research Institute said in an e-mail. (See how the recession has affected Americans' spending habits.)

But even if the outright decline in economic activity — a.k.a. the recession — ends later this year, we won't exactly be out of the woods. "We are so focused on whether recovery will be at the end of this year or the beginning of the next that we lose sight of the more important question," said Mohamed El-Erian, CEO of bond-investing giant Pimco, at a conference in Los Angeles last week. "It's not whether the recession will be over; it's what does the new normal look like?"

There's pretty widespread agreement that the recovery, when it comes, won't be robust. "Even after a recovery gets underway, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while," said Bernanke in his testimony to the Joint Economic Committee on Tuesday. That means unemployment will keep rising even after the economy has stopped shrinking. And if unemployment keeps rising, consumer spending won't rebound strongly, bank-loan losses will keep rising and a recessionary relapse isn't out of the question. The next monthly employment report, due Friday, is expected to show continued heavy job losses. So no signs of a reprieve from that quarter.

Then there's all that bad debt. We've now mostly worked through the subprime mortgage mess that started this whole debacle, but lots more losses — from prime mortgages, credit cards, commercial real estate, you name it — are still to come. Morgan Stanley economist Richard Berner estimated on Tuesday that even in the most bullish case, banks and other lenders have only recognized about half the $1.7 trillion in loan losses they're likely to suffer over the course of the downturn. In Berner's "bear" case, losses will top $4 trillion.

It is this bad-debt overhang, however big it turns out to be, that is likely to cast a pall over the recovery for years to come. An economy, even the world's biggest, simply can't work its way out of a mess like that in a few months' time. So enjoy those green shoots as they sprout. They're good news, but they're not enough to live off of.

See how Americans are spending now.

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