GDP Report: What It Tells Us About the Debt

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The bad news just keeps coming.

The U.S. economy grew even less than expected in the second quarter, at a rate of 1.3%, down from what many economists predicted would be 1.8% or higher. The reasons for the continued lackluster performance haven’t changed. Consumers, squeezed by higher gas and other prices, are buying less of everything from electronics to meals out to new furniture. Japan’s tsunami, which raised production costs for U.S. auto makers, hasn’t helped. Those factors are keeping a lid on U.S. jobs, which are, of course, the economy’s ticket to higher short-term growth.

But the dismal overall growth numbers masked some potentially good news for U.S. jobs. On the bright side, businesses spent more (up 6.3%) in the second quarter, and in a rare move, investments in housing ticked up (3.8%). Those are crucial for U.S. job prospects, since the bulk of job creation comes from stifled small businesses, which rely most on a rebound in housing to invest and spend.

So far, small business hiring has been dragging for two reasons. One is because those businesses can’t get access to credit, and the other is because they’re reluctant to borrow given the slew of economic uncertainties ahead. They lack access to credit because the bulk of their loans come from small and medium-sized banks, which still have the bulk of the country’s bad real estate investments on their books. Real estate loans comprise only 52% of large banks’ loans but 74% of smaller ones’. Small and medium-sized banks own an even bigger share of the more troubled commercial real estate sector and real estate development loans, since, unlike with the residential market, those loans weren’t all parceled up and sold off.

(MORE: Does the Debt Ceiling Make Deficits Worse?)

Small business hesitations about the future have partly to do with the recovery’s fragility. But they’re also suffering from the same problems as their banks: small businesses own a lot of feeble property and real estate investments. 49% own their own office space/land, while 39% own investment real estate, according to this National Federal of Independent Businesses study (hat tip Zero Hedge). The good news out of the GDP numbers is, if housing investment continues to tick up and buoy property values, it will provide huge relief where the jobs market (via small banks and small businesses) needs it most.

(MORE: Housing Double Dip: Is It Over?)

That is, unless those gains continue to be overshadowed by growth-eating government cuts. Another key takeaway from the Commerce Department’s GDP report is that much of the drag on growth in the second quarter came from government pullbacks. Government spending overall fell 1.1 percent in the second quarter. The sharp drop off in state and local government spending (a 3.4% drop) reflects the dry up in federal stimulus, which has forced local authorities to slash tens of thousands of jobs and billions of dollars in spending to comply with balanced-budget requirements. In the first quarter, government represented 1.23 percentage points of the overall growth drop, with state and local cuts accounting 0.41 percentage points of that and defense cuts making up 0.74 percentage points.

The current debt debate is bound to make things worse. Macroeconomic Advisers estimates the leading proposals from House speaker John Boehner and Senate majority leader Harry Reid would start slowing GDP almost immediately by continuing those cuts. Boehner’s plan would reduce growth by an average of 0.1 percentage point a year from 2012 to 2015, while the Reid plan would slow it more, by 0.25 percentage point on average over that period. And yet, the biggest message out of today’s GDP numbers is that immediate austerity would hurt, not help, the country’s debt, which is a problem rooted firmly in the medium to long-term. Congress’s potential failure to reach a deal by the August 2 deadline is piling political risk on top of that economic threat, a factor credit raters have indicated they aren’t willing to ignore.

And so, the very policymakers scrambling to make good on our obligations by slamming on the breaks are the ones threatening to escalate government debt.

CORRECTION: The sentence “government represented 1.23 percentage points of the overall growth drop, with state and local cuts accounting 0.41 percentage points of that and defense cuts making up 0.74 percentage points” has been corrected to reflect that this is from the first quarter.

Roya Wolverson writes for TIME. Find her on Twitter at @royaclare. You can also continue the discussion on TIME’s Facebook page and on Twitter at @TIME.