We got some very good news on the Initial Claims for Unemployment Insurance front. This week, initial jobless claims fell by 43,000 (or 40,000 if one takes into account the 3,000 upward revision to last weeks number). The 4-week moving average, however, only fell slightly — by 1,000 to 468,500.

The week-to-week numbers can be very volatile, so the 4-week average is really the number to keep an eye on. As the graph below (from http://www.calculatedriskblog.com/) shows, the 4-week average started to soar at the very beginning of the recession. It reached its peak back in mid-April and has since been falling dramatically.

It might be hard to see on the graph, but over the last few weeks it has rebounded sharply. The pattern from late April through the middle of January looked very similar to what we saw after recessions prior to the 1991 downturn. In contrast, following the last two downturns, after an initial drop claims found a high plateau, which corresponded to a jobless recovery.

It was for this reason that the rebound in initial jobless claims over the previous three weeks was particularly troubling. However, the core of the problem this time around has not been a excessive number of lay-offs, at least not outside of the darkest months of last winter. The problem has been an extraordinarily low rate of job creation (see this discussion of the Job Openings and Labor Turnover Survey, or JOLTS).

If we also found that layoffs were finding a high plateau then it will be even more difficult to bring the unemployment rate down. The decline in the initial jobless claims this week gives me hope that we are back on the right path, but I don’t want to get too excited about just one week’s data. This is particularly true when we have seen massive storms which might have shut down some unemployment offices, and thus artificially depressed claims.

So call this portion of the report good news, but with a caveat. Still the longer-term initial jobless claim trend has been down, and we are well below the 601,500 the 4-week average was at a year ago. A 19.3% reduction in a year is significant.

Continuing Claims

We also got some good news on the continuing claims front. Regular claims for unemployment insurance fell by 79,000 to 4.538 million. That is actually also below the year-ago level of 4.755 million. However, regular claims, which are paid by State unemployment insurance funds, run out after 26 weeks.

In January, half of all the unemployed had been out of work for 19.9 weeks or more, and 41.2% had been looking for work for more than 26 weeks. Clearly a measure of unemployment that excludes more than 40% of the unemployed is deeply flawed.

After regular claims run out, people move over to extended claims, which are paid by the Federal Government, largely through the ARRA, better known as the Stimulus Act. There are now 5.684 million Americans on extended claims (combining the two largest programs), or more than a million more than on regular claims.

There was good news on that front as well, as extended claims dropped by 171,500 this week. Well actually, there is a bit of a timing difference as regular continuing claims data is one week behind the initial claims data, and the extended claims are a week behind the regular claims data — but when I refer to this week, I am referring to the data that was released today.

Relative to a year ago, there is not a lot of good news, as the current level is over three times as high as the 1.822 million level of a year ago. The extreme length of time that people spend looking for work after they get their pink slips is one of the things that has really set the Great Recession apart from all previous post war recessions. (click here for a more in depth discussion).

Those extended claims have been a very important part of the Stimulus Act. Without it, there would now be 5.684 million Americans (and their families) with no income at all. By the time they have reached the 26-week mark, they will have probably have already dipped into their savings, and run up their credit cards.

Extended Claims and Home Mortgages

In previous downturns, the homeowners among the long-term unemployed could have tapped the equity in their homes to survive. But today, one out of five homeowners (according to Zillow) is now underwater on their home.

Keep in mind that over 30% of homeowners own their houses free and clear, so the percentage of homeowners with mortgages who are underwater is much higher. Most of the people who own their houses free and clear are elderly, and thus not likely to be among the ranks of the unemployed.

Millions more homeowners are right on the edge of being underwater. For those people as well, the home equity option is simply not available. With a very low savings rate, particularly among the working and middle classes going in to this recession, their savings would have quickly been eliminated after their income fell to zero. These people would be then be left with no IRAs or 401(k)s and would face a very bleak picture for their retirement years.

With no income and no savings, and credit limits maxes out, they would fall into abject, third-world style poverty. In the process, they would, of course, stop spending all together. As they did, they would no longer be able to shop even at Goodwill or the Salvation Army, let alone discount chains like Wal-Mart (WMT) or Big Lots (BIG).

That would lead to still further job losses at those stores and among the workers who make and transport those goods. These people are probably already high on the list of those who are defaulting on their credit cards, and not paying their mortgages ( not all of them, however).

If people were not getting their extended claims, almost 100% of the long-term unemployed would be defaulting on their debts. That would put even more pressure on bank earnings and capital, making it even less likely that the banks would be lending to small businesses, thus even further shutting down job creation in the economy.

It is not for nothing that things like unemployment insurance are referred to as automatic stabilizers. However, the automatic part only lasts for 26 weeks. After that, in the absence of the Stimulus Act, the destabilization would start to occur again.

The ARRA is good humanitarian policy, but it is also good economic policy. It is not just about soft hearts, but there is also a very good hard-headed reason for it as well.  To those who claim the ARRA has done nothing, I say tell it to the 5.684 million Americans who remain consumers and bill-payers because of it. Otherwise we would be in a self-perpetuating downward spiral.

Yes, there is still plenty of work to do on the jobs front, and extended benefits are not a good long-term substitute for real jobs, but they sure beat having people starve to death.

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.

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