What's scary about this recession
Let me tell you why I think we're looking at something other than a normal recession and what that means for investors.
Recessions are a normal part of the capitalist business cycle.
Recessions wash out excesses in the system by shaking out inefficient companies, thus clearing the way for new competitors, and they work to keep supply and demand in sync over the long term.
In the past 50 years, we've had recessions (or recessionlike economic downturns) in 1969-70, 1973-75, 1980-82, 1990-91 and 2001.
(notice the short period of 1-3 years timeframe)
Some of these have been relatively mild:
The 2001 recession saw three quarters of negative growth, but the economy contracted by just 0.6%, 1.6% and 0.3% in those quarters.
Some have been much more painful:
In the second and fourth quarters of 1981 and in the first quarter of 1982, the economy contracted by 2.8%, 4.6% and 6.5%, respectively.
Some downturns are extremely brief: The recessions of 1990-91 and 2001 lasted for just three quarters each.
Some go on and on: The downturn that began in the second quarter of 1980, when the economy contracted by 7.9%, didn't fully release its grip on the U.S. economy until the fourth quarter of 1982, 10 quarters later.
There's bad news in those numbers.
The evidence says recessions will be longer than average if they follow a financial crisis, especially if that financial crisis was caused by efforts to keep the economy humming by flooding the market with cheap capital.
Unfortunately, that's a very good description of where the U.S. economy stands right now.
The pin that popped the bubble and set loose the current financial crisis was the collapse of inflated housing prices. Those high prices led people to take out mortgages they couldn't afford from banks that should have known the money wouldn't be repaid.
But homebuyers and mortgage lenders were by no means alone in their love of cheap money.
We're now suffering through the reaction to a global three-ring circus of leverage.
Hedge funds, private-equity investors and even banks borrowed directly in Japan, the U.S. or wherever money was cheap in order to buy more debt, stocks, real estate and commodities than they could have bought with their own money.
Pension funds, insurance companies, company chief financial officers and money market funds borrowed money indirectly by buying derivatives created with that borrowed money.
Why not increase your buying power by borrowing 30 times your actual capital, as Lehman Bros. (LEHMQ, news, msgs) did before its collapse, when you could borrow at an interest rate below the inflation rate, thus ensuring that, in real terms, you paid back less than you borrowed?
After all, the bull market, fueled by this borrowing, virtually guaranteed a profit.
When the assets -- starting with real estate and gradually expanding to take in stocks, commodities, corporate loans, commercial paper and the derivatives based on them -- that were the foundation of this mountain of leverage fell in price, all that borrowing had to be unwound, as creditors demanded more collateral on loans and borrowers rushed to sell before asset prices fell further and creditors demanded even more collateral.
That fear, compounded by uncertainty about what anything that had been purchased with borrowed money was really worth, drove financial institutions such as Bear Stearns, Lehman Bros. and Washington Mutual (WAMUQ, news, msgs) to -- and then over -- the edge of insolvency.
And it created a credit crunch as even the lenders with money decided it was better to sit on the cash rather than make a loan that might not be repaid.
http://articles.moneycentral.msn.com/Investing/JubaksJournal/whats-scary-about-this-recession.aspx
Recessions are a normal part of the capitalist business cycle.
Recessions wash out excesses in the system by shaking out inefficient companies, thus clearing the way for new competitors, and they work to keep supply and demand in sync over the long term.
In the past 50 years, we've had recessions (or recessionlike economic downturns) in 1969-70, 1973-75, 1980-82, 1990-91 and 2001.
(notice the short period of 1-3 years timeframe)
Some of these have been relatively mild:
The 2001 recession saw three quarters of negative growth, but the economy contracted by just 0.6%, 1.6% and 0.3% in those quarters.
Some have been much more painful:
In the second and fourth quarters of 1981 and in the first quarter of 1982, the economy contracted by 2.8%, 4.6% and 6.5%, respectively.
Some downturns are extremely brief: The recessions of 1990-91 and 2001 lasted for just three quarters each.
Some go on and on: The downturn that began in the second quarter of 1980, when the economy contracted by 7.9%, didn't fully release its grip on the U.S. economy until the fourth quarter of 1982, 10 quarters later.
There's bad news in those numbers.
The evidence says recessions will be longer than average if they follow a financial crisis, especially if that financial crisis was caused by efforts to keep the economy humming by flooding the market with cheap capital.
Unfortunately, that's a very good description of where the U.S. economy stands right now.
The pin that popped the bubble and set loose the current financial crisis was the collapse of inflated housing prices. Those high prices led people to take out mortgages they couldn't afford from banks that should have known the money wouldn't be repaid.
But homebuyers and mortgage lenders were by no means alone in their love of cheap money.
We're now suffering through the reaction to a global three-ring circus of leverage.
Hedge funds, private-equity investors and even banks borrowed directly in Japan, the U.S. or wherever money was cheap in order to buy more debt, stocks, real estate and commodities than they could have bought with their own money.
Pension funds, insurance companies, company chief financial officers and money market funds borrowed money indirectly by buying derivatives created with that borrowed money.
Why not increase your buying power by borrowing 30 times your actual capital, as Lehman Bros. (LEHMQ, news, msgs) did before its collapse, when you could borrow at an interest rate below the inflation rate, thus ensuring that, in real terms, you paid back less than you borrowed?
After all, the bull market, fueled by this borrowing, virtually guaranteed a profit.
When the assets -- starting with real estate and gradually expanding to take in stocks, commodities, corporate loans, commercial paper and the derivatives based on them -- that were the foundation of this mountain of leverage fell in price, all that borrowing had to be unwound, as creditors demanded more collateral on loans and borrowers rushed to sell before asset prices fell further and creditors demanded even more collateral.
That fear, compounded by uncertainty about what anything that had been purchased with borrowed money was really worth, drove financial institutions such as Bear Stearns, Lehman Bros. and Washington Mutual (WAMUQ, news, msgs) to -- and then over -- the edge of insolvency.
And it created a credit crunch as even the lenders with money decided it was better to sit on the cash rather than make a loan that might not be repaid.
http://articles.moneycentral.msn.com/Investing/JubaksJournal/whats-scary-about-this-recession.aspx
