Thread: Don't count on a 'normal' recession

Don't count on a 'normal' recession

Wall Street expects financial innovations and global growth to keep any US slowdown in 2008 short and shallow. But the stock market is likely to be seriously disappointed.

By Jim Jubak

The stock market doesn't much care whether a 2008 slowdown in the economy is an official recession or not. As far as Wall Street is concerned, there's just not much difference between economic growth falling to 1% or to minus-0.5%.

As long as the slowdown, recession, whatever, is short. No more than two quarters. Over and done with by mid-2008. Then the economy and the stock market, Wall Street believes, can look forward to another long boom.

That's why global stock markets recovered so quickly after the Federal Reserve cut short-term interest rates by three-quarters of a percentage point in a surprise move before the market's open Tuesday. What had been near panic on global exchanges Monday and early Tuesday turned into a rally by Wednesday because Wall Street still believes the Fed, the White House and Congress can keep the U.S. economic downturn short.

Recent history supports that view. Over the past two decades, recessions have been remarkably short and remarkably mild. If any 2008 recession is a "normal" one, investors are absolutely right to look past it to an economic recovery in the second half of 2008.

Disappointing odds
But what if a 2008 slowdown or recession isn't normal? What if it drags on for 12 months and not just six or eight? Then the stock market has set itself up for serious disappointment, with multiple dips in the major averages as investors gradually realize that 2008's economic slowdown will be lengthier than expected.

The odds of that kind of disappointment in 2008 are, unfortunately, high. This sure doesn't look like the "normal" recession. Because so many consumers got used to drawing against their rising home equities to fund their spending, the bursting of the housing bubble and the crisis in the subprime-mortgage market have resulted in far more damage than usual to consumer cash flows. The drop in consumer demand is well beyond what you'd expect in an economy that's still producing jobs at a decent rate.

Even with personal income rising at a 6% annual nominal rate -- that's before subtracting inflation -- consumer spending has started to slow. If employment growth drops, as the Federal Reserve projects in 2008, then the drop in consumer spending could well accelerate. And at the current rate of progress in the housing market, it's going to take way more than a couple of quarters to repair consumer balance sheets damaged when the bubble burst in 2007.

The bad old days
A 2008 economic slowdown or recession wouldn't need to be one for the record books in order to disappoint Wall Street. It could simply mark a return to the bad old days, from 1959 through 1983, when recessions lasted 50% longer, were nearly twice as severe and took place about twice as often.

A September 2007 report from the Federal Reserve Bank of Dallas summarizes the difference between a recession in the bad old days and now:

"On average, the five recessions from 1959 to 1983 were 47 months apart, lingered 12 months and were associated with a 2.17 percent peak-to-trough decline in real gross domestic product. By contrast, the 1990 downturn came after 92 months of expansion, lasted eight months and involved a 1.26 percent decline in GDP. The 2001 slump ended a record 120 months of uninterrupted growth, lasted eight months and entailed a GDP decline of only 0.35 percent."

Economists first picked up this shift to shorter, less severe and less frequent recessions in the late 1990s. Since then, they've been working hard to explain why the economy is behaving this way. Explanations for what has been dubbed the Great Moderation include:


Structural changes in the economy, such as "just in time" production systems that prevent a big buildup of inventories that can result in a slump in new orders as companies work off old stock.

Financial innovations, such as home-equity loans that smooth the swings in consumer buying that can result from dips in personal income and employment.

The creation of global markets for raw materials, including labor, goods and services, that smooth out shifts in the growth rate of any individual economy.

It's the second and third of those three possible causes for the Great Moderation that form the crux of Wall Street's hopes for a quick and shallow downturn. Yes, it's absolutely true that the surge in mortgage refinancing and home-equity lending fueled the boom in U.S. consumer spending that drove not only the U.S. economy but also the world economy.

The cash coming out of U.S. home equity turned into massive purchases of goods and services from China, India, Japan, the oil economies of the Middle East and Russia, and the European Union. And that purchasing produced double-digit growth or near-double-digit growth in those economies.

Those economies pumped a good percentage of their cash back into the U.S. through purchases of Treasury bills and mortgage-backed securities. Those purchases lowered U.S. interest rates and made it possible for another round of home-equity refinancing at lower interest rates and another round of home-equity cash-outs.

Global insurance policy
It was great while it lasted, but now it's time to pay the piper. The fountain of U.S. home-equity cash has dried up. U.S. consumer spending is slowing, and so is the nation's economy. A weak dollar is enabling U.S. companies to increase exports, which cuts into sales by overseas companies. At some point, all this adds up to recession or near recession in the U.S. and a slowdown in global economic growth.

Not so fast, Wall Street says. In your emphasis on cause No. 2, financial innovation, you've forgotten about cause No. 3.

In a global market, consumers in the fast-growing economies of China, India and Russia have become rich enough that they increasingly demand goods and services. These emerging-economy consumers can take the baton from U.S. consumers and keep the race going. Not only will that be enough to keep the global economy as a whole from slumping, but growth in these countries will moderate the depth and duration of any decline in the U.S.

Think of this increase in demand as a kind of insurance policy for U.S. and global economic growth. If an economic storm strikes the U.S., this policy will work to minimize the damage.

But any insurance policy has its limitations. For example, a storm can be so intense that it inflicts damage beyond the coverage of the policy.

And that's the danger we face in 2008. As long as the downturn in the U.S. economy is modest, then, yes, demand from overseas consumers with newly increased incomes can pick up the slack. But if the downturn in the nation's economy is serious, there simply aren't enough consumers in China and India and elsewhere to pick up the slack.

According to the U.S. Bureau of Labor Standards, consumer spending accounts for about 60% of the country's $13.2 trillion economy. That's about $8 trillion. A 1% drop in U.S. consumer spending equals $80 billion.

The Chinese, Russian and Indian economies are significantly smaller than the U.S. economy, ending 2006 at $2.7 trillion, $1 trillion and $900 billion, respectively (at the exchange rates then). And consumer spending makes up a significantly smaller percentage of overall economic activity in these countries. Consumer spending in China, for example, makes up less than 30% of the total economy.

White-swan pricing
Using that 30% figure as an average to get a ballpark number, each 1% drop in U.S. consumer spending would require a 7% increase in consumer spending from China, Russia and India. That seems doable for these economies. At that level of decline in the U.S. economy, the global insurance policy could work, I'd say.

But increase the severity of the U.S. decline to 2%, and China, Russia and India would have to grow consumer spending by 14%. That would be tough. China is going full-tilt, with inflation racing ahead, and its GDP is growing at just 11% a year.

So investors are facing another version of the problem that sank the mortgage-backed debt market. Within some definition of "normal," the insurance policy works. In the mortgage-backed debt markets, in the normal world, AAA-rated securities are indeed safe. And in the economic realm, in the normal world, the U.S. economic slowdown is short and shallow.

But if we get an abnormal event -- what's called a black swan -- then "safe" mortgage-backed securities fail, and the U.S. economy experiences a downturn that lasts longer than Wall Street expects.

Right now, the stock market is priced only for white swans. Given Wall Street's recent record on valuing debt securities while underestimating the ramifications of a black-swan event, that makes me nervous.

A game of wait-and-see
So put me in the "show me" camp. I'll believe the downturn in 2008 will be "normal" when I see housing prices stabilize, when I hear Wall Street CEOs saying they know the size of their eventual write-offs and when I see banks willing to lend to each other again.

http://articles.moneycentral.msn.com/In ... ssion.aspx

Well on the smaller end of the economy, namely our household, and the households of ALL of our families and friends, it has been getting harder and harder to make ends meet lately.

Pay the bills on one paycheck (paid every other week), and there is nothing left (I mean NOTHING). Two weeks go by, and more bills are due and then there is a little left for some necessities, but then that is it, that is the entire month in a nutshell. Month after month like this for all too many people we know, and us.

Prices on good, services (electricity and such), and rent is all going up, but incomes are just not meeting that stride. It is crushing most people.

I would not call what has been happening in this country a recession, I would say it is more like a depression.

If Mike Huckabee cares anything about america and the republican party ,he will get out of the race before super tuesday.Tonight,Huckabee basically admitted he would only have chance to win in southern states next tuesday.Even if he wins those states ,he and his advisors clearly see that with him and romney in the race it gives iit to McCain.Huckabee has no money left and Romney has losts of it.If I did not know better I would think that Huckabee is staying in the race to derail Romney.Rudy did the right thing in his mind by basically quiting the race to stop taking away votes from McCain.Please,Mike if you care about the future of this country drop out of the race this week.

Pay the bills on one paycheck (paid every other week), and there is nothing left (I mean NOTHING). Two weeks go by, and more bills are due and then there is a little left for some necessities, but then that is it, that is the entire month in a nutshell. Month after month like this for all too many people we know, and us

Boy do I know that routien. It was a pain for me because my bills were due on the "off" weeks....they wouldn't change your due dates to go along with your pay either. I swear it was constant running trying to make it the second before they'd cut off the electricity almost every month. You prayed for no holidays because that would throw your ability to get cash to pay those bills.....It wasn't like you ever got anything extra to even try and put something away or even stock-up when things were on sale. They switched the banking rules then so you couldn't have a checking account if you didn't have 500.00 in there un-touched at all times. Then started charging you to cash a check if you didn't have a personal account there....even when it was the bank your pay check was drawn on. It was so bad I was lost if I wasn't working on the day the checks came because I didn't have the money for the gas to make the extra trip to pick it up.

I know that every other week might have saved the companies money.....but I knew way too many people who were left hanging on the edge every other week as well. Heck....I remember begging for hours to work....a stable schedual so I could get another job......anything.....even if I got extra hours they would hold them so they didn't get penalized for going over their quotas and then pay me when they cut my hours. I would cringe everytime the kids would come home and say..."Mom....I need 20 bucks for this" for school or "Mom we have a project to do and I need....." My only saving grace was living in Florida so I didn't have winter heavy duty clothes and boots and such every year......yet to think I didn't qualify for food stamps or anything.....dollars away from it since they took averages....not how the money actually came in.....not one time when my kids were sick did I get free care......I doubt I would have survived if a friend down the street didn't help from time to time. But yet you're supposed to save for retirement living like that......ya right.

I know Crazybird. I raised my oldest one till she was 10 by myself, with no child support. I made a salary and was paid once a month. That was in 1988/89, and was making $840.00 after taxes. I had rent, electric, child care, phone and commuting cost's, afterwards, I was lucky to have an average of $80.00 left for the month for food.

The worst part was that I needed help, was not getting child support, and the state said I had too much income for food help, they stated that they figured the ordered support amount against my income, even though I was not receiving it!! Now, they do not do that now, but they were able to get away with it then (apparently some low-income watchdog group got hold of that and took the state of Oregon to task on it and made them change that rule).

It is always good to be self reliant, but sometimes it is impossible. I see the illegals in the store, buying hundreds of dollars in groceries with WIC and with the Oregon EBT card. I often get very angry over this, remembering how hard I worked to just feed my daughter, alone, and I could not get help to do that, yet now, the state will feed illegals without question.

We have a rule in our family (I am the last out of six kids and there are now 12 grandkids, of which 6 are adults now)) which my father implemented long ago (he is gone now). Not one of us will do without, EVER, we stick together and help each other. So when times are really bad for one of us, all others will chip in about $20.00 or so, and get a store card for food and needed items. Never fails and we always make sure the others have what they need. It is our own family "welfare" system.

Though Crazybird, it is so frustrating these days, when I see not only us, but everyone struggling so unbelievably hard, and most people I know do not even own their own homes. In the last six months we have sold off so many CD's, DVD's and other items in order just to feed ourselves (not that we had a lot, but what we did have we sold).

One last thought on our American ingenuity, and keeping oursleves above water. I feel strongly, that although Americans have been struggling, we have what it takes to survive, whereas it seems to me that the illegals do not, they have become too dependent on social service agencies and do-good groups to survive. This is a solace to me, to know that we have the tenacity to hang on and they will leave when the going get's tough (thus the reason we have won so many fights with the feds over differing versions of amnesty and the OBL/illegal crowds have not!!!!!