Fending Off a Lost Decade

By James Kwak

Why don’t all recessions seem to teeter on the brink of turning into a “lost decade,” as President Obama described, accurately, our current predicament?

In a standard recession, some people (or firms or governments) cut back on their spending. But others either maintain their spending or actually buy more. A recession is typically a good time to invest in relationships and buy longer-lasting assets; for example, it’s a good time for private universities (with endowments) to hire faculty, build labs, and acquire the land for new buildings. Anyone with a long time horizon, deep pockets, and access to cash ordinarily thinks in these terms.

But instead of this kind of countercyclical private sector investment behavior, Drew Faust, the President of Harvard this week sent a downbeat message to her stakeholders,

[W]hat has become clear is that we are living through much more than a bump in the road. Our economic landscape has fundamentally changed.

President Faust goes on to say that the endowment has lost value and cuts need to be made. I’m not questioning the judgment of President Faust or the idea that some parts of the university sector overexpanded during the boom - in fact, similiar messages are being communicated, one way or another, at many other schools.

On the contrary, there are few organizations that cannot take at least 3-5% out of their nonpersonnel costs after a long boom - we all get sloppy about our spending when times are good for a long while. This, of course, is part of why we face a recession.

What worries me much more is when organizations with long horizons and a strong balance sheet (e.g., anyone with an endowment, venture capital, private equity, people who own property without an onerous mortgage, etc.) decide that the only prudent thing to do is cut spending dramatically. And universities are likely relatively sheltered, e.g., people still go to college even in a prolonged downturn, and applications to some professional schools typically go up. I mention them here only as an example that shows the depth of our problem.

The rest of the world economy looks bad and likely to get worse. If you know of any bright spots (i.e., anyone, other than the US government, buying more than last year), post the details here or otherwise spread the word. I talk to a lot of people with information and ideas from many places; good news is scarce and official forecasts (which still contain an imminent recovery) seem greatly exaggerated.

If the global situation is really as gloomy as this suggests, surely the G20 leadership will finally get serious with recovery measures in time for the London Summit on April 2nd? If the global economy loses a decade, they are responsible. Tell them this, early and often.

Comments

[Dave Wrixon:]

Its all about the level of deleveraging that is required to regain stability.

Some recession are simply reduced demand due to things like high levels of interest rates. The current recession is an inability to lend because most borrowers are so severely underwater that there is in the US at least a very limited pool of credit worthy borrowers that actually want to borrow.

The shortage of borrowers will eventually force banks to look at the potential of credit worthy borrowers in Eastern Europe and Asia. Unfortunately, the is means that availability of credit for American consumers will never return to 2006 levels.

2009 Feb 21 01:06 PM

[Aristophanes:]

Eastern Europe's pool of borrowers is shrinking much faster than anyone else right now. A terrible demographic profile also raises significant long-term doubts about repayment on such leverage, not to mention the often confusion as to what is and is not sovereign with many of the companies.

Maybe Latin America, Indiia and Africa.


On Feb 21 01:06 PM Dave Wrixon wrote:

> Its all about the level of deleveraging that is required to regain
> stability.
>
> Some recession are simply reduced demand due to things like high
> levels of interest rates. The current recession is an inability to
> lend because most borrowers are so severely underwater that there
> is in the US at least a very limited pool of credit worthy borrowers
> that actually want to borrow.
>
> The shortage of borrowers will eventually force banks to look at
> the potential of credit worthy borrowers in Eastern Europe and Asia.
> Unfortunately, the is means that availability of credit for American
> consumers will never return to 2006 levels.

2009 Feb 21 01:14 PM

[CautiousInv...:]

i think much what you have said is a refection that, indeed, this time it is different.

George Soros, Nouriel Roubini and a growing chorus of others believe we have a long way to go in resolving the structural issues facing the global economy.

The global banking system must regain its footing by getting rid of problematic assets while at the same time remaining solvent. This is a highwire act and there is serious debate within the US as to how US banks should best accomplish this daunting feat.

In parallel, the entire US private sector, particularly households, must delever to the point where debt levels become sustainable in relationship to income levels as opposed to increasingly inflated asset levels. This will take time and require more savings and less spending.

Corporations, in addition to feeling the consumer delever, will delever themselves and in the course of doing so will experience lower returns on equity resulting from lower leverage. After decling for over ten years, effective tax rates are likley to move higher which will further reduce reported aftert tax earnings.

We will come out of this without losing a decade but in going forward we will be taking new and different steps.

2009 Feb 21 01:48 PM

[Moon Kil Woong:]

In my eyes, we already tried to fend off a lost decade 1999-2009 and failed. So I suppose we are now discussing fending off another lost decade. One can't blame Obama for what has happened.

Regarding lowering costs, you are right that after years of credit expansion there is room to cut by everyone. Those who say they can't should look hard in the mirror unless they can continue to grow profitably and take advantage of the demise of their less well managed competition. For such companies we need not fret. They are wel run.

Sadly, with the stimulus bill and record deficit spending put emplace by the Bush Jr. Administration, the Federal government will not be cutting away fat and steamlining. Enstead it will become fatter and more bulky.

I know, government spending adds to GDP. However, there is a meaningful difference between supporting government spending expansion for the sake of more spending and expansionist spending that will actually do some economic good. Sadly, as will Bush Jr's last 8 budgets and stimulus programs, I don't see much value add to the higher bill future taxayers are shouldering in this stimulus package.

Government should spend more time stimulating their mind on how to help their constituents/citizens and less on how to stimulate their budgets and the economy.

2009 Feb 21 02:09 PM

[sheridan:]

People should all be excited by what is happenning to our/world economy. If you're a true capitalist and thus patriot you know that these are the periods when fortunes are made.

2009 Feb 21 04:01 PM

[Dave Wrixon:]

Patriotism and Capitalism are not two concepts that have much in common. And if they do it, then it shear pragmatism.


On Feb 21 04:01 PM psheridan wrote:

> People should all be excited by what is happenning to our/world economy.
> If you're a true capitalist and thus patriot you know that these
> are the periods when fortunes are made.

2009 Feb 21 06:29 PM

[ROLEXDAYTONA:]

Another two lost decades are ahead of you, the new best ventures will be in drug cartels, monopolies, Somalia piracy, underground economy that is.
The times of Al Capone are here again, the crime, unemployment will rise dramatically worldwide, when animal (according to Darwin's theory) is hungry, he kills, when human is hungry he can be anything more dangerous than that.
Close your doors, windows...you know, like in the depression of 1920's just ask your grand father.

2009 Feb 21 06:59 PM

[HiSpeed:]

In the macro-picture, I'd keep in mind that the US is coming off a 25 year credit bubble so I wouldn't get too sanguine about getting long here.

Remember, the market can remain seemingly illogical for longer than a trade can remain solvent. Then again, maybe the market is right.

2009 Feb 21 11:40 PM

[Simon Smelt:]

Kwak remarks:
>If you know of any bright spots (i.e., anyone, other than the US >government, buying more than last year), post the details here or >otherwise spread the word.
Actually most government are spending or planning to spend more to rescue banks, make up for lost leveraging in the financial sector and to boost demand.
Of course, somebody has to pay for all that extra spend. Maybe some will think it's a good job that the private sector is cutting back so that the public sector can grow still more in its place. Of course, the U.S. may continue to hope that the Chinese will do their saving for them.

Is that what you expect G20 to achieve?

2009 Feb 22 01:48 AM

[Al-USA:]

psheridan said:

"People should all be excited by what is happening to our/world economy. If you're a true capitalist and thus patriot you know that these are the periods when fortunes are made."

Spoken like a true Capitalist.

This recession/depression started because there are now more goods produced than the working-class American can afford to buy. For the last 30 years, the average wage of the working class has been stagnant, while profits for the ruling class where reaching record levels. For a while, the working class got by on increasing levels of debt. That has ended...

Without increasing levels of debt to fuel increasing consumption of goods the ruling class is no longer able to make above average profits. As true Capitalists, the ruling class will never invest in lower than average profit making businesses simply because they don't need to. It is in their interests to keep people unemployed and hungry.

With declining consumping by the working class , the ruling class now happily resorts to the second method of keeping their profits up: they start imposing wage freezes and wage cuts.

Finally, and this is where we are now, the owners start sacking people and closing down factories/businesses. Unemployment is soaring, wages are being slashed, working class confidence is diving. Eventually, assuming liberal capitalism survives the coming social unrest, this recession/depression will end as it began - when the economic conditions are right for the ruling class.

Even then however, as the economy pulls out of the recession/depression only one thing is certain - it is going to collapse again.

Therefore capitalism can only offer to the worker a continuous struggle, against the ruling class, for the necessities of life. We can never be as rich as the ruling class, because we can never own what they own.

Not pray tell, how is Capitalism compatible with being a Patriot?

2009 Feb 22 02:01 AM

[paxjds:]

Yes James, people are starting to buy more gold now versus last year. In the near future more will switch to buying gold versus US Treasuries. Opining gold is not a short term bubble, but Treasuries are.

2009 Feb 22 11:47 AM

[Mad Hedge F...:]

Why don’t we accept the wisdom of crowds and accept the market’s judgment that the big banks are worthless? Let them all go bankrupt. With Bank of America (BAC) and Citigroup (C) down 95% from their peaks, shareholders have already been wiped out. All we are arguing about here is whether they should be allowed to come back in the next economic recovery. The Geithner bailout plan missed a golden opportunity to shock us all to our senses. Whatever happened to creative destruction? Let the weak banks go, and they will be replaced by stronger, better managed ones without any government involvement at all. Let the natural Darwinian survival of the fittest run its course. I watched with chagrin while Japanese banks pretended they were solvent for 15 years. Everyone in the country suffered as a result, and a whole generation’s worth of economic growth was lost.

2009 Feb 22 01:04 PM