State of the Recession: Long Way to Go 25 comments
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Going into this holiday weekend, we need to take a little time to reflect on the state of the economy and the financial markets. I certainly don’t want what I write below to sound like a “rosy scenario” but I would like to try and put some perspective on where I think we are and what is ahead of us.
First, as I have written many times, the liquidity problem is behind us. Liquidity problems are of short-term nature and require immediate action. The difficulties we now face are related to solvency and the ability to work things through. This takes time and it takes persistence, things that Americans are often impatient with.
My argument here is that many of the problems we face are known. In the words of the world-famous philosopher Donald Rumsfeld, in dealing with a “solvency problem” we are dealing with “known unknowns.” (To clarify my argument, I would argue that a “liquidity crisis” is related to “unknown unknowns.”) Banks and other financial institutions, along with non-financial organizations, unless they are just blinding themselves to the truth of the situation, know what they need to watch out for. That is one reason why banks are not lending much these days. (See my post The Clogged Banking System)
The “solvency problems” has to do with assets whose value is less than that recorded on the balance sheet of an organization. This “solvency problem” has been exacerbated by the large amounts of debt financial institutions and others have used to acquire these assets thereby leaving the problem of whether or not the equity base of the company exceeds the “hole” that exists between the “real” value of the assets and the value recorded on the financial statements.
The “unknown” here is exactly how much the organizations will eventually get from the “known” questionable assets. The answer to this hinges upon the issue of whether or not the value of the asset will improve if these organizations work with the asset, especially if the asset is a loan that the borrower has some chance of repaying in large part. The alternative, of course is that the value of the asset will never increase and needs to be “charged off” right now.
There is no question that banks and other financial institutions tend to be overly optimistic about their ability to “work things out”, but this is a time when they need to be as realistic as possible about the condition their assets are in. This is a turnaround environment and having led three (successful) bank turnarounds I know how important it is to be realistic about asset values at a time like this. Good leaders, good executives, are ones that face the problem head on and do not try and postpone the inevitable.
But, there is a second issue here. The government help that has been provided to the private sector has not always been helpful. If fact, some of the actions of our leaders have created an environment of greater uncertainty, something that an uncertain economy and financial system does not really need. For example, those of you that have read my posts over time know that I am very skeptical of the actions taken last fall by the Chairman of the Federal Reserve System. (See my post The Bailout Plan: Did Bernanke Panic? )
The followup to this was the execution of the bailout plan, fondly labeled TARP. It was obvious that our leaders were making up the plan as they administered it which led to several changes in direction that totally confused participants and the market. Plus there was never any oversight administered to the program so the money went out and no one knew where it went.
Now we have a “recovery package” that has been approved by Congress. Again, there is great uncertainty about what the “package” is and what will it do.
Then, following this package we had the “summary” of a bank toxic asset program presented by Secretary Geithner that bombed, and then the presentation of the P-PIP, which Nobel prize-winning economist Joe Stiglitz and others have torn into as providing a fantastic “real option” that provides tremendous upside for private investors and horrendous potential downsides for tax payers. Furthermore, in response to criticisms that this opportunity was just for “big” players, the Treasury responded that, well, smaller organizations would be let into the game — and, well, we may let the individual investor get into the scheme just like the patriotic program that allowed individuals to buy Treasury bonds during World War II.
The third issue centers on the amount of debt outstanding in the world. We write about the plight of the United States consumer and all the debt that he/she accumulated during the credit bubble of the early 2000s. This is a problem and will take a long time to work itself out with layoffs and unemployment increasing and bankruptcies, both individual and small business, on the upswing, along with rising delinquencies on credit cards and other consumer loans and with the overhang of large amounts of residential mortgages repricing over the next 15 months or so. This will be a drag on the United States economy for a while.
Real investment in the economy will not begin to rise until consumers get their balance sheets in order and feel confident enough to spend once again. However, many analysts are arguing that the economy is in for a structural shift, returning the United States consumer to a more fiscally conservative balance sheet with more of their disposable incomes going toward saving. This will require businesses to be smaller and more conservative in their operations. Both will retard recovery.
In addition, there is the problem of debt in the world. There are huge amounts of debt outstanding in the world that are going to have to be dealt with over then next three years of so. (An example of this looming problem is discussed in the Financial Times this morning, Eastern Eggshells.) This just points to the fact that this recession is world wide in nature and the fate of the United States is going to be tied up with what goes on in Eastern Europe, in Japan, in China, in Russia, in Western Europe, and so on and so on.
This is why a growing number of people, like Niall Ferguson, author of “The Ascent of Money” is concerned that the United States — and others — are trying to resolve the problems created by too much debt and financial leverage by increasing the amount of debt and financial leverage that is in the world. These people are contending that we are all in this together and we must fight extreme national self-interest and protectionism.
The state of the nation is precarious — there is no doubt about that. However, I believe that we have progressed to the point that we are dealing with “known unknowns” rather than “unknown unknowns”. There is still much uncertainty in the economy, in the world, and people are attempting to work through the problems they face. But, because there are many people feeling a lot of pain right now and there will be more joining their ranks in the near future, there is a great deal of pressure to do a lot of “something” about it. And, in the minds of many, the effort must err on the side of doing too much rather than in doing too little. The potential downside to all these efforts is that much of what will be done may actually create more difficulties than they solve. Impatience is not always a virtue.
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There are people commenting all over the place about
1.Wells Fargo lying about their quarter
2.If they did so well why don't they pay back TARP.
Like as if this supposed never ending depression people are resigned to and some rooting for could magically be turned around in 1 week. These people failt to understand the steps we take once things actually turn around(could be soon, could be years off) are just as important as the steps taken now.
Here are things we will see again in the near future:
Oil Crisis. Why? Because people only get fired up about it when gas prices are high. The minute they go down its yesterdays news and becomes "too expensive" to fix.
Until countries of the world realize much debt out there just cannot and will not be paid back and cut it out to move forward, we will be stuck in these situations every few years(I think the time between them will lessen)...This is akin to 10 people in a closed system who all find themselves in varying degrees of debt. There is no reason to cut out the overlapping debt or cut the debt all together. The world needs to do this without letting chaos and currency runs ruin things along the way.
On Apr 09 05:45 PM CJJ wrote:
> I agree with this article. All the thousands of articles daily by
> "journalists" and bloggers and comments on them amount to a bridge
> to nowhere.
> There are people commenting all over the place about
> 1.Wells Fargo lying about their quarter
> 2.If they did so well why don't they pay back TARP.
>
> Like as if this supposed never ending depression people are resigned
> to and some rooting for could magically be turned around in 1 week.
> These people failt to understand the steps we take once things actually
> turn around(could be soon, could be years off) are just as important
> as the steps taken now.
>
> Here are things we will see again in the near future:
> Oil Crisis. Why? Because people only get fired up about it when gas
> prices are high. The minute they go down its yesterdays news and
> becomes "too expensive" to fix.
>
> Until countries of the world realize much debt out there just cannot
> and will not be paid back and cut it out to move forward, we will
> be stuck in these situations every few years(I think the time between
> them will lessen)...This is akin to 10 people in a closed system
> who all find themselves in varying degrees of debt. There is no reason
> to cut out the overlapping debt or cut the debt all together. The
> world needs to do this without letting chaos and currency runs ruin
> things along the way.
This crisis is far from over -- unemployment continues unabated: new claims are holding steady around 650K/month for the 5th month in a row, and continuing claims are *up* several thousand each of the last few months. Not good. That consumer spending that makes up 70% of GDP -- unemployment ain't gonna help that. And all government has done is add a staggering amount of debt, while rewriting all the rules, and exercising unprecedented control -- and they are not done yet. That is an ill wind for the economy.
We may be seeing a bit of an uptick from Chinese infrastructural demand. But I don't believe it will translate into much for the U.S., as it will largely benefit raw materials (think the "BR" part of "BRIC") and only a couple sectors of the U.S. industrial complex (machinery from the likes of CAT). Growth in any other U.S. sectors has to come from elsewhere than China, IMO. And I don't see anywhere else that will be doing much growing or generating much demand anytime soon. We will see a small blip up in retail & electronics as some people use their tax refunds. But that will be short-lived, and not fully participated, as many save that money or use it to pay down debt.
So, good luck to the likes of Cetin -- don't blow your wad all in one place.
How could anyone reach such a silly conclusion? The remark is a non sequitur; moreover, it suggests an analysis this is impossible to perform.
The facts are that the economy may have reached an inflection point, but that only means - for now the rate of decline has slowed. Nothing more can be said in good faith. We have just as high a probability of going off the cliff again until employment starts to stabilize and recover.
Beyond the write downs, and losses, liquidity and solvency issues – the main issue would be consumer confidence. Will the always euphoric US consumer come back- that would be the $700B question, likely bigger. US consumer went on a spending binge (from 65% of GDP to 72% of GDP), negative savings (from historical average of 10%), and borrowing (from 50% of GDP to 100% of GDP from 2000 to 2006). Now US consumer will earn less – job losses and pay cuts, also will save more – this will have a heavy toll on world economy and of course US economy too. Best case scenario is job losses end in a few months @10% or so and we get stability, but it will be at a much lower level – likely GDP contraction of 10%.
Will suggest investors to tread lightly, bad news can come from the left field – Wall Street pros can play it either way – “priced in or worse than unexpected” – the regular racket on Wall Street.
On Apr 09 04:24 PM BigJake wrote:
> Cetin, is there an article you do not have a comment about? We realize
> that you think this is the start of a bull market. We get it. We've
> been getting it since mid march. Why not write articles instead
> of comment on every single article someone writes if you want everyone
> to read what you have to say?
I wonder if bear market rallies occur because people can only digest so much bad news for only so long. We all have crisis fatigue, and are ready for all of this to be over. Economic forces act on a different, longer time scale that we can't identify with, just as the eye can't round the horizon.
Just thinking out loud. But in this vein, it is easy to gloss over an ominous point in the article, which is imbedded in the text to almost damn it with faint praise. That is the point about the structural changes in household behavior---amounting to a sesmic move toward savings and less consumption, with a pervasive fear about the future and about what the government might be up to next. If savings go up to 10% of income that may take ? 2 trillion out of the GDP (that is a number I've read before). This is a huge "unknown unknown"---which should give us pause before we hail the rebirth of the Bull.
Your article has a lot of guts, and I concur with your assessments.
I have one "small" thought though - it would be naive for anyone to think that the Obama regime would do anything to truly correct the mess. So far their economic actions (or really in-actions) had been well anticipated - typical, classical, and bureaucratic.
Teutonic
Just wait until the commercial real estate implodes ! Will make the residential mortgage defualts + bank failures resulting from same look like a walk in the park !
Unfortunately, it is far from clear that we are acting logically in our nation's economic policies, especially viz-a-viz the financial sector. It is fairly clear that several large banks (starting with Citi) and insurance companies (AIG!) as well as the financial arms of Chrysler (GMAC) and maybe GE (GEISCO) are insolvent. Yet, because we have ASSUMED that they are "too big to fail," we have not taken the logical business step which is to restructure or liquidate them through bankruptcy. The TBTF argument--based wholly on unsupported hand waving and hand wringing fears about financial system stability--has led us to a policy approach that shifts the burden of the financial sector's trillions in bad debt to the public sector, and ultimately to the taxpayer.
In contrast, an economic policy strategy that pursued the rapid and orderly nationalization/bankru... including changes in management, banishment of bad debt, and decentralizing banking, before returning the new financial institutions to private hands would better serve the American public and the world economy. First, we would be through the pain of dealing with toxic assets much more quickly. Second, the financial system that came out of this process would be much more healthy than the patches now being made on the present system. Third, the people who took the risk--equity and debt--would be the ones paying for their foolishness and fraud, not the American taxpayer.
Until we take a more logical policy in dealing with the "known unknowns," we will not solve the economic crisis, just merely kick the crisis down the road at the massive expense of the American public.
The first 90 days of the Obama regime is rapidly coming to an end. They missed the boat entirely!
First, don't expect the same old Gang (Pelosi, Reid, Geithner, Bernanke, etc.) to be able fix THEIR problems which they created and were unable to alleviate in time. How could these old hands be able to fix their own misdeeds and tame the Financial Tasmanian Devil that continued to stun everyone. The same old CEO's and their followers are still in charge (Henderson, Lewis, Pandit, etc.)
Bottom Line? There had been NO CHANGE. What we see is what we get - Business as Usual.
The wise oracles of Soros, Ichan, Schiff, Whitney, Krugman, Galbraith, etc., to drastically down size governments and nationalize the banks have fallen on deaf ears.
Get ready for a Dead Man Embrace in Quick Sand!
Teutonic
moneyneversleepsblog.b...
Another topic to debate is how do you define a depression?
moneyneversleepsblog.b...
Keep in mind there are always positive black swans as well as negative so perhaps there is something out there that could be a game changer. Makes more sense the more negative people become.
At its current price of 856, the S & P 500 is down about 46% from its peak. If actual earnings from Q1 turn out to be closer to $40 than $63, we may see a retest of the March low.
On Apr 10 05:12 PM Mad Hedge Fund Trader wrote:
> I have a question. Will someone please help me out here? Q1 corporate
> earnings are expected to drop by 38%, and the market rockets 26%.
> Is there a disconnect here? I know I only got a magna cum laude
> in math in college, not the summa cum laude I deserved. But is it
> possible that the market has gotten ahead of itself? Just a tad?
> Is the economy really going to have the massive bungee cord type
> recovery that the market is discounting here? Could we be setting
> up for the perfect sell in May and go away scenario, like we saw
> last year? I don’t get this. I await your comments in earnest.
It would take little effort to craft a small and accurate sampling or mortgages. People know exactly where we are....... with more than a 95% confidence interval.......they just can not, or do not, TELL US!
I read a report on this fiasco that was produced in March of 2007 (by Credit Suisee), stating exactly where we were..... and were headed.......with tons and tons of very specific data! Two years later, no one can figure out what are condition is........bullshit!
The article sounded kind of like Peter Schiff light.