The current "Great Recession" began four years ago with the collapse of the U.S. mortgage and housing markets. The market has treaded water ever since: the Dow was 13,264 on December 31 of 2007 and 12,217 on December 31, 2011.
But merely getting the market and economy back to where they were years ago is not enough to generate full employment and its associated higher levels of profits and share prices. There have also been productivity increases and population increases. Production, employment, and stocks are still far below the levels the economy is capable of generating.
More specifically, today the US economy is only employing enough of its workforce and production capacity to produce $16 trillion goods and services. That's $4 trillion short of the economy's $20 trillion capacity and the higher profits and share prices that would be generated at that level.
The production shortfall and the lost profits is huge. It means millions of unemployed workers and has caused millions of bankruptcies, foreclosures, and business and bank failures - with more in the pipeline. It also resulted in significantly lower-than-they-could-be share prices and huge deficits at every level of government - unemployed workers and profitless businesses don't pay taxes.
Congress and the President tried to help
Congress and the White House responded when the recession began. They quickly cobbled together a "Keynesian" spending program - to rescue a few too-big-to-fail financial institutions by buying their troubled assets (TARP) and providing loans to a couple of car companies to save their union jobs.
The effort failed because Keynesian remedies designed for the UK are not applicable to the US. (See the January 1 Seeking Alpha article "Krugman, Keynes, and the Economy" to understand why fiscal policy is ineffective in the U.S despite all the politicians and quasi-experts who naively think otherwise.)
The Federal Reserve was active from the beginning
The inability of fiscal policy to end recessions in the United States leaves it, for better or worse, dependent on the monetary policies pursued by the Federal Reserve. Brave political speeches and unworldly and insufficiently trained economists to the contrary, there is no viable alternative.
The Federal Reserve System is the United States' central bank. It has the statutory duty to maintain full employment and the power to achieve it. The majority of the Fed's decision makers, its Governors, are appointed by the President and confirmed by the Senate.
The Federal Reserve immediately responded to the mortgage crisis and resulting recession: It lowered the overnight rate of interest banks pay for reserves in the incredibly naive belief the banks would increase their loans to businesses and consumers with money they have to repay 24 hours later.
The Fed also engaged in "quantitative easing." In late 2008 the Fed's Open Market Committee (FOMC) went to the bond market and bought $600b of bonds and other assets with newly created money (QE1). It continued thereafter buying and by early 2010 had purchased an additional $800b. But there was no recovery. So in November of 2010 the Fed again began additional new money and used it to begin buying another $600b (QE2).
Buying government bonds in the open market is the traditional way the Fed increases the amount of money banks have available to loan to their clients. Banks and other financial intermediaries buy the bonds because they are safe interest-earning investments which are easily sold.
When the Fed buys bonds the sellers inevitably deposit the money in their local banks. Thus, the banks have more loanable funds and, being the profit seekers they are, tend to loan the additional money out to earn interest.
Traditionally the borrowers then spend the borrowed money - so business expands, profits are increased, and more workers are hired. This is the way US recessions are usually ended by the Federal Reserve.
The situation was initially so dire the Fed also did something rare - it created a relatively small amount of new money and loaned it directly to banks as is done in the UK. This let the banks obtain money to cover depositor withdrawals and loan renewals without having to sell assets and book taxable profits.
The Fed and FDIC simultaneously hammered a "stress test" nail into the dying economy's coffin
The Federal Reserve appeared to respond decisively to the recession with QE1, QE2, and direct loans to increase the banks' liquidity so they could renew expiring working capital lines and resume consumer lending.
But at the same time the FDIC and the Fed began conducting "stress tests" and using them to justify raising the capital and lending requirements of all banks - thus requiring the banks to hold as reserves the QE1 and QE2 money they would have normally loaned to consumers and businesses. In other words, because of the offsetting stress tests the Fed has not yet acted in a meaningful way to increase the banks' supply of loanable funds.
The higher stress tests for all banks combined with directing the special assistance only to those too-big-to-fail resulted in the smaller financial institutions being closed and their assets transferred to their bigger too-big-to-fail competitors - in effect, rewarding the too-big-to-fails for the recession they caused and giving them even more market share and profits.
Simultaneously, the Fed and FDIC bank examiners took steps to make even fewer consumers and businesses eligible for the few loans that the banks had money to fund.
As a result, during the first years of the current "Great Recession," and continuing to this day, loans and mortgages issued by commercial banks and other lenders are constantly being defaulted on by financially distressed families and businesses who cannot make the payments.
The resulting loan losses in combination with the banks' higher reserve requirements, of course, resulted in even more bank failures and a further inability of consumers and businesses to get normal loans and credit - further depressing the economy and resulting in even more unemployment, foreclosures, bankruptcies and bank failures.
Where are share prices and the economy today after years of mortgage fraud, useless fiscal policies, and Federal Reserve incompetency?
It's an economy where investors should not reasonably expect higher share prices in the near future. And things are worse than investors have been led to believe. In a word, the United States continues to be mired in a recession and there is nothing on the horizon to end it (see the January 6 Seeking Alpha article "Jobs Data Isn't As Cheery As They Would Have You Think")
The current responses are not adequate
The Bush/Obama White House and its appointees continue to generate costly and time consuming policies and regulations - all of which discourage lenders, employers, and business investments. (Bush and Obama are lumped together here because Obama kept the unqualified Bush appointees who got us into this mess - Bernanke, Geithner, and Bair at the FDIC)
And Congress is doing its part to keep the recession going - cutting spending to reduce the deficit even though less spending will mean less production and more job cuts and, thus, more foreclosures and business failures and even bigger deficits. (the US would have a budget surplus if its economy had full employment instead of today's unemployment - See the January 24th Seeking Alpha article "A Letter From Adam Smith To Investors")
And the governors of the Federal Reserve are doing their part to keep the recession going. They still naively act as if reducing the overnight interest rate and keeping it low will somehow cause banks to have more money to loan and that they will do so - even though the money they borrow has to be repaid within 24 hours and there are now fewer qualified borrowers due to all the bankruptcies, foreclosures, and business failures, to say nothing of the higher loan standards that the banks are now required to impose.
Recovery remains right around the corner. And will stay there
The currently depressed economy of the U.S. would quickly recover if it could get enough purchasing power into the hands of its people and businesses - so more people go to work as businesses increase their outputs and make more profits and their stock prices rise. Then tax collections rise and the deficits, which so wrongly worry Congress and rightly worry the states and local governments, would tend to disappear.
Since fiscal policy and monetary policies using overnight interest rate changes do not and cannot work in the United States, monetary policy based on quantitative easing is the only viable way for the United States to get enough additional purchasing to end the current Great Recession.
Today that means the Federal Reserve must create "enough" new money and actually get it into circulation - not too much additional money so as to cause inflation from excessive spending nor too little so as to cause unemployment from inadequate spending. Nothing will happen until it does.
Similarly, the US has gone too far in letting anything and everything stand in the way of increasing its tax bases. It would do well to revisit its excessive regulations and the their delay-intending appeals processes. At the very least the progress of employment-delaying lawsuits could be accelerated with regulatory courts at the appeals level and "loser pays the costs" rules.
Is a solution even possible so that the market rises?
So far the United States has proved once again that a modern economy based on profits, incentives, and wages cannot cut or regulate its way to prosperity. The only alternative is to keep the economy prosperous and let private investors grow its tax base - and that requires seeing enough revenues flow into its profit and nonprofit employers and they are not held back by useless regulations and regulatory delays.
A solution is possible. The Federal Reserve could quickly abandon its naive reliance on the overnight rate of interest and actually put spendable money into our economy - either indirectly via adding loanable funds to our banks, or, if things have so deteriorated so much that there are too few borrowers left, directly via funding high propensity to consume spenders such as social security recipients. In other words we need a program of "quantitative easing." It would be the first - because the Fed-approved "stress tests" prevented much of the QE1 and QE2 monies from being loanable.
Sooner or later the Fed will act. When it does investors will be greatly rewarded as profits and stock prices tend to increase faster than production increases as an economy comes out a recession. The stocks of companies that can rapidly ramp up production will be the biggest winners. That would be the time to buy a broad portfolio of stocks. That time is not now.
The current "Great Recession" will not be ended soon
The Federal Reserve, Congress, and the White House do not appear to be any closer to rescuing the economy than they were when the recession started. To the contrary, if the recent Federal Reserve governor nominees are any guide, the Fed will continue to have no trained macroeconomists with business or banking experience. Thus it is likely to continue focusing its efforts on changing the overnight rate of interest and helping the handful of too-big financial firms that got us into this mess in the first place.
In other words, investors need to be skeptical that the economy and the stocks associated with it will recover so long as the same old people at the Fed do the same old thing in the same old way over and over again.
So Today These Are The Best Investments
In the foreseeable future the economy will continue to stagnate and there will be no bull market. Until the Federal Reserve begins to act investors would be well-advised to stick with companies which might grow despite the recession such as Microsoft (MSFT) and Caterpiller (CAT) and the to-big-to-fail favored few: Goldman Sachs (GS), Deutsche Bank (DB), Bank of America (BAC), JPMorgan Chase (JPM) , CitiBank (C), Credit Suisse , and Morgan Stanley (BJI).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
