Thursday, December 4, 2008

Second Great Depression Not Off The Table

I like Jim Cramer of CNBC's Mad Money and think he is both witty and smart. I have also found that he is objective, hard-hitting, and a truth teller -- until this week. It seems that Cramer wants to be considered for the position of the new SEC Chairman, and with it, he has adopted the very optimism of the politicians he seeks to thrash for their non-awareness of the problems. This week Cramer declares, the great depression 2 is off the table -- “Enough with the hysteria,” Cramer said during Tuesday’s Mad Money, we’re not going to suffer another Great Depression." http://www.cnbc.com/id/28017109


oh really.......... awareness of the problem is the root of solving it. If people think that we are not going to go through the pain, they will hold out thinking falsely that somehow this time is different; it is not. With collective voice, nearly all acknowledge that the global economy is contracting rapidly with many developed nations now in declared recessions, and even more developing nations at great risk from economic dependence in terms of trade with developed nations. During this downturn we have observed the speed and depth of the downturn surpass prior barriers -- the post 9/11 downturn, the 1991 recession, the 1987 stock market crash, the 1974 deep recession. Each time the bar was lowered as the market continued to retract faster and more severely than past experience.

The only remaining comparable to our current market is the Great Depression of the 1930s, sparked by the dramatic collapse of the stock markets in the fall of 1929. Those were extraordinary times that nobody seeks to repeat. Optimists for subscribing to the theory that this time will not be as bad as the Great Depression point out that we have learned from the Great Depression and have pulled out all the stops to create a soft landing for the economy, and hopefully, wishfully, prayfully to declare that the Great Depression Two is off the table for the following reasons.

More response monetary policy and interconnected or correlated international banker actions including massive coordinated interest rate cuts to spur investment and liquidity.
US Federal Reserve policies to provide needed liquidity to markets through multiple tools introduced since the 1930s with advantage of lessons learned.
  1. US Federal government responses like the US TARP provide liquidity and capital to financial markets.
  2. FDIC insurance safeguards individual depositor accounts in banks up to $250k preventing runs on banks.
  3. Federal and state unemployment insurance for employees losing jobs preserving a modicum of income for households for the first few months of unemployment while workers find new work opportunities.
  4. Many other New Deal policy actions of the federal government.

Some also comment that since we are not now at Depression levels that somehow are times are irrelevant. Take for instance this post commenting on the parallels of the Great Depression to today, and how times are somehow different now.
“By the afternoon of March 3, scarcely a bank in the country was open to do business,” FDR said in his March 12, 1933, fireside chat (now available on a very cool podcast at the Federal Deposit Insurance Corp.’s Web site). In 1933, some 4,000 commercial banks failed, causing depositors to take huge losses. (There was no FDIC back then.) The recession that started in August 1929 lasted for a grinding 43 months, during which unemployment soared to 25 percent and national income was cut in half. By contrast, through mid-November 2008, only 19 banks had failed. The Federal Reserve last week said it expects unemployment to top out at 7.6 percent in 2009. Economists surveyed by the Philadelphia Federal Reserve Bank believe the recession, which started in April 2008, will be over by next summer. (Of course, back in January the same guys forecast that the economy would grow nicely in 2008 and 2009.) But don’t take it from me. Take it from this year’s Nobel laureate in economics. “The world economy is not in depression,” Paul Krugman writes in his just-reissued book The Return of Depression Economics. “It probably won’t fall into depression, despite the magnitude of the current crisis (although I wish I was completely sure about that).” This quote and more on this line of thought can be found at http://www.outsidethebeltway.com/archives/not_the_great_depression/

Balderdash. From a factual frame of view, no economic downturn in the past 100 years has occurred more sharply or deeply as our current condition. Perhaps it is our electronic broadcasting, rapid news transfers, or speed of transactions and movement of capital, or perhaps or recollection of history that has caused this downturn to hit with more speed than any other of recorded history in the past century. The scary facts are this -- the stock market collapse, an indicator of market sentiment and store of value, has now reached (touched) market levels not seen since the 1929 stock market crash. While it took more time for the market to reach it current levels than in 1929, there are many conditions that exist that portend extremely stormy weather ahead. Here are some trends that bespeak more negative news in the future.

First, despite political leadership commenting otherwise throughout last year that the fundamentals of the economy were sound -- they clearly were not. We are now confirmed as being one-year into the Recession that started December 2007, as reported by the National Bureau of Economic Research, as reported 12/01/08; http://www.washingtonpost.com/wp-dyn/content/article/2008/12/01/AR2008120102771.html You simply cannot listen believably to political leaders that in the face of negative facts hope to prop up the markets with their unbridled optimism when the facts speak otherwise. Political leaders are cheerleaders and hope to not yell 'fire' in the theatre causing greater mayhem, so while we need political leaders to conduct actions for the benefit of the general public, to rely on their boldfaced statements is to put your head in the sand.

Second, housing prices continue to slide downwards impacting individual wealth and prosperity and wealth-making options in the US. Massive unemployment and layoffs announced during the past 90 days, if continued, may cause a would-be housing bottom in spring 2009 to fail, and we could be headed further down if more home loan defaults occur. Home equity is one of the primary vehicles used by entrepreneurs, small business owners, and new business start-ups to provide cash for their businesses whether the homes are used as collateral for business loans, or more simply as credit lines in the form of Home Equity Loans. When housing prices are expected to continue falling, the amount of capital that banks are willing to lend on an asset-backed basis severely contracts.

As a small business owner since 1994, I too have used the equity in my home(s) as a backstop for my business enterprises both as collateral for loans and performance bonds, as well as home equity loans. The appreciation in real estate values in the 1990s and early 2000s enabled me to provide capital to my company relatively easily and quickly. And when business cycles impacted my business, such as the NASDAQ market crash in 2000 or post 9/11 terrorism events, I was able to use my home equity to create a soft landing and recovery means for my business to conduct a business-cycle recovery that would not otherwise been available to me or my employees.

Third, massive unemployment announcements continue to weigh down on the overall market, suppressing consumer views of the economy and market, and reducing expectations. There has been much written on this topic elsewhere. The important thing here is that unemployment impacts other variables, and lack of income creates crime opportunity for those that would otherwise be law abiding. "The national unemployment rate rose last month at the fastest pace in 26 years, foreshadowing what economists fear could be the biggest increase in joblessness since the recession of the 1970s. There are now more than 10 million Americans out of work, nearly 3 million more than a year ago, with manufacturing, construction, and retail sectors particularly hard-hit."
http://www.boston.com/news/local/massachusetts/articles/2008/11/08/unemployment_rate_in_us_surging/
The unemployment levels of the mid 1930s at massive levels occured some four years after the 1929 stock market crash. The banks that collapsed at their peak in the mid-1930s collapsed within four years of the crash. While the recession started December 2007, the market crash actually is pin-pointed to the collapse of Lehman Brothers on 9/15/08. It is too, too early to say that today's unemployment and massive layoffs will not lead to further deterioration. Just look at what happens in Detroit with the massive restructurings, whether through bankruptcy or not, will grossly impact the current unemployment rolls, along with the associated microcosim of markets of suppliers, servicers, etc.

Fourth, another shoe to drop in this centipede market is the credit card bubble and contraction of consumer credit, just at a time when many employees are losing their jobs. Credit cards have been viewed falsely by individuals as a store of value, safety, or safe haven for consumers to smooth the periods between financings. I have openly chastised financial planners such as CNBC's On the Money analyst for encouraging individuals to pay-off all of their credit card debt with available cash, when she fails to tell these same individuals that once they pay-off their credit cards, that the credit card companies can unilaterally cut their credit availability and they would end up with no credit and no cash -- the worst of the situations in an economic downturn. On an individual basis, the only prudent move is to hold as much cash and credit available to make it through the rough patches ahead -- if you spend all your cash, you are prone to paying higher prices as you have fewer options ahead.

On this note, the Motley Fool cited, "Meredith Whitney -- bank analyst extraordinaire -- predicts that the credit card industry may slash more than $2 trillion of existing credit lines -- 45% of the total -- over the next year and a half. Yikes! The obvious outcome here would be a huge risk reduction for companies that issue consumer credit, such as JPMorgan Chase (NYSE: JPM), Bank of America (NYSE: BAC), and Citigroup (NYSE: C), while kicking an already-bloodied consumer -- and to a lesser extent, card processors Visa (NYSE: V) and MasterCard (NYSE: MA) -- while they're down." Read more on this at: http://www.fool.com/investing/dividends-income/2008/12/01/the-death-of-credit-cards.aspx

Fifth, residential and commercial lending crises in regional banks to be a future shoe to drop. Regional banks have financed home loans and loans for small businesses and construction loans throughout the US. Reuters reports that "Regional banks exposed to deteriorating home equity loans are facing a greater risk of bankruptcy, possibly extending a U.S. credit crisis to 2010, a senior Morgan Stanley credit analyst said on Monday. Wall Street bank exposure to sub prime mortgage debt and structured finance products already has resulted in more than $400 billion of write-downs and losses since last year. Now other consumer debt, such as credit cards and auto loans, may be the next source of busted loans. See http://www.reuters.com/article/InvestmentOutlookMid08/idUSN0964320080609

Sixth, commercial real estate bubble to burst in coming year. Massive unemployment of white collar positions in banking, advertising, and other traditional salaried positions will be leaving massive amounts of commercial real estate empty. Of the trillion notes to be refinanced in 2009, over 1/3 are underwater, meaning they cannot be refinanced. One blogger posts, "Fitch has been saying since last April that commercial real estate was exhibiting the same sort of frothiness as subprime. CMBS spreads started widening sharply last August. Investors started pulling back from purchases in September, expecting prices to fall considerably. In November, Nouriel Roubini added commercial real estate to his list of impending financial train wrecks, estimating the damage at $100 to $150 billion." http://www.nakedcapitalism.com/2008/03/surprise-commercial-real-estate-woes.html

Seventh, government receipts from tax collections are impacted significantly and will be another source of economic harm in the economy. California has warned of danger of running out of operating capital in 2009 without significant financial assistance; they are not alone. "Led by California with a $28 billion hole in its budget, 41 states are in financial trouble, and many of their leaders are looking to Congress to bail them out." http://www.idahostatesman.com/1425/story/571171.html Not only are the states in trouble, but many cities are in financial trouble and looking for ways to cut services and costs at a time of peaked needs. It is not just the tax revenues that are down, but also the state and local governments ability to borrow as many tax-based finance bond auctions have gone under-subscribed since 9/15/08.

I could go on, but you get the idea. The confluence of the above negative events if left unabated will create an economic death spiral for the economy that will lead to the second great depression and the concomitant other ills such an economy brings. Our leaders are using the playbook of lessons learned from the great depression, and that book of experience has its limits. Communication is faster, transportation quicker, capital moves electronically, news reaches a boiling point swifter, and the world is more interconnected. Criminals are more sophisticated and using complex instruments and technology to dodge responsibility and capture. Add to this milieu the fact that we live in a troubled world of anarchists, terrorists, pirates, and extremists, and you have a cocktail of misery for the next year and several years.

Consequently, not talking about the second great depression will not forestall it. We do however need to focus attention on solutions as being a town-crier on its own does not solve the problem. However, recognition of our current dilemma and its gravity, is necessary to proactively combat the economic forces that weigh us down today. Only the collective genius of all working to make active change to our current circumstance will make a difference.

Unfortunately, a hard landing is in the offing, and if you live in the pockets of misery such as Detroit, what was bad, is about to get unbearable; http://www.youtube.com/watch?v=ufexZnViDiU It was sad to see recently in a local Detroit newspaper print 137 pages of tax foreclosure notices, and only 4 pages of employment opportunities -- and the massive layoffs from the automotive industry have not occurred in any meaningful way yet. Many of the tax foreclosure notices were on properties that are underwater or homes that cannot sell in this market. This story also illustrates the loss of working capital of state and local governments that need funds to operate.

At this holiday season of gift giving, let us pray that US law makers move, not for the industry, but for the broad market and the families of the automakers and allied industries to create a softer landing for the over 1.2 million workers vulnerable in the mid-west from a prolonged downturn in the US automotive industry.

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