Where are we?
Well, here we are a couple months down the road from my last article on the subject and the big three automakers are in Washington because they’re running out of cash. The economic community is finally in agreement that we’re in a recession and have been for about a year. It must be nice to have a job where you’re well-respected if you can accurately tell the world what happened a year ago. The bail out is in process, if moving slowly. The banks to watch (for both ups and downs) are the ones who say they don’t need the bail-out money. More businesses are failing, the stock market is schizophrenic, the malls don’t seem as frantic as they normally do this time of year, unemployment is rising, and everyone feels that they stepped down a notch on Maslow’s Hierarchy of Needs.
What’s happening?
The global economic problem has grown and is continuing to do so. Financial institutions are receiving injections of liquidity from the Fed and they aren’t passing it through, they’re shoring up their own balance sheets (not an evil thing).
Keep in mind that in the middle of this people continue to buy cars, houses, businesses, and get new credit cards – the issue isn’t that nobody can get funded, but the banks have gotten more conservative in their lending (not a bad thing). Things have tightened up and it is more difficult to get financing for a big ticket item if it is perceived to in any way strain your finances.
When I first purchased my house I was scared, even if the ratios said that I could make the payment – it was new territory for me. In this economy with the same situation, I would have much greater difficulty passing muster with the banks.
It is of no help to the situation that the former head of the NASDAQ confessed to a Ponzi scheme that swindled $50 billion from investors. I am surprised that it didn’t have more of a negative effect, considering his former position. In my opinion, the heads of the stock exchanges and regulatory bodies must have a higher level of integrity than your average Joe-Trader or money manager. To have that level of swindle that high in the system brings the entire system into question. It would be like seeing Alan Greenspan at a rally for the Communist Party.
What is a recession?
In a nutshell, a recession is a decline in the gross domestic product (GDP) for two successive quarters. GDP is the total value of all goods and services produced within the country. That explanation is pretty dry, so let’s look at it like this: (1) people buy less stuff for a variety of reasons, (2) because people buy less, producers produce less, (3) this general trend continued for six months or more.
Recessions are a normal occurrence in our economy that have happened many, many times over the last 200 years or so. Our economy pulses and usually has a lot less to do with the person in the Oval Office than what the Fed Chairman had for breakfast.
I am hearing that the longest recorded recession is 16 months. That doesn’t seem too bad at all, considering that we’re about thirteen months into this one. But again, we won’t officially know we’re out of it until we’ve been out of it for a year.
What is a depression?
What constitutes a depression is less clear than the symptoms of a recession. In general, a depression is a recession that lasts a lot longer than normal.
Looking back, the Bureau of Labor Statistics says that the country’s worst unemployment in the last 60, or so, years was just after WWII in the 10% range. This makes sense with the war machine throttling back. By comparison, the unemployment rate in the Great Depression rose to almost 24% over a four year period, from 3.2% in 1929, and started to decline in 1934.
In comparison to the crash in 1929, the Dow peaked at about 380 and bottomed out at about 40, a drop of almost 90% over a three year period. From there it grew a bit, and stabilized, but it didn’t hit its pre-crash level for another twenty years. By comparison, the Dow has now peaked at about 14,280 and bottomed at about 7,392 one year after the peak – about a 48% drop (so far). The best illustration that I was able to find was that in a depression, average people begin selling personal effects to pay for necessities.
Where are we going?
What we’ve seen
· We’ve seen higher unemployment – current unemployment levels are more the norm of what we have seen over the last 50 years.
· American car makers hit the skids in the seventies and were able to rebound in the eighties.
· We’ve had banking and credit issues, most notably, the S&L crisis of almost 20 years ago.
· We have a credit crunch every time we have a recession, which happens once every 10-15 years.
· We’ve been through housing corrections about every 20 years or so – the last one in the early 90’s just before the housing explosion.
· Wall Street sees the cyclical correction of individual markets, as well as the broader market, most recently the bursting of the dot-com bubble and correction into about 2003.
· Wall Street has also had its’ share of corruption and fraud – Michael Milken comes to mind.
What’s different this time?
So… if all of these issues are nothing new, what’s the big deal? The big deal is that they are all happening at once. We have had crisis, scandals, market corrections, interest fluctuations, the whole enchilada. What we haven’t had is a massive convergence of issues.
Snowballs and dominoes
The beginnings were covered in “The Credit Crunch” article, so I won’t go too in-depth on the beginnings, only that the current, progressing situation began with the rabid real estate market combined with an easy-credit economy. As interest rates have risen as a deterrent to inflation, those variable rate mortgages got harder and harder to pay. As the rates went up, defaults on loans followed suit. As defaults went up, financial institutions became increasingly conservative tightening up the credit markets and several of them failing under the pressure.
With mortgage rates increasing along with the default rates, many homeowners, especially those defaulting, are under water on their mortgages. This chain of events causes home prices to begin dropping rapidly as banks and investors have to unload real estate at a loss.
The dollar began falling on the foreign exchange markets, making everything purchased overseas more expensive (read: oil). Combine this with speculation of the part of investors and you find gasoline nearing $5 per gallon. The tightening credit market and $5 gasoline conspire to torpedo the American auto makers who have been churning out SUV’s and 4X4’s like crazy. GM, Ford & Chrysler can’t move enough product and could run out of cash and find themselves in Chapter 11 in a matter of weeks or months.
Wall Street sees the bank failures, potential failure of the big three, companies of all sizes issuing warnings related to future earnings. The Dow Jones Industrial Average drops 48% in twelve months. An investment fund which is ran by a past President of the NASDAQ is continuing to report solid gains in the face of the down market. It turns out that the fund was a $50 billion Ponzi Scheme that hosed some of the worlds largest companies and non –profits.
Unemployment of 6.7% in the grand scheme of things, isn’t bad at all. It could top out at 10% without being accompanied by famine and pestilence.
Edge of the knife
I believe we are in a very precarious position. Congress wound up passing the $700 billion bail-out package for the financial institutions and has considered & rejected a bail-out for the auto industry.
Let me talk about my thoughts on the auto industry. I don’t believe that the American auto industry has been competitive for the last 35 years. If you strip out the government and fleet contracts, leaving Joe consumer as the deciding factor… The big three would be toast.
My first vehicle was a ’71 Ford F-150 it was a work horse that took me and my friends to school and to the races faithfully. That was my last American vehicle until an ’85 Escort that was a complete POS. If you ask people on the street what they should buy if they want a “best-buy” or an economical car, or a reliable car and nine out of ten will tell you to buy a Toyota or a Honda, with a few adding Nissan into the mix.
I am a free-market, liaise- faire capitalist and, as I said in the Credit Crunch article, failures should be allowed to happen – propping up the inefficient will only encourage sloth and incompetence (well, maybe I wasn’t that harsh). I believe that to be the case here – propping up the big three will only prolong the inevitable.
That said… We can not allow the American auto industry to fail and they must be bailed out.
The progression of events
If the American auto industry fails, unemployment will immediately jump 2% and over the following six months or so will increase by an additional 3% as the effects of the Chapter 11 proceedings trickle down the automotive food chain. Over the next six months, unemployment will increase an additional 5% as the effects spread into non-automotive industries like office supplies, shop supplies, chemicals, uniform companies, etc.. The problem grows to include service providers and professionals as there are fewer companies to buy the services and Joe Average can no longer afford them.
While all of this is going on, the airlines are back at the well in Washington because too few people are flying to be able to stay in business. What would this add to unemployment, 1% maybe extending to 3%?
As this grows, financial institutions see even higher defaults on mortgages with the problem including consumer debt this time around. More cuts at financial institutions and, because the tax base is evaporating, government can no longer pay its’ bills and has to issue IOU’s. That 6.7% unemployment rate is now over 20% with the U.S. taking the worst part of a global depression. The rest of the world is hit, but not as hard, as China and India step in and replace the consumers that the world economy lost in the U.S. Then we’re in deep kimchi.
How to keep this from happening
Let’s go back to what was said previously, the problem is not that the big three are failing, the problem is that everything is happening at once. How do you stop a row of dominoes from continuing to fall? You take a key domino out of the equation. How do you stop a snow ball from growing and becoming huge & deadly? You stop it from rolling before it gets too big to manage.
Revised progression of events
If Congress reconsiders the bail out (or the Fed gets away with using part of the financial bail-out), then we can put off the inevitable until the other dominoes have fallen and we can better absorb the impact.
The bail out extends Chrysler’s life until mid-2010 at which time it enters Chapter 11 and is eventually purchased by Hyundai.
GM and Ford experience mixed results at reengineering their companies and merge in May of 2012, which is approved by Federal regulators because they are not the only two American car companies any more – the vast majority of Toyota’s, Nissan’s and Honda’s are made in this country. The company shoots out of the gate with much fan fare, but like Sears & K-Mart, they find reality harder to deal with than theory and they are acquired by Tata in 2014.
Bitter pills
I don’t like it. It reeks of socialism. But there is no other way to preserve the economy and allow it to heal.
– John Leonard