Do I think we're headed into another Great Depression? No, that is impossible because the Great Depression was a time and place which is now past and can never return. Like every crisis we face, we measure our current prospects by the past. Iraq was not going to be another Vietnam for a thousand reasons. Amazingly, Iraq has turned out to be Vietnam for a thousand reasons no one could have guessed at the outset. This growing global economic crisis will not be a repeat of the Great Depression for a thousand different reasons. However, it looks to be a searing experience for many which will alter the rules to a degree and extent we simply cannot imagine right now.
I remember a conversation I had as a very young man with my grandfather, an old school capitalist who survived the Great Depression and considered "FDR" a curse. When asked about the 1929 crash, he said the Crash was not a huge event in itself. He said the news came slowly and the market rebounded so quickly that it seemed like a blip at the time. He said there was no single memorable precipitating event, rather it was the relentless stream of discouraging news and results -- month after month, quarter after quarter, year after year, that characterized the Depression. He said it just ground down optimism over a long period of time, squeezing confidence out of the markets and the entire system.
I recall this as I look at the markets and wonder what the next 2-3 quarters of earnings will present, how world recession plays out and a world of opaque balance sheets deleverage from among the banking and non-bank sectors. The Fed/Treasury have succeeded in putting a stop to runs on banks and the first panic, but there's plenty to suggest we're in for a remarkable, extended stream of bad news which won't be as susceptible to federal credit extensions.
It seems to me the Lehman shock, as those repercussions spread through the global financial markets, pushed the federal government into a situation akin to what the Japanese government has struggled with since their collapse in the late 1980's. If there are entities which are too big to fail, they can become the "credit zombies" -- effectively insolvent but too costly to unwind -- that still haunt Japan. At the time, it seemed obvious that the Japanese government didn't have the political will to let these giants fail. Robust capitalists in the West smugly discounted the Japanese lack of courage. Events of the past few months make pretty clear that -- when contemplating the consequences face-to-face -- we are similarly lacking.
I find it hard to believe we're facing anything less than a multi-year squeeze. All the talk of attractive share prices based on historical P/E's is just a snapshot out the window of a fast moving car. The earnings denominator is beginning a rapid, sustained decline and, until there's greater stability in overall economic activity, the price numerator is a lagging indicator I view as pure gambling to chase.
Where does it end? Conventional wisdom says the Second World War ended the Great Depression. It might as easily be said the Great Depression ripened the world for that awful war. I'm not saying we face a global depression or that a global war will follow. I'm simply saying we delude ourselves to somehow imagine we know better now. We delude ourselves to think the federal government -- and national governments throughout the world -- didn't do their utmost, with the best intentions and grasp of circumstances they had, to combat the economic collapse of the 1930's. We delude ourselves when we assume we're somehow smarter, more evolved, or wiser than that earlier generation. The proof is everywhere around us. Together, we all drank the kool-aid and accepted unprecedented good times as normal. Together, just as every generation before us, we'll find the challenges we face these next few years are, to some extent, beyond our comprehension because they, too, are unprecedented.
Monday, October 27, 2008
Sunday, October 26, 2008
Stormy Weather
Quite a storm last night. There's a metaphor here, but I may not find it before the end of this post.
I've heard from a number of neighbors since my last post, mostly kind and encouraging words about the blog itself, but also a number of one-on-one questions seeking advice about the economy. When I point out that I'm not a professional investment advisor, the response tends to be "that's why I'm asking." I've noticed an overall shift in the business media as well -- moving past the vilification of Wall Street and towards a more wary sense of skepticism towards all the punditry - - CEO's and Treasury officials included. I think that's progress, but am still troubled by h0w little thoughtful news coverage and debate addresses the fundamental engine to the current swoon.
I know that I don't know how bad things may get or how those bad things will present themselves. I'm pretty sure no one else knows either. I do think there are a few hints to suggest we're in for tougher times internationally, nationally, and locally, than we can hope to identify at this juncture.
We are experiencing the natural rejoinder to an extraordinary, once in a lifetime, economic boom. The sustained strength of economic activity and the unprecedented wealth creation throughout an increasingly globalized economy -- despite serious shocks in the late 1990's and 2001 -- slowly edged us all further and further along the risk aversion continuum to levels of borrowing and speculation which would have seemed utterly reckless just a few years ago. The boom changed the rules simply because it continued for so long.
I think it's important to recognize the communal delusion beneath it all because that delusion hasn't lifted, it's simply shifted. There were plenty of people saying things were out of whack as early as the late 1990's. I know because I was convinced the stock market had become idiotic back in 1998 and I read every Cassandra I could find to reaffirm my fear. But between 1998 and the stock swoon in the months prior to 9/11, I lost faith in my own doubts as day after day, quarter after quarter, the markets boomed. The relentless good news made caution seem foolish and, while I felt temporarily vindicated by the internet bubble bursting, the markets recovered in a matter of months and roared forward for another seven years.
I think it's very likely we face the same dynamic with the bust.
The Treasury Department can only go to the well so many times to dollop liquidity on the credit markets. The stream of CEO's and pundits speaking reassuringly about the long-term prospects for the economy will dwindle. As with the relentless nature of the boom, the sustained negative trends will progressively sap the residual optimism among business people and households. What replaces that optimism should concern us all.
We have just passed through the first panic of this downturn. The Treasury Department and Federal Reserve -- aided by Congress -- acted admirably and forcefully to head off a complete collapse of international banking. Their interventions to prop up individual institutions, and increasingly all the major national banks, have not saved these institutions, they've simply headed off panicked runs as they've arisen.
The ad hoc, reactive nature of the federal government's efforts are best seen in the amazing morphing "bail-out" package approved by Congress. First presented as an effort to take a bullet for the banks by assuming their "toxic liabilities," the bailout soon became a direct infusion of capital into the largest federal banks, and most recently, a combined carrot and stick the federal government is using to compel consolidation, feeding weaker banks to their stronger brethren.
The federal government is doing everything it can to prevent a complete collapse of the financial markets. The feds have gone far beyond what anyone imagined it could manage, legally or politically, just twelve months ago. Consistent with the boom, this bust is also changing the rules, with each successive stagger downwards justifying greater desperation and fundamentally altering our assumptions of what is possible.
The bottom line should be clear: The Fed is buying time, keeping credit markets on life support until the critical stage of the disease passes. I'm sorry to say I find it difficult to believe they can succeed. Oh, the patient will survive, but the cost will be astounding. The price we may all pay can only be counted nominally in dollars. The real price, as in the Great Depression, will likely be the toll on our sense of well-being wrought by a relentless constriction of possibilities and opportunities over these next few years.
Pretty dire stuff.
Right now, the federal government -- and national governments throughout the world -- are working daily to keep capital markets from closing up. Those capital markets only bring the economic horse to water, they can't make it drink.
The fate of our economy will be decided by the aggregate of millions of individual circumstances. A very large number of households and businesses borrowed more than their underlying assets and/or economic prospects warranted. Some indeterminate number of households and businesses are just this side of bankruptcy or foreclosure, counting on a positive turn in the economy to stave off personal disaster. But the vicious cycle is picking up steam. Every layoff announcement pushes a few more households over the brink, reduces overall consumer spending and business income, pushing more businesses to the edge. With every bankruptcy/foreclosure, lenders are forced to recognize the true scale of their losses on that loan. As optimism wanes, the potential cost balloons, the true extent of those losses can only be verified by actual bankruptcies and foreclosures. No one knows the ultimate cost because the cycle self-perpetuates for some period. The credit risk of borrowers changes as the individual circumstances of those borrowers changes. No one knows where the cycle will end.
In other words, the focus of federal efforts and most analysis of our prospects remains on credit availability. We are facing a credit crisis and, to my limited grasp, it appears to me they're doing their best. But the credit crisis is a symptom and consequence of the underlying equity crisis -- too much debt in too may hands with worsening prospects for repayment. That equity crisis can only be resolved by reducing the amount of outstanding debt to a level where it's sensible to lend and borrow once more. Traditionally, that occurs through foreclosures (net loss to home owner and lender); bankruptcies (net loss to lender and borrower); and refinancing (net loss to lender). The potential scale of losses makes the lender's job very tough.
If we were only worried about a credit crisis, it seems plausible governmental intervention could tide us over until lenders regained confidence. Facing an equity crisis we face a conundrum. Every step towards resolving that crisis - - clearing bad debt - - perversely puts more debt in question -- exacerbating the credit squeeze. We face a similar conundrum as a society and economy: The crisis deepens as optimism wanes. Optimism wanes as the crisis deepens.
I do not understand how this equity crisis can be resolved in months or even over the next year or two. The longer it lasts, the worse it will get; the more optimism ebbs away. Oddly, our collective delusion -- our tendency to maintain optimism despite the evidence, works in our favor here. However, at some point the litany of bad news can exhaust that optimism and the delusion swings too far to the other side. At that point, a vicious cycle undermines economic and political stability and gives way to demagoguery and literal bloodletting.
Perhaps our more highly developed and efficient capital markets will allow us to clear bad debt more quickly than during the boom/bust cycles of some prior generations. Or perhaps our more highly developed and efficient capital markets allowed us to gorge on debt to an extent only a ferocious emetic can clear.
It's sunny outside.
I've heard from a number of neighbors since my last post, mostly kind and encouraging words about the blog itself, but also a number of one-on-one questions seeking advice about the economy. When I point out that I'm not a professional investment advisor, the response tends to be "that's why I'm asking." I've noticed an overall shift in the business media as well -- moving past the vilification of Wall Street and towards a more wary sense of skepticism towards all the punditry - - CEO's and Treasury officials included. I think that's progress, but am still troubled by h0w little thoughtful news coverage and debate addresses the fundamental engine to the current swoon.
I know that I don't know how bad things may get or how those bad things will present themselves. I'm pretty sure no one else knows either. I do think there are a few hints to suggest we're in for tougher times internationally, nationally, and locally, than we can hope to identify at this juncture.
We are experiencing the natural rejoinder to an extraordinary, once in a lifetime, economic boom. The sustained strength of economic activity and the unprecedented wealth creation throughout an increasingly globalized economy -- despite serious shocks in the late 1990's and 2001 -- slowly edged us all further and further along the risk aversion continuum to levels of borrowing and speculation which would have seemed utterly reckless just a few years ago. The boom changed the rules simply because it continued for so long.
I think it's important to recognize the communal delusion beneath it all because that delusion hasn't lifted, it's simply shifted. There were plenty of people saying things were out of whack as early as the late 1990's. I know because I was convinced the stock market had become idiotic back in 1998 and I read every Cassandra I could find to reaffirm my fear. But between 1998 and the stock swoon in the months prior to 9/11, I lost faith in my own doubts as day after day, quarter after quarter, the markets boomed. The relentless good news made caution seem foolish and, while I felt temporarily vindicated by the internet bubble bursting, the markets recovered in a matter of months and roared forward for another seven years.
I think it's very likely we face the same dynamic with the bust.
The Treasury Department can only go to the well so many times to dollop liquidity on the credit markets. The stream of CEO's and pundits speaking reassuringly about the long-term prospects for the economy will dwindle. As with the relentless nature of the boom, the sustained negative trends will progressively sap the residual optimism among business people and households. What replaces that optimism should concern us all.
We have just passed through the first panic of this downturn. The Treasury Department and Federal Reserve -- aided by Congress -- acted admirably and forcefully to head off a complete collapse of international banking. Their interventions to prop up individual institutions, and increasingly all the major national banks, have not saved these institutions, they've simply headed off panicked runs as they've arisen.
The ad hoc, reactive nature of the federal government's efforts are best seen in the amazing morphing "bail-out" package approved by Congress. First presented as an effort to take a bullet for the banks by assuming their "toxic liabilities," the bailout soon became a direct infusion of capital into the largest federal banks, and most recently, a combined carrot and stick the federal government is using to compel consolidation, feeding weaker banks to their stronger brethren.
The federal government is doing everything it can to prevent a complete collapse of the financial markets. The feds have gone far beyond what anyone imagined it could manage, legally or politically, just twelve months ago. Consistent with the boom, this bust is also changing the rules, with each successive stagger downwards justifying greater desperation and fundamentally altering our assumptions of what is possible.
The bottom line should be clear: The Fed is buying time, keeping credit markets on life support until the critical stage of the disease passes. I'm sorry to say I find it difficult to believe they can succeed. Oh, the patient will survive, but the cost will be astounding. The price we may all pay can only be counted nominally in dollars. The real price, as in the Great Depression, will likely be the toll on our sense of well-being wrought by a relentless constriction of possibilities and opportunities over these next few years.
Pretty dire stuff.
Right now, the federal government -- and national governments throughout the world -- are working daily to keep capital markets from closing up. Those capital markets only bring the economic horse to water, they can't make it drink.
The fate of our economy will be decided by the aggregate of millions of individual circumstances. A very large number of households and businesses borrowed more than their underlying assets and/or economic prospects warranted. Some indeterminate number of households and businesses are just this side of bankruptcy or foreclosure, counting on a positive turn in the economy to stave off personal disaster. But the vicious cycle is picking up steam. Every layoff announcement pushes a few more households over the brink, reduces overall consumer spending and business income, pushing more businesses to the edge. With every bankruptcy/foreclosure, lenders are forced to recognize the true scale of their losses on that loan. As optimism wanes, the potential cost balloons, the true extent of those losses can only be verified by actual bankruptcies and foreclosures. No one knows the ultimate cost because the cycle self-perpetuates for some period. The credit risk of borrowers changes as the individual circumstances of those borrowers changes. No one knows where the cycle will end.
In other words, the focus of federal efforts and most analysis of our prospects remains on credit availability. We are facing a credit crisis and, to my limited grasp, it appears to me they're doing their best. But the credit crisis is a symptom and consequence of the underlying equity crisis -- too much debt in too may hands with worsening prospects for repayment. That equity crisis can only be resolved by reducing the amount of outstanding debt to a level where it's sensible to lend and borrow once more. Traditionally, that occurs through foreclosures (net loss to home owner and lender); bankruptcies (net loss to lender and borrower); and refinancing (net loss to lender). The potential scale of losses makes the lender's job very tough.
If we were only worried about a credit crisis, it seems plausible governmental intervention could tide us over until lenders regained confidence. Facing an equity crisis we face a conundrum. Every step towards resolving that crisis - - clearing bad debt - - perversely puts more debt in question -- exacerbating the credit squeeze. We face a similar conundrum as a society and economy: The crisis deepens as optimism wanes. Optimism wanes as the crisis deepens.
I do not understand how this equity crisis can be resolved in months or even over the next year or two. The longer it lasts, the worse it will get; the more optimism ebbs away. Oddly, our collective delusion -- our tendency to maintain optimism despite the evidence, works in our favor here. However, at some point the litany of bad news can exhaust that optimism and the delusion swings too far to the other side. At that point, a vicious cycle undermines economic and political stability and gives way to demagoguery and literal bloodletting.
Perhaps our more highly developed and efficient capital markets will allow us to clear bad debt more quickly than during the boom/bust cycles of some prior generations. Or perhaps our more highly developed and efficient capital markets allowed us to gorge on debt to an extent only a ferocious emetic can clear.
It's sunny outside.
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