Is this Stock Market Recession Worse Than Expected?

by | Mar 25, 2008 | Asset Management

There was an article distributed nationwide, written by the Associated Press, and carried locally in the Asbury Park Press on March 22, 2008.

I’ve re-printed the article here, but dropped in my own comments after each paragraph. The main point to take away from this exercise is that by the time news reaches Main Street, Wall Street has already seen it, digested it, and moved on.

Take a look:

March 22, 2008

Recession may be worse than expected

Bear Stearns collapse shakes market


It’s been almost an article of faith: Any recession this year will be mild and brief.

TPM: It is human nature; no one likes to be the bearer of bad news

But now the stunning meltdown of a top Wall Street investment bank and stubbornly persistent financial market turbulence has called that into question, raising fears that severe problems in housing and the nation’s bedrock financial system could cripple the economy and wallop many millions of Americans.

TPM: we have been recommending avoiding the entire financial sector since the first quarter of 2007. It still remains a highly toxic and risky area. Stay away.

No less an authority than former Federal Reserve Chairman Alan Greenspan wrote this week that “the current financial crisis in the U.S. is likely to be judged as the most wrenching” since the end of World War II.

TPM: who put us in this position? Greenspan pumped more money into our financial system than all the previous Fed Chairmen combined.

Other noted economists are also sounding alarms. Harvard professor Martin Feldstein, the former head of the National Bureau of Economic Research, said recently he believes the country is now in a recession and it could be a severe one.

While it will be many months before the bureau’s cycle dating committee, the unofficial arbiter of when recessions begin and end, makes its own ruling, a growing number of private economists already have a downturn figured into their forecasts. They are generally calling for a mild recession that will end this summer when the economic stimulus checks going to 130 million households start getting spent.

TPM: The average recession lasts 11 months. But we do not*officially* have a recession until we have two quarters (six months) of negative economic growth. So the government can’t tell you the economy is in a recession, until we are usually half way through it, in most cases.

Additionally, I don’t need the government to tell me when things are slowing down. I talk to my clients every day, many of them business owners and executives and they started telling me last summer how slow things had become. That’s the best indicator anyone can have: the man or woman on the street.

It will be a coincidence that your stimulus check will arrive at the same point in time when the recession might be ending. Since that will be 11 or 12 months from the point things began slowing down.

But it makes for a nice newspaper story, doesn’t it?

But the severe credit crisis that erupted last August and claimed its biggest victim this past weekend with the forced sale of Bear Stearns Co. is raising doubts about those mild forecasts.

TPM: this is a public service announcement, and serves as a reminder: newspapers and financial TV channels have been created to sell advertising. Please remember that when you read inflammatory comments like what you just saw above.

“Bear Stearns was a clear wake-up call. It resonates with everybody and highlights the severity of the stresses in the financial system,” said Mark Zandi, chief economist at Moody’s

TPM: it was Moody’s and Standard & Poor’s (the rating agencies) that were constantly reaffirming positive ratings on all of these bonds and subprime loans over the past year. That allowed banks and brokerage firms like Goldman Sachs and Bear Stearns to continually borrow against the inflated value of these bonds.

What got people’s attention was how quickly Bear Stearns, the nation’s fifth-largest investment bank, could go from a stock market value of about $3.5 billion when the market closed on March 14 to being sold at the bargain-basement price of about $236 million two days later.

TPM: these brokerage firms and banks have been playing musical chairs on the Titanic. Unfortunately for Bear Stearns, the music stopped and they were left without a seat. This could have very well happened to Goldman Sachs, Lehman Brothers, and Morgan Stanley or any other bank instead.

Despite what Moody’s, Standard & Poor’s or any other rating agency would say about the value of the toxic bonds these firms held, the real value is what you can sell the bonds for, right? Incidentally, Moody’s and S&P downgraded Bear Stearns on Friday, March 14.

The Federal Reserve rushed in to take unprecedented actions. It provided a $30 billion line of credit to facilitate the sale and is employing Depression-era provisions that for the first time are providing direct Fed loans to investment banks. Most analysts said the Fed was justified and that its efforts highlighted the severity of the dangers facing the financial system.

TPM: I would debate the use of the term *rushed in.* Much of the turmoil could have been prevented if they paid attention to indicators.

The turmoil produced wild swings on Wall Street this week.

TPM: perhaps that was the reason. But consider this as well: there were only four trading days this week; we had a Federal Reserve meeting where interest rates were cut, every brokerage firm reported earnings this week, and we also had triple witching option expiration on Thursday.The Dow Jones industrial average surged Tuesday after the Fed aggressively cut a key interest rate, only to plunge Wednesday on renewed worries about the economy, and then stage a 262-point gain Thursday. Markets were closed Friday.

More turbulence is expected in coming weeks because there remains a great deal of uncertainty about how many more victims the credit crisis will claim.

TPM: Anyone can speculate on why markets are volatile. The fact remains; we have been telling our clients that the market is trying to put in a bottom right now. Stock market *bottoms* can be a lengthy process, and usually not a one day event.

The problems began last year with rising defaults on mortgages as a housing slump intensified, but they have now spread to other parts of the credit markets with institutions growing fearful about making other types of loans.

TPM: The problems did not begin last year. Exotic mortgage products have exploded in the last four years. In the past year, many of these exotic mortgages began their reset phase. If interest rates had remained low, a good portion of these problems would possibly never have happened.

The bigger issue, which rarely gets mentioned in articles like this, is that the growth in the US economy for the last 20 years has been driven less by increases in productivity of the US worker — and driven more by consumer spending.

These exotic mortgage products allowed us to keep more money available to buy toys. Most Americans save very little money (or save nothing). We are constantly bombarded with ads to *take that dream vacation* or *you deserve that 96 inch flat screen plasma TV!*

But, personally, it might be better if we are constantly bombarded with reminders to save money, exercise restraint, and that there is honor in having a rainy day fund. Most Americans are operating without a safety net.

The main ingredient of a recession is fear. It is fear that holds people back from buying PlayStation 3, or taking a dream vacation. In every single recession, people lose jobs. It doesn’t really matter if those jobs are in the financial sector (like at Bear Stearns), the healthcare sector, the manufacturing sector or any other part of the economy.

No one wants to lose a job because so many are operating without that safety net.

The concept of a recession is that the economy gives back some ground, moves backward, and recedes. Essentially, an economic recession is usually due to a recession of confidence. We become afraid. We are fearful of losing our job, and/or losing money.

It is the ability to get credit that makes the financial system and the economy it supports function. When banks stop lending to other institutions that, like Bear Stearns, depend on credit to conduct their day-to-day operations, the results can be catastrophic.

TPM: I get the impression reading that last paragraph that what happened at Bear Stearns was not entirely their fault. Bear Stearns, like Goldman Sachs, Lehman Brothers, Morgan Stanley, Citibank, and Merrill Lynch are run like hedge funds. What happened at Bear Stearns could have happened to any investment firm. In the game of musical chairs, Bear Stearns was left without a seat.

“We can’t afford to stagger from one day to the next without knowing what large financial institution might be the next to go down the tubes because of a lack of liquidity. That is way too dangerous a game,” said Lyle Gramley, a former Fed board member who is now an economist with the Stanford Financial Group. “It is possible that we could be entering the worst recession of the post-World War II period. The threat is certainly there.”

TPM: fear mongering! That’s how they sell newspapers!

Because of Bear Stearns, many analysts are raising the odds that a 2008 recession could be worse than expected.

TPM: The recession could be worse than expected — because of one company? Really?

“The potential freezing up of the financial system could have pretty negative ramifications on bank lending which would have negative ramifications on consumer and business spending,” said Nariman Behravesh, chief economist at Global Insight, a Lexington, Mass., forecasting firm. He said he had upped the chances of a worse-than-expected recession to 40 percent, from 25 percent odds before the Bear Stearns troubles.

TPM: just my opinion here, but isn’t every recession *the worst recession we’ve ever experienced* I think the potential freezing up of the financial system has just happened right before our eyes (culminating in Bear Stearns getting pulverized). It appears that — even though they are late — the Fed is doing everything conceivable to maintain order (and liquidity) in the markets.

David Wyss, chief economist at Standard & Poor’s in New York, said he now has a worst-case-scenario in which the country could endure a double-dip recession in which the economy would briefly recover this summer, helped by the $168 billion in tax relief, only to quickly slip back into a downturn. Under this scenario, the economy’s total output, as measured by the gross domestic product, would drop by 2.2 percentage points, making it the third-worst recession in the post-World War II period.

TPM: Funny S&P is now predicting a double-dip recession. Standard and Poor’s (and Moody’s) both re-affirmed their investment-grade ratings on Bear Stearns just days before it was essentially squeezed out of existence.

Something was clearly wrong at Bear Stearns and all these other investment banks — for the past year. And I don’t believe the trouble is over yet. That is as plain as the nose on your face, when you look at these charts.

My problem is getting clients to understand the risk they are taking when they get involved in some of these sectors that are completely falling apart.

Why is the stock market so volatile lately? Some of you may have heard the term *the stock market is a discounting mechanism.* What that really ought to mean to you is the stock market tends to look ahead -anywhere from 6 to 12 months ahead at what’s happening in the economy.

Keep in mind what was mentioned earlier: the average recession last 11 months. The stock market began reflecting a recessionary economy six months before the government could even say whether we were in a recession or not.

Now, the financial sector, which is the largest sector of the stock market, began falling apart nearly 12 months ago. The stock market as a whole –began sliding in late September/October last year.

Right now it appears the stock market is trying to put in a bottom. And stock market bottoms are really a process-they rarely go straight down and come straight back up. The market will go up then retest the bottom, then move up again, and then retest the bottom, over and over several times. And sometimes that bottom is merely the landing on the staircase-there could be more to come on the way down.

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