Saturday, November 22, 2008

DEPRESSION, ugly correction, seismic adjustment, or just a gut check recession

Over the last two months politicians, economists, the media and investors have gradually expanded the current lexicon of an economic downturn. The speculation evolved from "painful correction" to "recession" to "are we going to say the D word" to "depression" and finally in the last week to "Great Depression". So, let's speculate here, take off the rose colored glasses and look at that Great Depression and how it compares to today. Here are a few thoughts on "not like" or "like" the big one.

---This year's equity decline has been crushing and fast, but unlike the crash of 1929 it was not preceeded by a period of wild speculation with price/earnings ratios in the stratosphere and everyone and their crazy uncle claiming clairvoyance in the search for the next parabolic mover. We already did that in the year 2000. In 2007 average p/e ratios ranged from 16 to 17, not 25 or higher as during the tech mania. Perhaps with that experience under our belt, meaning successfully digested, we became somewhat complacent and underestimated what was happening. It was different, but events rarely repeat themselves predictably. not like or like, someone else decide

---We have not had a calamitous exogenous event that destroyed large parts of the economy as the drought and dustbowl did in 1930 and 1931. We couldn't handle one either, so deal with the car companies in some assertive way so we don't create a man-made calamity of equal proportions(just not part of TARP). not like... yet

---We have the FDIC deposit guarantees. We have safety nets like Social Security, Medicare, Medicaid and unemployment insurance. not like

---There is a majority bipartisan belief that some government intervention through regulation and relief is necessary. There is no widespread belief that protectionism, high tariffs, a balanced budget and higher taxes are the right solution as the Roosevelt Democrats and the Hoover Republicans both believed in 1932. not like

---Many members of Congress and the administrations have little understanding of the economic implications of their actions and are focused on narrow aspects of big problems. like

---There is a significant issue of unequal income and wealth distribution in the country. In 1929 33% of all annual personal income went to the top 5% of the population, almost twice what it had been 20 years earlier. In 2007 25% of all annual personal income went to the top 5% and 51% to the top 20%. From 1979 to 2005 total personal income growth was 175% for the top 1%, 70% for the top 20%, and on average less than 15% for the bottom 80%. In the 1920's the top 1% of the population had 44% of all wealth and in 2003(last data found) that 1% had 39%. like

---"The virtue of the investment trust was that it brought about an almost complete divorce of the volume of corporate securities outstanding from the corporate assets in existence." This quote from "The Great Crash" demonstrates Galbraith's wry use of the word virtue. It is also a mirror image of what happened in the credit default swap market. like

---"The investment trusts had invested heavily in each other." Galbraith again, and does this in any way remind us of the "funds of funds" concept in the private banking world's marketing of hedge funds. Does it even bring to mind those ETFs that are just aggregations of investments in other ETFs. More importantly is there a correlation to the fact that today's hedge funds tended to run in packs, investing heavily in the same securities. like

---Margin loans to individual equity investors in the late 1920's were allowed at up to 90% of funds invested. That same ratio was applied to raw Florida land at the time. Many residential mortgages made to the least qualified buyers in 2005 and 2006 essentially had infinite leverage. Cioffi's Bear pair of hedge funds had borrowings at 30 to 5o times assets. like

---The crisis is and was global. like

That's enough. Whether we will fly through this market meltdown and back out again like the man of steel is unclear. Some believe or hope that the amount of activist government intervention expected and the prevalence of information technology will lead to a resolution totally unlike the prolonged 1930's slump with its 25% unemployment numbers. That just does not seem possible. While the number of parallels to that depression of the past are of concern, we live in a different world. There is one wild card however, from this perspective...

In the 1930's the United States was in the midst of a long term industrial economic expansion. It was severely interrupted but the business model, factors of production, and technology were essentially the same in the 1920's as they were when the stimulus of WWII led the country out of the 10 year depression. That continuity of business model cannot be said of the United States in the beginning of the 21st century. The old industrial model has been globalized, the service and technology model has been adopted and the disruptive impact of transitioning to the new business model over the last 25 years has been profound. An economic system built on the foundation of marketing to the consumer, and that consumer consuming, is imperiled by recent economic events. How soon can recovery really begin.

The Great Depression ended when industry expanded to produce the goods for war. That industrial expansion was massive. That industrial production forced mass migrations around the country to industrial job sites, moves that would not have taken place without the impetus of new work. Today in many parts of the country the old jobs are gone and the new ones pay marginal wages and benefits. The government and corporations fund new job training, computer skills and the like for a few years but what is attractive enough to go through the expense of moving to another location in hopes of a better job. Optimists see this as a period of necessary transition and despite the individual hardships believe that the long term transition to a broad based information technology and service driven business model will lead to greater prosperity. That may be right, but this current market disruption may prove to be a sticky wicket. Sticky Wicket, where did that come from. Post concluded.


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