Download Financial Market Crisis Overview I

Financial Market Crisis Overview I
This first podcast presents an overview of the financial crisis at the beginning of January
2009. In a series of podcasts that follow I will attempt to explain how we got into this
mess in the first place. I will examine the subprime mortgage problem, the collapse of the
financial markets and institutions (including the investment banks, mortgage bankers, and
commercial banks), the financial instruments such as the credit default swaps that are the
cause for much of the problems in the financial markets, and the actions the government
has taken to try to correct the situation and get the markets and the economy back on
track.
Right now the U.S. economy is in one of the most severe recessions on record. The
National Bureau of Economic Research (NBER) is a non-governmental group comprised
mostly of university economists. The committee that dates the beginning and end of
economic expansions and contractions consisted of six university economists plus one
economist from the Conference Board. The NBER is responsible for determining when
the economy is shrinking (or is in a recession) and when it is growing (or is in an
expansion). At the end of November 2008 they stated that December of 2007 marked the
peak of economic activity and that December signaled the end of a 73-month expansion
that started in November of 2001. The previous expansion of the 1990s lasted 120
months.
The NBER defines a recession as “a significant decline in economic activity spread
across the economy, lasting more than a few months, normally visible in production,
employment, real income, and other indicators. A recession begins when the economy
reaches a peak of activity and ends when the economy reaches its trough. Between trough
and peak the economy is in an expansion.”
The NBER emphasizes broad based measures of economic activity that rely heavily on
production and employment and real Gross Domestic Product and Gross Domestic
Income. Their report points out that the number of jobs filled in the economy based on
the Bureau of Labor Statistics data reached a peak in December of 2007 and has declined
every month since.
You may wonder why it took the economists so long to date the end of the expansion. In
order to determine if there is a hiccup in a long-term trend rather than a change in the
direction of the trend, they need several quarters of economic activity. There is an old
saying that you never know when a recession starts until you are already in the middle of
it. This is also true for reversals of a recession into an expansion. You never know when
you are out of the recession until you are in the early phases of the expansion. This may
be a good time to remind you that the stock market usually leads the economy and often
the market goes down before the recession is announced and goes up before the
expansion is confirmed. 2008 brought the third worst stock market returns since 1907
and 1931 with the major market indexes such as the Standard & Poors Index down over
38 percent. Don’t be surprised if the market starts going up sometime during 2009 even
when the bad news is still in the headlines. Investors usually look six to nine months out
into the future. The question is whether investors can forecast any better than the
weatherman.
Since WWII recessions have averaged 11 months with the longest one being 16 months.
The longest recession in the 1900s was the 43 months during the great depression of the
1930s. It started in March of 1993 and ended in May of 1937. As of January 2009 we
have already passed the post WWII average of eleven months and according to most
economic forecasters this recession could continue into the third quarter of 2009 with
many economist predicting that this recession could last into the first quarter of 2010. I
should point out that economic forecasts are not as accurate as weather forecasts and so
we need to be careful what we believe.
We do know however that the automobile industry is in serious trouble and GM and
Chrysler are close to bankruptcy and even Toyota recorded its first loss in recent history.
Automobile and light truck sales dropped 35% from December 2007 to December 2008
and economists forecast a drop from 13.3 million units in 2008 to 11.1 million units in
2009. The unemployment rate reached 7.2% in December, a 16 year high. Not only is this
high rate surprising but the speed with which the rate changed from 4.4% unemployment
in March of 2007 to 5.0% in December of 2007 and then dramatically moving up to 7.2%
in December of 2008 as companies started laying off workers in large numbers to combat
the decline in sales. Of course with more people unemployed, there is less money to
spend and government taxes declines both at the federal and state level. In this recession,
people are behaving as usual. They are paying down credit card debt, cutting back on
consumption and generally trying to save more. All of this behavior diminishes demand
for goods and services.
Clearly the economy is in trouble but I don’t think the dire predictions that we will live
through another 1930s style depression is realistic. This may be a more painful recession
than most, but the government is smarter than it was in 1930s and the government’s
economic stimulus programs are already in place with more to come with the Obama
administration. Additionally, we have safety nets such as Social Security, Medicare,
Medicad, pension funds and Federal Deposit Insurance of bank accounts now raised to
$250,000 per bank account. Normally as the Federal Reserve lowers interest rates in a
recession, housing is the first to help jump-start the economy. This time it is different.
Consumers are overburdened with debt, house prices have fallen for several years and
new construction has collapsed. Clearly this is a different type of recession than normal.
Only time will tell what is in store for us, but for many it is a time of great uncertainty. In
the next podcast, I will discuss one of the major issues that may have created this
miserable economy, the subprime-lending situation.