Sunday, February 22, 2009

ARE WE IN A DEPRESSION?

One night last fall, after witnessing several days of horrendous losses in the stock market, I woke up about 2 am and flipped on the TV in the basement to see if the Asian markets were settling down at all. My worst fears were confirmed. The Asian markets were tanking again-badly. I went upstairs, got out a little glass and poured myself a shot of Jack Daniels and took a sip. “This time, it’s different,” I thought, “Life is going to change.” It was like being an eyewitness to a bloody accident on the highway.


Few public figures have been willing to say the word. On Feb. 4, Gordon Brown, prime minister of Great Britain made a comment in which he spoke of pulling the world out of depression. His handlers scrambled and said it was a slip of the tongue, but the damage had been done. The quote ricocheted around the world. Richard Posner has publicly stated that he believes that we are indeed in a depression and in a few months he will be releasing his new book, “A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression.” Most other economists and commentators have been more circumspect and careful about using the term. And, while there are different definitions of a depression, I define it as a deep and persistent economic downturn that damages well-run companies and prudent individuals along with the rest, and which cannot be solved with traditional monetary and fiscal measures alone. A depression leaves lasting scars and a forever altered landscape. But I think a depression is exactly what we are experiencing and here’s why:

  • The suddenness and ferocity of the downturn. Although the rumblings of stress in the financial markets had been with us since August of ’07, hell really didn’t break loose until Lehman was permitted to fail. The severe restriction of credit availability whacked the economy immediately with full force. Economists and policymakers were caught flatfooted and have consistently underestimated the depth and breath of the damage. The Fed and Treasury both missed it. Ben Bernanke admitted that he underestimated the scope of the subprime problem And consider this quote from Treasury Secretary Henry Paulson in April of ’07, "I don't see (subprime mortgage market troubles) imposing a serious problem. I think it's going to be largely contained." Today, Paulson’s quote, along with the “Mission Accomplished” banner at the conclusion of the initial phase of the Iraq war will certainly make the top 10 misjudgments of the decade. Almost all sectors have been pounded—manufacturing, services, retail, tech—you name it. We have had the worst 3 months of job losses in 45 years and even the most optimistic forecasters are talking about ’09 as a lost year. The speed and scale of the downturn are almost unprecedented.
  • Systemic triggers. Most recessions, by accident or design, are Fed created. In the usual scenario, momentum in the economy builds, slack comes out of the system, labor demands higher wages, producers demand higher prices. Inflation begins to set in and the Fed raises rates to cool things down. Because of the time lag (6 months to a year) before interest rates take effect in the economy, the Fed cannot calibrate perfectly and often overshoots, squeezing too hard and pushing us into recession. The Fed will then lower rates to spur credit creation, and lowering interest rates along with tax cuts typically work. And then the cycle begins all over again. That’s not what happened here. Our current downturn was triggered by asset deflation and a credit crunch, and so is fundamentally different than the past several recessions.
  • Deflation signs. The inflation numbers came in at the lowest level in 53 years last week. Economists aren’t seeing serious deflation in the economy---yet. But I am seeing little indications of deflation beginning to pop up. Law firms have frozen billing rates, and sometimes lowered them. Retailers have slashed prices. Even the local delis are offering “recession fighting new lower prices”. ACCO recently announced steep pay cuts for its workers. In short, very few players in the economy have any pricing power at all. If significant deflation takes hold, look out.
  • Worldwide reach. This contagion is truly global. When Northern Rock failed, it made the papers, but few saw it as a harbinger of what was to come. Asia and Europe are contracting, with Japan in particular showing a sharp decline. Eastern Europe is close to defaulting on its debt and Western European banks are holding lots of Eastern European paper. Iceland is insolvent. Ireland is nearing default on its debt despite the fact that just a short time ago Ireland was a darling performer in the world economy. Because the rest of the world followed us right down quickly, exports aren’t going to be much help in getting us out of this. This is truly a global phenomenon.
  • No consumer help. The consumer is severely wounded and is not likely to lead the way back. No one is spending. We all have holes in our balance sheets. Most ordinary Americans have wealth in 2 principal assets—their home and retirement account and both have taken heavy hits. Because of this and because of the generalized fear, consumers aren’t spending. Indeed, consumers saved rather than spent 87% of the tax rebates that the Bush Administration authorized to help jumpstart the economy. Since the American consumer represents roughly 60% of our economy (and therefore a significant factor in the world economy), the consumer will be unable to spark a comeback anytime soon.
  • Fear. If you don’t have at least some fear in this environment, you are either so wealthy that it really doesn’t matter or you have a mild mental illness. This is an area in which the new administration has been woefully inadequate. Instead of reassuring us, Obama’s message of hope has been inverted. By using the politics of fear to get the stimulus package through, he is has stoked anxiety and panic. Instead of saying, “We will get through this together,” he has chosen the language of fear. He warned of a “catastrophe” if the stimulus bill didn’t pass immediately and without debate and warned that we may go into an irreversible tailspin. Maureen Dowd, Bill Clinton, Robert Schiller, and the Wall Street Journal have all commented on Obama’s fear mongering. He needs to project hope and calm reassurance. We don’t need to be reminded of the potential for dire consequences.
  • Vibes from the front. Last December, I attended a large function sponsored by the Turnaround Management Association, a trade group comprised primarily of consultants and other professionals that assist companies in crisis. Ordinarily, a downturn is met with some glee at these events for it translates into more billable work for its members. But this time, I noted a very different tone in my conversations. “This time, it’s different,” was most common reaction. There was a somberness in the room that I had not seen before. You know it’s bad when the workout guys look shell-shocked.

    Taken together, I believe that we are in a depression—a multiyear swoon that will be very painful for us and will leave permanent changes in our society. A few like Richard Posner have had the courage to say it and Gordon Brown said it by accident. But it is clear that this is an episode that will inflict a great deal more pain before it’s over. I, for one, am willing to call it by its proper name.

    Now that you know where we are, if you are interested in very readable books on the Great Depression era, I highly recommend The Worst Hard Times by Timothy Egan (focused on the Dust Bowl) and The Forgotten Man by Amity Schlaes. Both are quite good and will give you an appreciation for our ultimate fortitude and ability to persevere in a pretty harsh environment.

    All is not lost, however. Stay tuned. We will get through this and next week, I will give you my list of things to be happy about despite the fact that we are in a depression. Remember that after 9/11, we all feared that massive terrorist attacks would be regular occurrences. 9/11 hurt a lot of people and caused some permanent changes in our society, but none of the worst things that we feared ever happened. That is what I predict the ultimate endgame of this depression will be like.

Thursday, February 19, 2009

A Pattern

"God Damn America."

Jeremiah Wright



"For the first time in my adult life, I am proud of America."

Michelle Obama



"America is a nation of cowards when discussing race issues."

Eric Holder


What do these three people have in common? They either are or have been close personal advisors to President Obama. When they speak to him, he listens. Individually, these statements are bothersome. Taken together, they are warning signs of a potentially troubling pattern.

Eric Holder is a very smart, very well educated man, and a lawyer by training. He is a person that understands that words have meaning. He is not just some over the top, hyperbolic preacher, or a person whose words can be explained away by saying that they were taken out of context.

He couldn't be more wrong. It is a mark of maturity and greatness of this country that we elected an African American as our chief executive. And it is the supreme irony that he has his position because of our maturity and greatness. Racial issues were discussed in the main stream media and in the blogosphere throughout the campaign and we faced those straight up. The Bradley Effect turned out to be as relevent as Y2K-- a whole lot of nothin'. As a country, we finally and conclusively determined that race didn't matter.

America has lost a measure of confidence in this financial crisis. We will in time get it back. Especially at this time, we need to have people around our president that will remind him (and us) of our greatness-- not insult us in the most vile way. We have our faults, but cowardice isn't one of them.

Sunday, February 15, 2009

READY TO LEAD?

We were all tired of George Bush and after bungling Iraq, the response to Katrina, and the initial phase of the market meltdown, and last November we gave a big thumbs down to Bush and his fellow Republicans. Barack Hussein Obama won last November’s election on the themes of hope, competence, judgment, bipartisanship and a commitment to use facts, reasoning and science to guide his thinking rather than pure ideology. Although I have generally voted Republican, even I had hope that Obama would be different. In the opening weeks of his presidency, he had an opportunity to calm and anxious and scared nation and jittery markets by demonstrating that he was in control and that meant what he said. Instead, he whiffed. As his first month comes to a closes, he has given us substantial evidence that our worst fears were true—that Barack is an inexperienced freshman senator with strong and very partisan liberal instincts.

As a U.S. senator and state senator, he had no major legislative accomplishments to his name so it is no surprise that when the opportunity to lead on one of the most pieces of legislation in 50 years came about—he punted to Nancy Pelosi. What came back was predictable. Very few credible economists have been very enthusiastic about the pending Stimulus Bill (see Becker Posner blog link). It was as if Nancy gave a loud whistle in the halls of Congress and announced, “Hey, boys, you’re gonna have one shot to get all of your pet projects in one big package so hurry up and get it in while the gettin’s good!” So, instead of a stimulus bill that we could all live with (mostly public works projects sooner rather than later), we have a liberal grab bag of nonsense like money for the National Endowment for the Arts, a huge Big Brother database to lay the infrastructure for government run healthcare, “fish barriers”, and most dangerous of all a “Buy American” provision (thankfully, though, watered down). It is very little stimulus and very little this year. Scores of economists took out full page ads and asked him to slow down, clean this up and get it done right.

But not to be deterred by reason and having a bill that was not defensible on its merits, Barack resorted to old rhetorical gimmickry to sell the hurry up Pelosi-made product— using the politics of fear and by knocking down straw men. “If we don’t act immediately,” he said, “our nation will sink into a crisis that, at some point, we may be unable to reverse”. Huh? All because we don’t have fish barriers, STD prevention, and a few off-broadway plays? What happened to “the only thing we have to fear is fear itself?” His other ploy was to go partisan and attack straw men, claiming that “tax cuts alone can’t solve all of our problems”. He is correct, but no one is actually claiming that tax cuts are a cure-all for this crisis. His pre-election promise to work for bipartisanship evaporated quickly and the Stimulus Bill received a grand total of 0 votes. In the middle of all this Senator Gregg bugged out as Commerce Secretary, citing “irresolvable conflicts.” He knows where Team Obama is headed. So much for reaching across the aisle.

The other disaster of the week was Tim Geithner’s bank bailout plan –the Unplan. After hammering away at Bush (justifiably so) for invading Iraq without a plan, one of Team Obama’s first trips to the plate saw the indispensable Geithner present a “broad outline” with very little details. Not surprisingly, the market tanked with one commentator referring to the Unplan as “Shock and Ugh”.

These blunders came on the heels of the capping executive compensation for executives at financial institutions at $500,000, which I guess is designed to punish all financial institutions for the bad judgment of John Thain who accelerated bonuses and then spent an egregious amount of money refurbishing his office. I understand the point, but right now, we need the best management talent available at these floundering behemoths. I don’t know about you, but if I were on a plane landing on the Hudson, I wouldn’t want a pilot that was subject to a salary cap because he’s “just a glorified bus driver.” These are large, complex organizations with monumental problems that have thousands of employees, and they are vital to the resuscitation of our economy. Why would you want to ensure that you can’t attract first rate talent to fix them?

After the events of this week, I was able to come up with a couple of proposals. First, the Stimulus Bill should reserve approximately $250 billion and contain a provision whereby an aircraft carrier takes $100 bills out to the middle of the Atlantic and shovels them into the ocean. A second carrier would clean them up, dry them, take them back to the mainland and distribute them at centers in large cities. The way I figure, an aircraft carrier has upwards of 5,000 crew and airmen. Then we would know with certainty that at least 10,000 jobs will have been created and the money would have gotten into the hands of individuals other than government bureaucrats.

My second recommendation is a new SEC rule which would provide that if the Dow drops more than 100 points during the presentation of any government official, the presentation must immediately cease and desist. It was unnerving to watch a split screen with Timothy Geithner speaking on one side and the Dow plummeting on the other. The 100 point gag rule would act as a circuit breaker which would require would ensure that a government official would be required to shut up and stop doing damage to our already decimated 401(k)s.

Between the tax problems of his cabinet nominees, the lack of planning for the Gitmo detainees once it is closed, and the sketchiness of Geithner’s Unplan, the Obama administration has not demonstrated the great leap forward in competence that we hoped for. He has given in to his shopworn liberal Democratic instincts, and has refused to push back at Congress. He promised to deliver more than politics as usual. Our national crisis demands it. He can do better than this.