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Recession or Depression
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The only good thing about a recession or a depression is that you find out you have been in one after it is almost over. Great economists and governments spend most of their time either denying it or speculating over it.
I will consider myself in recession if I am broke (which is most of the time), and in depression if I do not even have a job while I am broke. But seriously, what is the difference?
A recession is a decline in a country’s gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year. A severe or long recession is referred to as an economic depression. A devastating breakdown of an economy is called economic collapse.
Since 2007, there has been considerable discussion about a possible recession starting in late 2007 or early 2008. The United States housing market correction (a consequence of United States housing bubble) and subprime mortgage crisis have significantly contributed to anticipation of a possible recession.
While some economists are confident about a recession, others are not convinced. Some believe that the current slowdown may at best be a mild and brief recession.
Nouriel Roubini has outlined a harsh 12-step scenario.
1. U.S. home prices will fall between 20% and 30% from their peak. NYTimes chart
2. Losses to the financial system from the subprime disaster, as high as $300 billion, are now spreading to near-prime and prime mortgages.
3. The recession will lead to a sharp increase in defaults on other forms of unsecured consumer debt.
4. Monoline insurance companies will take losses on their insurance of residential mortgage-backed securities, collateralized debt obligations and other asset-backed securities products, which are much higher than the $10 billion-to-$15 billion rescue package that regulators are trying to arrange.
5. The commercial real estate loan market will soon enter into a meltdown similar to the subprime one.
6. Some large regional or even national banks that are very exposed to mortgages, residential and commercial, may go bankrupt. Bear Stearns Companies, Inc. collapsed on March 16, 2008, and was bought out by JP Morgan Chase.
7. Banks’ losses will grow as a result of hundreds of billions of dollars of leveraged loans on their balance sheets at values well below par, currently about 90 cents on the dollar.
8. Once a severe recession starts, a massive wave of corporate defaults will take place. Typically U.S. corporate default rates are about 3.8% (1971-2007); in 2006 and 2007 this figure was a rather low 0.6%. And in a typical U.S. recession such default rates surge above 10%.
9. The “shadow banking system” (as defined by Pimco, it is composed by non-bank financial institutions that borrow short and in liquid forms and lend or invest long in more illiquid assets), will soon get into serious trouble.
10. Stock markets in the U.S. and overseas will start pricing in a severe U.S. recession and a sharp global economic slowdown.
11. The credit crunch that is affecting most credit markets and credit derivative markets will lead to a drying up of liquidity in several financial markets, including otherwise very liquid derivatives markets.
12. A vicious cycle of losses, capital reduction, credit contraction, forced liquidation of assets at below fundamental prices will ensue, leading to further credit contraction.
When recessions are building and when economic activity slows, the landscape always looks uniquely bleak. Commentators always say, “This time it’s different and this time it’s going to be another Great Depression.” But is it really so? I don’t think so beacuse the earlier Great Depression was caused by a Federal Reserve deliberately trying to slow down the economy and drastically overshooting its mark.
This time, the Fed is actively trying to stimulating the economy and flooding it with liquidity. Unless the Fed is actively seeking to crimp economic activity — as it did in the late 1970s and early 1980s, there will not be a genuine depression. The economy is in recession but a real depression, wit |
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