Last April, amid strong market rallies, I shared my concern of a possible US recession with financial sector insiders. Most dismissed my pessimism saying the US economy is strong and resilient so a chance of recession is zip.
I thought to myself: There must be something about recession that spooks us into self denial. The tendency in us is strong to brush the dust of the possibility of recession under the rug until the pile of dust becomes too obvious to ignore. By then, however, it is too late to fix things.
When asked about the basis of this gloom-and-doom outlook, my answer was simple: Human nature.
Whether good or bad, human nature will prevail and never fail to show itself. It will, eventually, override all other factors.
My take on the Subprime Crisis is as follows:
1) Investment banks export subprime loans, sliced, diced, and packaged in the form of Collateralized Debt Obligations (CDOs) to foreign banks.
2) Lenders cash in on surging home prices, offering subprime loans via mortgages to home buyers with limited credit history.
3) Home builders build aggressively into an inventory pile up.
4) Housing prices reach their apex, teeter, and then fall. This spurs a resetting of rates and an cost of payment increase for homeowners—who eventually cannot meet payments, default, lose their homes, tighten their belts, and curb spending causing the economy to slow down.
5) Lenders reverse course by tightening credit, which curbs spending some more.
The 1997-1998 Global Financial Crisis began in Thailand and drove 40% of the global economy into recession. This led to a credit crunch that toppled Long Term Capital Management on August 18, 1998 and sent the US credit markets into a panic.
Historical charts of the tumultuous one-year period between October 6, 1997 and September 20, 1998 (i.e., between the Asian Crisis of 1997 and the Russian Default Crisis and the LTCM Crisis of 1998) show that the Dow Jones Industrial Average Index (DJIA) rose to 8,194 on July 28, 1997 and then fell to 7,581 on Nov. 10, 1997.
Eight months later, on July 13,1998, the DJIA peaked at 9,337 and bottomed out at 7,640 on August 31,1998. When then Fed Chairman Alan Greenspan undertook a series of rate cuts, the market reacted by rising 22% from 7,640 to 9,358 within five months, from Aug. 31,1998 to Jan. 29, 1999.
Will rate cuts spur a similar rally now? I believe a rally is not in the cards because the epicenter of the current crisis is in the US, unlike the 1997 Asian crisis.
What may be worrisome is the degree of fallout commensurate and relative to the degree of excessive behavior, which is magnified by efficiency caused by the ever-increasing sophistication of newer financial technologies.
Simply put: The greater the excess, the greater the fallout—which will eventually affect the global economy since the US is still the world’s biggest economy and largest consumer of global goods.
Should the excess be muted (or even nonexistent), the US may escape recession or merely fall into a fleeting one. But this will take a lot of scrambling and a confluence of favorable events.
My opinion, however, is that recession, though painful, may not necessarily be a bad thing. Recession detoxifies the economic system of inefficient excesses. It is no different from a glutton going through junk- food withdrawal.
So, be not afraid of the “R” word. Instead, be wary and fearful of the “G” word, greed. It is the common thread that runs through history and explains the ills that befall mankind: wars, pillaging, conflicts, corruption.
Greed never fails to rear its ugly head, driving one to excess and creating a recurring craving for instant gratification. Greed must never be underestimated as the prime motivating factor in man’s decision making, for man, in his folly, may never learn from the lessons of the past.
Let’s face it: We will be perpetually vulnerable to committing the same mistake of greed again and again,
until the end of time.
print ed: 02/08