Current Recession Is a Severe Credit Bust of Depression-Era Magnitude

• Recession or depression? Quite clearly depression! What is alarming is that the current world financial order is coming to an end. The USD hegemony and debt driven growth seems to be coming to an end also. The western world needs to deleverage by many orders of magnitude, from 30x-40x to 8x-10x . This means credit contraction like it or not. So, anyone looking for a quick recovery is in for disappointment.
   
• Mike Whitney opines :
   
  “The consumer is running on empty and the chances of a robust recovery are nil.”
   
  There’s a big difference between inventory-driven recessions and credit-driven recessions. An inventory recession is caused by a mismatch between supply and demand. It’s the result of overcapacity and under-utilization which can only work itself out over time as inventories are pared back and demand builds. Credit-driven recessions are a different story altogether. They typically last twice as long as and can precipitate financial crises. The current recession is a severe credit bust of Depression-era magnitude.
   
  The financial system has effectively melted down. The wholesale credit system (securitization) is frozen, the banking system is dysfunctional and insolvent, and consumer spending has tanked. The Fed’s multi-trillion dollar lending facilities and monetary stimulus have kept the financial system from grinding to a halt, but the underlying problems still persist. Fed chairman Ben Bernanke has chosen to avoid the hard decisions and keep the price of toxic assets artificially high with the help of a $12.8 trillion liquidity backstop. That’s why stocks have rallied for the last 4 months while conditions in the real economy have steadily deteriorated. Bernanke is using all the tools at his disposal to keep the market from clearing and prevent the mountain of debt that has built up over decades from being purged from the system. Unfortunately, as Ludwig von Mises said, “There is no means of avoiding the final collapse of a boom brought on by credit expansion.”
   
  The surging stock market has made it harder to see that the economy is resetting at a lower rate of economic activity. Deflation is setting in across all sectors. Housing prices are leading the retreat, falling 18.1 percent year-over-year according to the new Case-Schiller report. Vanishing home equity is forcing households to slash spending which is weakening demand and triggering more layoffs. It’s a vicious circle which ends in slower growth.
   
  Also, the banking system is still broken. The $700 billion TARP program was not used to purchase toxic assets, but to buy equity stakes in the banks and to bailout insurance giant AIG. Bernanke knows that a hobbled banking system will be a constant drain on public resources, but he refuses to nationalize the banks or restructure their debt. Instead, he’s expanded the Fed’s balance sheet by $1.2 trillion and ignited a rally in the stock market. Bernanke’s bear market rally has lifted the financials from the doldrums and generated the capital the banks need to survive the downgrading of their bad assets. Former Fed-chief Alan Greenspan (unintentionally) clarified this point in an editorial in the Financial Times :
   
    “The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies…. Previously capital-strapped companies have been able to raise considerable debt and equity in recent months. Market fears of bank insolvency, particularly, have been assuaged.
    ….
  Jordan Irving, who helps manage more than $110 billion at Delaware Investments in Philadelphia told Bloomberg News, “This has been a government-induced rally. We need to see some real positives coming from internal demand, as opposed to government-related demand, and it’s just not there.”
   
  Still, the Fed’s intervention in the markets hasn’t removed the threat posed by toxic assets; a problem which only gets worse over time. That’s why The Bank of International Settlements (BIS) issued a report last week warning of the “perils” of not tackling the issue head-on. Here’s an excerpt from the report:
   
      “… Despite months of co-ordinated action around the globe to stabilize the banking system, hidden perils still lurk in the world’s financial institutions according to the Basel-based Bank of International Settlements.
   
      “Overall, governments may not have acted quickly enough to remove problem assets from the balance sheets of key banks,” the BIS says in its annual report. “At the same time, government guarantees and asset insurance have exposed taxpayers to potentially large losses.”
    ….
  The toxic assets problem is further compounded by an estimated $2 trillion of additional losses from defaulting residential mortgages, commercial real-estate loans, credit card loans, and auto loans. It’s is the double-whammy; a fetid portfolio of non-performing loans and garbage mortgage-backed derivatives.  At the same time, personal consumption has fallen sharply and the signs of economic contraction are visible everywhere, from the bulging homeless shelters, to the long-lines at the unemployment offices, to the empty state coffers, to the half-filled shopping carts at the grocery store. Unemployment is rising at 600,000 per month, consumer confidence is at record lows, retail sales have fallen sharply, and housing continues its historic plunge. The data is clear; there are no green shoots or silver linings. Billionaire Warren Buffett summed it up like this in an interview with CNBC this week:
     
  “I get figures on 70-odd businesses, a lot of them daily.  Everything that I see about the economy is that we’ve had no bounce.  The financial system was really where the crisis was last September and October, and that’s been surmounted and that’s enormously important.   But in terms of the economy coming back, it takes a while…. I said the economy would be in a shambles this year and probably well beyond.  I’m afraid that’s true.”
      ….
  The financial meltdown has left homeowners with the worst debt-to-income ratio in history. Working people have been forced to cut discretionary spending and begin to save. The household savings rate zoomed to 6.9 percent in May, a 15-year high. The rate in April 2008 was zero.”
   
  The downside of the rising savings rate, is that it will deepen and prolong the recession. The negligible increase in retail spending can be attributed to fiscal stimulus. Without the government checkbook, the economy will continue to struggle.
   
  There’s been a sudden shift from debt-fueled consumption to thriftiness. The trauma of losing one’s job, health care or home; or simply living one paycheck away from disaster will probably shape attitudes for years to come. Personal savings will continue to swell as households build a bigger nest egg to weather the slump and make up for lost equity, droopy retirement accounts, and the possibility of losing their job.  This fundamental change in consumer behavior points to less economic activity, more inventory reduction, additional layoffs, and smaller corporate profits. When consumers save, the economy contracts. Rob Parenteau, editor of the Richebacher Letter, sums it up like this:
   
  “We have never seen households retire debt like this, now in three of the past four quarters, over more than a half century of results reported in the Flow of Funds accounts….(“Q1 2009 Flow of Funds results show the housing sector ran a net saving position of $341b in the past quarter, while paying down $155b in household debt)
   
    ….the widespread perception is that the old global growth model, dependent in no small part on the willingness of US consumers to deepen their deficit spending, can and will be revived. We would merely suggest with the level of household net worth to disposable income back to a level last seen in 1995 (before household deficit spending began), and with households extinguishing debt for the first time in over half a century, this assumption deserves to be questioned. Humpty Dumpty may not be able to be put together again.” (“What is Different this Time?”, Rob Parenteau, editor of the Richebacher Letter, and a research assistant with the Levy Institute of Economics, naked capitalism.com)
    
  Consumer spending is 70% of GDP, but consumers have suddenly stepped on the brakes. This is a real game-changer. Even if the credit markets are restored and the banks show a greater willingness to lend; there will be no return to the pre-crisis consumption-levels of the past. Those days are over. Households will have to devote more income to paying down debt and less on shopping, travel or nights-on-the-town. That means the Obama team will have to make up the slack in demand by providing more fiscal stimulus, jobs programs, state aid, and other forms of public relief. It’s the only way to keep the economy from sliding deeper into depression. And, don’t expect past consumption trends to predict the future. It’s a whole new ballgame. The Federal Reserve Bank of San Francisco explains the roots of the problem in their “Economic Letter: US Household Deleveraging and Future Consumption Growth”. Here’s an extended excerpt:
   
    “U.S. household leverage, as measured by the ratio of debt to personal disposable income, increased modestly from 55% in 1960 to 65% by the mid-1980s. Then, over the next two decades, leverage proceeded to more than double, reaching an all-time high of 133% in 2007. That dramatic rise in debt was accompanied by a steady decline in the personal saving rate. The combination of higher debt and lower saving enabled personal consumption expenditures to grow faster than disposable income, providing a significant boost to U.S. economic growth over the period.
      …..
  Household wealth has slipped $14 trillion since the crisis began. This includes sizable losses in investments, real estate and retirement funds. Home equity has dropped to 41% (a new low) and joblessness is on the rise. When credit was easy; borrowing increased, assets prices rose and the economy grew. Now the process has gone into reverse; credit has dried up, collateral values have plunged, GDP is negative, and consumers are buried under a mountain of debt. Personal bankruptcies, defaults and foreclosures are all up. Deflation is everywhere. It will take years, perhaps a decade or more, to rebuild household balance sheets and restore the flagging economy. The consumer is running on empty and the chances of a robust recovery are nil.

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