Earlier this year, I was looking at what shape the recession would be. Would it be a U, V, W or L-shaped?

RGE Monitor chairman and New York University professor of economics Nouriel Roubini writes that the US could face a double-dip, W-shaped recession with the tax rebate that US households will receive in mid-2008 going towards paying off high credit card balances or postponing mortgage delinquency.

"Given a severe financial crisis, declining home prices, and a credit crunch, the US is facing its longest and deepest recession in decades, dashing any hope of a soft landing for the rest of the world. While a global recession will be averted, a severe growth slowdown will not."

London-based investment consultants Independent Strategy say this recession will be different from those that came before. In their paper, they warn not to take too much heart from any rally and that this is not your "typical" recession. The reason for that is because of the high level of indebtedness created by the banks.

"The credit excesses we are struggling with are really the means of financing economic imbalances whose epicenter is the lack of thrift and the unearned consumption of a large proportion of the rich world's households – not all of them American.

"This excessive consumer leverage resulted in global economic imbalances such as the US current account deficit, the China bubble and so on … For a decade or more, people were conditioned to spend what they earned plus what they could borrow
on their rising asset prices. Those rising asset prices were themselves the result of excess leverage and liquidity and, in a second phase, it was the credit financed consumption. So there was excess leverage at two stages of the process: in hefting asset prices and in financing consumption.

"The financing model that supported this is now broke! This is not because it has lost $500 billion of banks' risk free capital. After all, the banks have about $1.8 trillion of the stuff in the US and Europe. While tragic for their greedy managers, the losses are by no means fatal for the financial system.

"No, the model is broke because the whole system depended upon the banks' business model of Loan origination and distribution. That allowed a bank to make a loan and then sell it off its balance sheet together with any subsequent responsibility for its quality, which, perforce, progressively deteriorated.
The result was the bank used up precious little credit capacity to make loans, which is why their balance sheets (and total credit) exploded. That sort of lending is now over

"As the imbalances are vast and painful to address, it means that dragging the US and other OECD consumers back to solvency and thrift will take a very long time. As the consumer accounts for 70% of GDP, that means that the workout will also last a very long time. That does not warrant optimism about a short sharp downturn followed by a quick recovery in the US or OECD economies."

In other words, this recession is likely to be long and painful.


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