Sunday, October 12, 2008

There won't be a Depression, but there WILL be...

One of the biggest reasons why the Great Depression starting in 1929 was so deep and so long was that Herbert Hoover's administration first denied that there was any problem, then blamed it on its political opponents, and finally depended on the free market to fix its own problems for far too long. It took a change of administrations, the willingness to try just about anything, and time, to get the economy going again. The Bush Administration might have denied the risks involved with the subprime housing market and Credit Default Swaps for far too long, but whether through luck or plan, Ben Bernanke and Hank Paulson know their history (Bernanke is considered by some to be the world's leading academic expert on the economic history of the Great Depression.) Bernanke and Paulson knew that they had to take action; they couldn't rely on the free market alone to fix the problems.

We're now seeing coordinated international action to address liquidity problems, stabilize the banking system and restore confidence in the equity markets. None of this occurred in the 1920s and 30s. At the end of the day, these efforts may still not work, but there's an excellent chance that we'll avoid a repeat of 1929.

What we'll be left with, however, won't be pretty:
  • The recession is likely to stretch into next summer, if not beyond.
  • Unemployment will probably reach 8%.
  • Even after the recovery begins, credit will remain very hard to get. For businesses, it will be much more expensive. For consumers, who will likely benefit from reduced interest rates and fees that are lowered or eliminated by Federal law, credit will be available to only the most creditworthy borrowers.
  • Tight credit will directly impact the sale of high-ticket items, such as homes and cars. Home prices will finally stabilize, but sales will take longer and be more difficult to complete. People will keep their cars longer, and when they buy new cars, much bigger down payments will be required. Car production will have to slow to adjust to the lowered demand, and more dealers will go out of business.
  • Restrictions on the interest rates and fees that can be charged to consumers will make credit card issuers much more selective about who they offer cards to, and how much credit they offer. Only the safest borrowers will get cards, and many borrowers with existing cards will see their credit lines decreased or frozen by banks.
  • As a result, the credit- and consumer-driven expansion of the economy will come to an end. Business investment will have to pick up the slack.
This is all bad, but it's not a Depression, and the economy will eventually recover. It might actually benefit the stock market, since much of the capital that had been flowing into banks will end up going either into stocks or Treasury bills. And as I've previously written, there are many true bargains in the stock market that are at no risk of bankruptcy.
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