If you can't pay back the bank, the bank takes your house or your car. If a stock you own loses its value, there's no collateral you can go after to cushion your loss. This is why Bush's debt recession will be far far worse than Clinton's equity one.
The stock market in the last year of George Bush's term is following a pattern that reminds me of the last year of Bill Clinton's. The Clinton market tumble -- where the NASDAQ fell in March 2000, rose through September 2000, and then began a straight down plunge through January 2001 -- preceded a brief recession in 2001. But I think that the Bush recession -- following Dow and broader market quakes in March 2007, August 2007, and the 14% decline since the October peak -- will be much much worse.
The reason? Clinton's recession was driven largely by a collapse in equity prices, while Bush's will be driven by an implosion in the value of debt. Before focusing on what Bush's recession might look like, it's worth remembering that Clinton's was driven by the collapse of the NASDAQ as the dot-com bubble burst. It also involved debt -- $1 trillion worth of borrowing by fiber optic network builders like Global Crossing that went bankrupt when they couldn't pay their debts as their customers, the dot-coms, went belly up.
For all those individual investors who got burned by the dot-com bust, after the dust had settled they had lost lots of money in their stock market accounts, but most people still had jobs, houses, and cars. And Clinton left the Federal budget in surplus with the national debt declining to $5 trillion. Bush used that recession to sell $1.3 trillion in tax cuts and to lower interest rates to 1%. With the $2.4 trillion worth of wars in Afghanistan and Iraq, the Federal budget went into deficit and the national debt ballooned to $9.2 trillion.
One effect of Bush's lower interest rates was to temporarily revive the economy by making it cheap for consumers to buy houses. Thanks to securitization, mortgages could be originated, packaged and sold as securities such as Collateralized Debt Obligations (CDOs) to investors around the world. The fees for closing CDO deals were so high that when the supply of credit-worthy borrowers ran out, the Securitization Industrial Complex (SIC) found a way to make loans to people who could not afford them -- 47% of the $1.3 trillion in subprime mortgages were made to people who did not document their income.
We now know that the CDO cancer has spread to Wall Street banks like Merrill Lynch & Co. (NYSE: C), which yesterday revealed, according to MarketBeat, that it was valuing these CDOs at 25 cents to 60 cents on the dollar. This means that wherever CDOs lie, there will be a huge capital shortfall as their holders must write down the value of the CDOs while begging for capital.
Meanwhile, consumers -- no longer able to borrow against their homes to pay their bills -- will start to default on their $2.46 trillion worth of debt in the form of credit card loans, auto loans, student loans and others. The two million families that will lose their houses to foreclosure by 2009 will put further downward pressure on housing prices. And as consumer demand falls off, companies will see their revenues drop. This will put pressure on the $3.7 trillion corporate bond market -- particularly the part that financed the formerly booming leveraged buyout market.
Unlike Clinton's equity recession, Bush's debt recession will be more demanding. When equity holders lose value in their stock, they have no recourse to get their money back. But lenders are different -- they need to be paid back. And if the lenders aren't paid back, they take possession of the collateral -- the house or the car. Moreover, regulators demand that CDO owners write down the value of their lousy investments and raise capital to make up for that loss of value in order to have enough capital to backstop their liabilities.
If layoffs start to spread throughout the economy, consumers will have to cut back on spending. And they'll also stop paying back the loans they've been using to keep up with rising gasoline and food prices. This will create a cycle of bank writedowns and capital shortfalls that will make your head spin.
If you need money this year that's now invested in stocks, use today's bounce to sell and deposit it somewhere safe.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.
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Reader Comments (Page 1 of 2)
1-18-2008 @ 11:43AM
Ted L said...
This post quantifies some of my concerns. This downturn looks more like a secular downturn.
1-18-2008 @ 3:06PM
susan baxter said...
don't listen to them ! that is why you are where your are today ,in a jam.we are ,the middle class people are in a recession,not the rich people ,the unempolyment will be getting worse ,due to lack of spending,where is bushes tax money coming from,us ,stop spendding ,the middle class people make a statement ,enough is enough stop spendding!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
1-18-2008 @ 11:46AM
Mark said...
I am neither Democrat or Republican. Both parties have sacked our country. I do know that my business (environmental) has severely suffered under the economy of George W. Bush. Perhaps if I were making bullets things would be better. I personally believe that G.W. Bush is the worst President that this country has ever elected. Oh that's right, we didn't elect him, did we?
1-18-2008 @ 1:51PM
Warren said...
You must be too young to remember President Jimmy Carter, the unemployment rate was about double the current rates, and the inflation rate was about three times what it is now. In his last year in office the S & P was selling at about 9 times earnings.
1-18-2008 @ 11:53AM
V Sabnis said...
But why did the lenders make sub-prime loans to the credit unworthy? Becuase there just are not enough educated skilled people in America to own homes ! They took a chance. Our education is so poor that most people have to be content with a meager income. These people do not marry, raise families or if they do they do not have the resources to do so. And then there are million abortions a year. That is one reason illegals are flooding the US. America is starving of manpower in every field. Who employs the illegals when they come here? The legal Americans ! We need real growth in people who are ambitious, educated skilled and talented in fields in demand: science, technology, business, healthcare. Our poor education has failed our young. That is why the recession.
1-18-2008 @ 12:03PM
Alex Vallas said...
The war has now cost over $375 billion and could exceed $1 trillion. Who do you think is paying for this illegal war? The stocks have tumbled causing extreme hardships for those dependent on the stock market for their income (i.e. retirement annuities). The housing market has tumbled. The dollar is so far down against the Euro and other major currencies that other countries can buy American companies at bargain basement prices. Health care costs are soaring with more and more people being left out. Jobs are being oursourced at an astronomical rate. . If this keeps up people will not be able to afford the gas to go to the polling booths to vote. It looks like Bush and his neocons have started the beginning of the Declline and Fall of the United States. I sure as heck hope not!!!!!!
1-18-2008 @ 12:04PM
C Marvin Cohn said...
nO, WE DID NOT ELECT gEORGE w. AS PRESIDENT, THE sUPREME COURT ELECTED
HIM.
iS THERE A POSSIBILITY, THOUGH REMOTE,
THAT GEORGE W. MIGHT RESIGN AND GO BACK
TO CRAWFORD, TEXAS/
OR, IS THERE A POSSIBILITY THAT WHAT HE
HAS DONE TO OUR COUNTRY, MAY BE REASON
ENOUGH TO CALL FOR HIS IMPEACMENT///
1-18-2008 @ 12:31PM
bigbuxjdo said...
george bush has done more damage in 8 yrs than our country has incurred since 1776. not only is he the dumbest president this country has ever but each time he opens his mouth he disgraces himself. the money we have spent on the bush war could have made our economy the strongest in the world. instead we're a joke to the rest of the world; our dollar is at its nadir and as a military power we are a joke. its no wonder we're hated by 99% of the world. thx "w"
1-18-2008 @ 2:30PM
lillian said...
you could not have said it any better.......what a shame for the united states to have this happen to them and what is ironic is that there are still people out there who would vote forhim again???they truly do not see all the damage that bush has done.and the lives he has lost and the kids who are crippled snd have lost limbs and their youth and for what??? for lies and deception to the cheneys and roves and bushes and yet noone stands up to say anything.......the dollar has tanked.our deficit is in the stratosphere....and there isnt a country who admires us or who respects us any longer...........
1-18-2008 @ 12:51PM
Beltway Greg said...
Use today's bounce......not so fast there sports fans. Actually, many stocks are doing reasonably well (earnings wise) and giving decent guidance going forward. We're in the midst of a panic and we've probably been in a recession since Oct./Nov.
Bush couldn't balance his checkbook. If we hadn't invaded Iraq on false pretenses we wouldn't have introduced the level of instability into the equity markets that we're seeing. Oil is actually higher because it is priced in dollars and the dollar has dropped in value therefore oil costs more. (Don't worry, Gdumb doesn't understand either.) After WWII America was the only store in the county. Deficits didn't matter. We were the only engine in the global economy and had been so for any number of years. Surprise. Democracy may not have take the world by storm but capitalism certainly has and other countries can now get along quite nicely without our didactic economic posturing. We live in a different world today; a world in which we're practically begging other countries to buy our debt. Why? See above. We are no longer the only place that offers a modicum of stability and a decent return on investments. Besides if you can get around those onerous laws and the FDA, OSHA, activist shareholders and lawyers of all shapes and sizes not to mention do nothing corporate boards and brain dead politicos well, all the better. Have we become a junk bond?
Could someone get Michael Milken on the phone?
Beltway Greg
Short the dollar since 2002.
1-18-2008 @ 1:17PM
gslv said...
I'm not sure if there will be enough resiliency in a free market to make up for what Cohan predicts. Maybe. As for the mideast wars, should you complain? They're supposed to give America sources of oil. They free Israel from those threats. Disfortunately it didn't go as predicted... Iraqi saboteurs destroyed oil production causing the price increases and supply decreases. The US foreign debt is bound to come home to roost in a little while.
1-18-2008 @ 1:41PM
R Shanker said...
GB does not even have the intelect to manage the house keeping department in the white house, but some how he has become the C in C. In addition he has been incapable of seeking the advice of the time honored experts in various fields., that is because he does not know his own limitations. The only thing that is larger than his failures so far is his enormous ego.
1-18-2008 @ 1:48PM
David Huston said...
Eeeeek! Where does all of this leave the trillions of dollars in credit swap transactions that are lurking out there? Is insurance as we've known it about to terminate? If so, what will replace it, and when? Meanwhile out fearless leader was fiddling around in Iraq while the economy collapsed around his too prominant ears.
1-18-2008 @ 2:33PM
JJP said...
Our country was founded by men of God, and they turned to him by faithed. Today this country
is taking God out, the result failure. We need prayer and God back.Remember GOD BLESS AMERICA
1-18-2008 @ 2:40PM
gary said...
wait till the dems come in and ruin the country, then you will remember jimmy carter- the worst president in U.S. history. you will see bumper sticker reading gee, we miss george. that is of coarse if you have a job and a car. the dems are going to bring socialism to the united states. we have the worst candidates in history to choose from.
1-18-2008 @ 3:45PM
lin said...
The Democrats come in and ruin the country? Are you kidding? It's already ruined. There is no need
to get political about it. Both parties have to bear
some blame.
That's a major problem in this country. Too many
people still trust politicians and political parties. When his term is over, Bush will go home and enjoy himself. And us? Many of us will still be
around saying it was this party or that party's
fault.
Neither party is capable of governing a dog pound.
We just prefer not to believe it.
1-18-2008 @ 4:01PM
mmac1883 said...
This credit crisis has come primarily from the state of California and Florida. It is easy to blame George W. but he didn't make one loan of the 47% that went to people not credit worthy enough to receive them in the first place. Why aren't we examining the billions of wasted dollars going to illegal aliens through health care and welfare payments, as well as the trillions being wasted on welfare itself? And now is a great time to ask the question, when will the environment wackos take responsibility for the high gas prices as our country's ability to produce more supply has been eliminated due to no new refineries being built over the last 40 years as China and India are gobbling up supplies without any restrictions on polution. For all you Bush bashers and haters, when he is gone, the current situation will still be here as it was before he was elected. A bloat of able bodied welfare recipients raping our govenment coffers, a spiraling polluting economy in India and China and our country being influenced by a liberal Left media that continues to place blame on George Bush. Wake up, Government is the Problem as President Regan's policies proved correct to create the largest economic boom in our countries history. Lower taxes and government handouts to able bodied people, placing an importance on education and productivity. Build more refineries now because we have an abundance of oil in our own country and if given the opportunity to drill and produce it would eliminate our debt and economic struggles overnight with the increase of blue collar jobs that would be generated that are being outsourced to other global countries.
1-19-2008 @ 10:46AM
lttldblj said...
Well Said
1-19-2008 @ 4:29PM
bruce said...
Build more refineries now because we have an abundance of oil in our own country and if given the opportunity to drill and produce it would eliminate our debt and economic struggles overnight with the increase of blue collar jobs that would be generated that are being outsourced to other global countries.
Reply
right damn on
1-18-2008 @ 4:19PM
jetncat said...
But aren't we safer today than before 9/11? Isn't that what this costly war was supposed to do? Where are all the flag wavers that supported Bush during his wild and crazy spending years? Let's hope America we'll do better next time we vote a leader in. Next time don't listern to promises and what the candidate thinks America should be. Next time vote for a leader by his accomplishments and his record for which George Bush had NONE