Just A Slowdown?
Early last August as the subprime crisis started to cause wild equity market gyrations, I shared a few beers with one of Wall Street's quantitative hedge-fund wizards who predicted the crisis was going to get much worse. Being a mere mortal, I still subscribed to the Ben Bernanke/Ben Stein school of thought, reasoning that the subprime problems were relatively small and would be confined to the banks that sold the toxic waste, the financial institutions that bought them and the borrowers who were being hit with resets.
So I replied it was pretty obvious Wall Street would have a recession, but I didn't think it would go far beyond that. The hedge-fund wiz disagreed, noting that Americans were vastly overleveraged and due for a serious wake-up call. This gent, who holds an engineering Ph.D. from a great university, said he foresaw a severe recession. Moreover, he predicted a Hillary Clinton victory in November 2008, followed by a sizable tax increase, followed by a bull market in equities, a near replay of the 1990s. Being a Republican, he found these prospects both amusing and slightly incongruous.
For five months or so, his scenario played out perfectly. But as it turns out, both of us were wrong. So was almost everyone else. And we're
only in Act Two.
It's increasingly clear that top economists such as Harvard University's Martin Feldstein, who were predicting a nasty recession only two months ago, are almost as clueless as the rest of us. And there is good news in the dreary numbers. Unemployment may have crept up to 5.0%, but massive layoffs haven't materialized. It seems instead that the labor market won't suffer so badly because businesses hired cautiously during the last expansion.
Whether the economy is growing at a 0.6% rate or shrinking at a 0.5% pace is of more interest to academics than ordinary Americans, who know we are in a slowdown and are content to parrot what they hear in the media and call it a recession.
What is clear is that ordinary Americans are facing no choice but to live within their means and save the old-fashioned way. In the 1990s, margin accounts, combined with surging equity portfolios, made saving income an option, just as home equity loans did until last year. Real savings are likely to translate into modest consumption gains for several years. But for a country that forgot what anything besides shopping until they drop is like, this isn't such a bad thing.
Ironically, some of the solutions to the subprime crisis, like the Federal Reserve's rapid reaction in cutting interest rates, may have triggered worse problems, like the commodity inflation everyone is now moaning about.
Don't expect Washington to ride to the rescue, election or no election. A Democratic Congress is planning billions in more subsidies for wealthy farmers already rolling in the bucks, while many Republicans remain wedded to the idea that George Soros and his billionaire hedge-fund cohorts should have much of their income, the carried interest component, taxed at a 15% rate.
It's little wonder that Middle America is ticked off. And everyone thinks we are headed in the wrong direction. When the $50 trillion credit default swap market is three times the size of the U.S. economy, something's out of balance. Yet somehow the intrinsic dynamism of the U.S. economy enables it to withstand the damage inflicted by delusional lenders, reckless consumers and corrupt politicians. Somewhere out there is a price to be paid, but we may not see it anytime soon.
Evan Simonoff, Editor-in-chief
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