Paul Krugman Thinks US Recession Will Be Over By September

For Krugman to be so bold in making that statement, its becoming a media circus. How are you going to take popularity votes from Roubini unless you make these aggressive calls that make everyone sit up and take notice. Even if your call does not work out, you are an outstanding economist, you role in life is to justify and explain why your predictions did not turn out the way you predicted. Great way to stay in the media focus and still be just doing your job, without achieving anything really in the end... mommas, don't let your sons grow up to be economists!!

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The US economy probably will emerge from the recession by September, Nobel Prize-winning economist Paul Krugman said.

"I would not be surprised if the official end of the U.S. recession ends up being, in retrospect, dated sometime this summer," he said in a lecture today at the London School of Economics. "Things seem to be getting worse more slowly. There’s some reason to think that we’re stabilising."

US stocks erased an earlier decline after Krugman made his comments. The Standard & Poor’s 500 Stock Index was little changed at 939.14 in New York after slumping as much as 1.5 per cent earlier, and the Dow Jones Industrial Average gained 1.36 points to 8764.49.

Krugman, a Princeton University economist, has warned recently that the US government hasn’t done enough to help the country’s economy recover. Last month, at a conference in Abu Dhabi, he said the fiscal stimulus is "only enough to mitigate the slump, not induce recovery".

The National Bureau of Economic Research, based in Cambridge, Massachusetts, is the official arbiter of US recessions and expansions. Last week, Robert Hall, the head of the NBER’s business-cycle-dating committee, said it’s "way too early" to say the contraction is over.

The US has been in a recession since December 2007, and the NBER may take months to decide when a trough has been reached. Recent reports have shown an easing of declines in industrial production and other measures that the group reviews when determining whether the economy is in a recession.

Even with a recovery, "almost surely unemployment will keep rising for a long time and there’s a lot of reason to think that the world economy is going to stay depressed for an extended period," Krugman said.

The unemployment rate jumped to 9.4 per cent in May, the highest since 1983, partly reflecting more people joining the labor force to look for work.

The US Federal Reserve’s efforts to stabilise markets - measures that have swelled the central bank’s balance sheet - have helped, Krugman said. "A lot of the spreads in the markets have come down” and “the acute financial stuff seems to have come to a halt," he said.

Fed officials lowered the benchmark interest rate to a target range of zero to 0.25 per cent in December and have switched to using credit programs and outright purchases of Treasuries, mortgage-backed securities and housing agency debt as the main tools of monetary policy.

$US2.31 Trillion

The balance sheet’s size peaked at $US2.31 trillion in December. It has fluctuated around $US2.1 trillion over the past two months.

The Fed’s swollen balance sheet is "a little alarming. In the long run you really don’t want the central banks to be so involved in the business of lending," Krugman said. "But it’s arguably necessary" even if there are questions about "where does it stop?"

p/s photos: Kim Ahep

Credit Crisis 101 - Leverage

Pick up any business magazine or paper, or watch the business channels, you will find a plethora of information on the credit crisis. Sometimes, too much information overload will distract from the real issues and when we talk about the crisis, we have too many angles on the problem. Unless we zero in on the root cause (not not ascribing blame), we won't be able to get a handle on the crisis and its effects.

Let's get the blame out of the way. I have blogged about the blame game: mainly its the ratings agency, followed by Greenspan and then the Wall Street firms. If you have to describe the root of the current crisis in one word, that word has to be "leverage". If you take leverage out of the equation, if we didn't have the many new fangled acronyms, which were basically packaged loans supported by derivatives like capital platform, we would have a very mild recession. This recession is the severest we have seen since the Depression because of the leverage i.e. derivatives. Leverage implies very little capital outlay for a certain contract of service or product. If we have derivatives and leverage during the 1920s, the whole world might have collapse even more brutally.

Yes, we have more knowledge since then, we have a better understanding of fiscal and monetary policy, and some say better laws and regulation (well, there are regulators but they did not do a good job at all). Its the leverage which brought about such a recession that is much worse than any we have seen in modern times. If you want to take an account of the mess, the more reliant you were on that leverage, the more you fell as the values were nothing but book entries. The investment banks would not have been in so much trouble if they did not get greedy themselves and bought most of the instruments.

Naturally, the front line got hit the worst, the investment banks that parlayed capital up to 20x-30x leverage to issue these papers, and when they collapsed it very easy to see capital totally vanishing with just a minor drop in values. Now we are talking of properties (which these papers were based on) losing 30%-50%, hence the negative equity. Those who bought properties using these kind of easy and unchecked loans were the first to be foreclosed. Even if you did not participate in those loans, you might have benefited via rising housing values, and refinanced, you would have got hit as well. Generally the affected banks lost about 90% or more in share price while most of the broader equities lost about 50% and counting.

The rest of the world got hit because they got a corresponding inflow of liquidity emanating from these gains. Liquidity was ample. Related areas which practiced excessive leverage were hedge funds. If these funds bought emerging market shares and commodity, those prices got inflated as well, hence when it came time to de-leverage, the outflow was very severe. In particular commodity prices. Its not just a bull cycle, it was the leveraged funding which went looking for "liquid assets" to move into. Hence the very sharp rise in commodity prices in 2004-2008, and they came down just as fast. Related to commodities were the commodity ETFs which were coming out like fresh donuts. Every commodity ETF basically just fueled the rise and trend even further, causing many pension funds to specifically target a substantial weighting in commodity as a critical portfolio composition.

Unfortunately, the US consumers represents a significant engine for global demand. They are key to the US economy, and they need to buy crap from the rest of the world, so that the rest of the world have the funds to buy crap from other countries. The wealth destruction from falling share prices and more importantly, the losses from property, have caused the US consumers to tighten their consumption patterns. That has severe ramifications for the flow on effects to the rest of the world relying on exports for growth. Yes, it may not be the rest of the world that is at fault, but you still get swept up in the tsunami.

The curtailment of credit and loss in wealth from the deleveraging is what is bringing global demand to its knees. Every country has attempted to reflate, whether the sums are big enough is still debatable, I think it is, but more than just reflating you need to address the root problem. Has the deleveraging stopped? Well, banks are still holding the toxic assets, refusing to write down to a fairer market value, say twenty cents to the dollar, as that would wipe out the bank's equity. Hence NATIONALISATION is the best solution going forward. You are not going to do it, let the government do it. Nationalisation of banks = forced sale of these assets = investors have a good idea of the losses = shareholders will be wiped out but its necessary.

As big as the TARP is, it is insufficient to replace the writedowns. You want a bad bank, you need $2 trillion minimum. Already the lawmakers are balking over the TARP's $780bn, the amount for bad bank is humongous. By nationalising, you basically close a few big banks that shouldn't be allowed to continue. By propping them up, you will eventually have to pump close to $2 trillion anyway to get them on even keel.

The other major contention is that property has to stop falling in price because as it keeps down trending, investors have no idea how to put a fair value on those toxic asset losses. A better plan Obama should have included is to put a stop to the slide - put up an incentive for new home owners to buy, e.g. $25,000 for new homeowners that qualify. Its pointless to renegotiate mortgages if prices keep falling. You need genuine long term buying.

As for auto sector in the US, the crisis basically hasten their demise. Their business model does not work and is inflated. They must be bankrupted so that they can negotiate a reasonable business model with a very much reduced pension/healthcare liability overhanging the car makers. But the US auto sector is the least of global concerns.

Things are coming to a head, falling share prices will force the government's hand. Keep an eye on developments on these two front:
a) how they deal with the toxic assets properly
b) how to stop property prices from sliding further

To that end, the markets looks oversold as a lot of liquidity is on the sidelines. To activate the flow back, we need to see catalysts that would trigger (a) and (b) in the right way. Bank nationalisation would be one. Bad bank is still OK but the hurdles on raising $2 trillion will not be easy.

Things are so bleak now that it gives me room to be optimistic that certain things will happen when you are forced into a corner. These are very difficult decisions, do you have the political will to nationalise banks.

Another potential positive catalyst will be Geithner roping in private equity and hedge funds to start buying up the toxic assets. Pricing will be an issue but the government is keen to get these funds to take off some of these assets via special funding, which may be hard to come by for hedge funds and private equity funds now. Geithner has a strong hand now, by forcing banks to sell the toxic assets to these funds or else face nationalisation. Geithner has seen his credibility being eroded quickly with his conceptual plan that lacked details and a pricing mechanism for the toxic assets. He can restore much of it by moving fast to move the toxic assets. Yes, banks will have to do massive writedowns, and many may be barely solvent, but that's part and parcel of what needs to be done.

Despite all the bad news, I am more hopeful than most as things are coming to a head - and tough decisions are forthcoming, which will be good for the markets.

p/s photos: Natasha Hudson

Roubini On Why US Consumers Are In For A Long Slump

20 Reasons Why the U.S. Consumer is Capitulating, thus Triggering the Worst U.S. Recession in Decades

Today’s news about October retail sales (-2.8% relative to the previous month and now down in real terms for five months in a row) confirm what this forum has been arguing for a while, i.e. that the U.S. has entered its most severe consumer-led recession in decades. At this rate of free fall in consumption real GDP growth could be a whopping 5% negative or even worse in Q4 of 2008. And this is not a temporary phenomenon as almost all of the fundamentals driving consumption are heading south on a persistent and structural basis. Consider the many severe negative factors affecting consumption. One can count at least 20 separate or complementary causes that will sharply reduce consumption in the next several years:

Krugman, Nobel Prize Winner, Makes Prediction

Bloomberg /SMH: The winner of the 2008 Nobel Prize for economics said the US is plunging into a ``nasty recession'' with a ``lot of suffering'' to come, even if policy makers succeed in unfreezing the credit markets. ``That's baked in,'' Princeton University professor and New York Times columnist Paul Krugman said in an interview on ``Night Talk'' with Mike Schneider to be broadcast later today on Bloomberg Television. ``There is a lot of downward momentum.'' He said a rise in the unemployment rate to 7% ``seems almost certain'' and he put the odds of an increase to 8% at ``better than even.'' The jobless rate in September stood at a five-year high of 6.1%.

Signs that the economy is falling into a recession multiplied this week with news that retail sales have fallen for three straight months, single-family housing starts hit a 26- year low and consumer confidence plunged the most on record. Krugman voiced some doubts that the steps that Treasury Secretary Henry Paulson is taking to combat the credit crisis will succeed and suggested that more might be needed. Paulson rolled out plans this week to use $US250 billion of taxpayer funds to purchase stakes in thousands of financial firms to try to halt a credit freeze that threatens to bankrupt companies and hammer the job market. ``It's not clear there's enough money,'' Krugman said.

He added that Paulson may also have to insist that the banks use the money they're receiving to make new loans if the plan is to work. ``They may need to be much more interventionist than they have been thus far,'' the Princeton professor said.

p/s photos: Pevita Pearce