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Why This Recession Hurts So Much

Thursday, 19 Feb 2009 | 9:53 AM ET

The recession may not yet be as bad as the long, deep ones of the 70s and 80s, but even those who haven’t lost their jobs or homes are feeling all the poorer for it.

“I think wealth loss is the defining quality of this recession,” says veteran economist Ram Bhagavatula, who’s managing director at the hedge fund Combinatorics Capital.

That’s evident in the stunning decline in household wealth, which according to Federal Reserve data, fell from a peak of $64 trillion in the third quarter of 2007 to $56 trillion in the third quarter of 2008.

“And the real damage was done in fourth quarter of 2008,” adds Bhagavatula.

The stock market fell off a cliff in the last few months of the year, with the S&P 500 losing half of its value.

But the decline in stocks is older and greater than that. The S&P 500 is down 50 percent since the official start of the recession in January 2008. And that's clearly hit home.

“The problem now is that there are more retirees with money in the stock market,” notes Christopher Rupley, chief financial economist at Bank of Tokyo-Mitsubishi.

Meanwhile, the housing market has been a wealth eraser for millions more, many of whom now have negative equity or are facing foreclosure.

The median price of a single-family home went from $219,000 in 2007 to $180,000 in the fourth quarter of 2008, a 13.7 percent decline.

“Consumers have so much of their wealth tied up in housing and stocks,” says Robert Brusca, chief economist at Fact & Opinion Economics, noting that it goes a long way in explaining the record lows readings in consumer confidence.

It may also help explain the growing sense of doom and gloom and why this recession feels so different to many Americans.

In fact, it really isn’t that different, according to economists. If anything, the differences are subtle ones but seem bigger because of popular misconceptions, reflecting the fact that a whole generation of workers has not experienced a long and deep recession.

First off, though many see the credit crunch as a one-of-a kind force, economists say that is not true.

"I don’t think it is new," says Rupkey. "Credit has been shut off before."

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Economists site the credit controls imposed by President Jimmy Carter in the 1970s and the discouraging and somewhat draconian high interest rates of the early 1980s when Fed Chairman Paul Volcker was ruthless in choking off inflation.

Secondly, the credit crunch is neither a separate event, nor did it precede the recession.

(An expert says the economy will be in a far deeper hole when the stimulus starts working. Watch for more...)

“We’ve had a two-part downturn this time,” says long-time Fed watcher David Jones of DMJ Advisors. “People still had some visibility until Lehman [Brothers],” whose collapse essentially sent the economy over a cliff, triggering rapid and intense layoffs.

Economists say the main recessionary culprit this time is the bursting of a broad asset bubble, not the conventional tightening of credit via higher interest rates from the Fed.

“There's so many features of the bursting of this credit bubble and that’s what makes it somewhat different,” says Jones.

“The difference is probably how everything melted down together—auto, housing, Wall Street,” says Rupkey. “We haven't seen all these facts colliding since the early 80s. It’s a first for a generation.”

Crowd of people on the street.
AP
Crowd of people on the street.

At the same time, there’s been more overlap between the recession and the stock market swoon. In the previous case, the recession was technically over in November of 2001, while the bear market in stocks was just getting started and didn’t bottom out until October of 2002.

The current bursting of the housing bubble has been all the more acute because housing was largely unaffected by the recession of 2000-2001.

In previous recessions, such as the 70s and 80s, real estate was largely in sync with the broader business cycle and was a “leading area of the inflation cycle," says Jones.

Those recessions were largely caused by inflation spikes and in some ways the Fed had made a deliberate effort to reduce demand.

“This time was different,” adds Jones. “We had no interruption and people started using their homes as a piggy bank. The housing sector became a problem unto itself as the credit bubble burst.”

That’s contributed to a vicious cycle, wherein the credit crunch is both the cause and effect, say economists.

“There are no buyers because people can't get credit,” says Bhagavatula. “The credit crunch is forcing people to de-leverage.”

As a result, consumer spending has declined for seven straight months and is expected to do so for three straight quarters, for the first time since the 1950s. And that slowdown also applies to credit demand. Consumers are in no mood or condition to borrow.

“In many ways, it is essentially the consumer running out of steam,” says Christian Weller of the Center for American Progress and the University of Massachusetts. “This was in the making for quite some time. We had such weak job and wage growth coming out of the last recession and that was kind of masked by the credit boom.”

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