When people who are normally completely uninformed about the market start talking about it and asking me about my fund's performance it is a sign of how bad things are. Indeed, unless you've been living in an underground shelter, you know that the market has been dropping like a rock. So what's the 411? Well, by at least one measure I have no reason to complain - I still have a job. Other than that, every day feels like a new chapter in some unlikely science fiction novel. If you think Lehman going out of business is big and sad news, imagine your whole country going bankrupt. One day you may be stunned by a $700 billion bailout in the US, but only until you find out the UK - with a much smaller economy and banking system - is ready to plow 500 pounds to rescue it's system (albeit with significantly less politicking and posturing).
So, are we done yet? Can it get any worse? In short: yes, it can.
The next shoe to drop will be a precipitous drop in consumer spending. We already saw hints of this in the August consumer credit report, that is before we even saw the true nature of the credit beast unravel during the events of September. The 29% drop in car sales in September gives us a slightly more accurate view of the more recent trends, but even that probably doesn't fully capture the massive shake up in consumer confidence that has occured in the second half of September and early October. Why does any of this matter? Until now, the actual economy hasn't really suffered that much - we have yet to see a quarter of negative GDP growth and unemployment is still in single digits. People are still holding on to the illusion that this is no Great Depression. However, with a drying up in consumer spending, that could change very quickly. Remember that in the last few recessions, it was the continued strength in consumer spending that has buffered the downturn in the economy - even if at the time we didn't fully appreciate the extent to which that was probably supported by a dramatic expansion of consumer credit.
Then just when the consumer drop becomes apparent we may potentially be served with more news from the banking industry. Part of the reason why all the recent liquidity measures have seemingly not done much to unfreeze the flow of credit is the growing suspicion that liquidity - while being part of the problem - is not the core of it. Felix Salmon makes an interesting point to consider:
There's an evolving consensus that we're no longer seeing a liquidity crisis, but rather a solvency crisis. Banks don't just lack cash; they're fundamentally insolvent, with their assets (things like mortgage-backed bonds) worth less than their liabilities (including their deposits). Improving liquidity, through rate cuts or swap lines or discount windows or buying unsecured commercial paper or any other means, can no longer get us out of our present hole. What we need is a recapitalization of the banking system.The government is slowly realizing this however can it act fast enough - given that only 2 weeks ago they claimed that buying up toxic assets from banks was the only plausible solution? And what if - in the process of recapitalizations - it turns out that the problem is much bigger that we can, even globally, afford to pay? Consider what this article says about credit default swaps - the financing instrument du jour - which dwarf the subprime mortgage problem:
So here is a global private market whose products, combined, have a nominal value roughly equal to the total size of the world economy’s output in a year, and apparently no one in any government knows the full market’s shape, distribution, or true vulnerabilities. Gulp.Last time I wrote about this distaster, after the failure of the bailout package in the House led to a 777 point decline in the DOW, I was worried about what all could happen before it's finally passed and implemented. Indeed, by the time it was approved, it was almost a moot point as it became clear that the rest of the world in even deeper trouble than the US and that the US employment saw a sharp drop. 5 different steps by the Fed later, it feels like we are perpetually 2 steps behind and 2 days too late.
Let's just hope we're not a few trillion too short.