Monday, April 07, 2008

Calling a Spade a Spade

In The Importance of Being Earnest, two young ladies are meeting for the first time in a garden, and they are verbally jousting for position. Cecily Cardew lays down her marker by declaring,” I always believe in calling a spade a spade.” Gwendolyn Fairfax responds by saying, “I am glad to say I have never seen a spade; it is obvious our social spheres have been quite different.”

The evidence is now overwhelming that the U.S. economy is entering a recession. Jobs are disappearing, mortgages are being foreclosed, and the dollar is in free fall, sending the price of oil and other commodities skyward. But the government apparatchiks will not use the “dreaded R word.” Instead, we are told by President Bush, Secretary Paulson, and others that we have entered a “slowdown,” a “rough patch,” and “period of economic difficulty.” Fed Chairman Bernanke conceded the other day that a recession was a possibility, and that concession made headlines the next day, though in reality he was simply stating the obvious.

Having worked for many years in the field of investor relations, I know something about the drill that attends the onset of a recession. And I can tell you that, ten times out of ten, the reaction of securities analysts, the financial press, and the afflicted companies is that all will be well in six months. Not three months, because that would not be credible, not two years, because that would put recovery beyond the time horizon of most investors, but six months. If the slowdown hits early in the year, the gurus will tell you that a second-half rebound is in the cards. And thus it is right now, as the eternal bulls, forced at last to admit that the economy has soured, turn to the nearest available crutch: Yes, the economy has slowed, but the recession will be short and mild, and by Christmas we will all be filled with good cheer.

Since WW2, the six-month rule has generally worked, because, as we are repeatedly told, our economy is resilient, and recessions reduce inventories and force companies to get rid of fat, so that even a tepid recovery generates earnings growth. But this time there are wild cards – China, India, the Iraq War – and it is hard to be as sure about our economic future. One can make a case for the six-month rule, but one can also make a case for a deep, 30’s-style depression lasting years. You won’t hear the latter prediction, though, because no one wants to ignite an investor panic.

But the government has just bailed out Bear Stearns, and in the congressional testimony given by the CEOs of Bear Stearns and its white knight, JP Morgan, there were frequent allusions to what might have happened had Bear Stearns filed for bankruptcy. It didn’t take a genius to figure out that what everybody was talking about was a doomsday scenario. The terms being thrown around were euphemistic – “there could have been severe and possibly uncontrollable consequences “ – but the meaning was clear: The Fed rushed in to save Bear Stearns in order to avoid the financial equivalent of nuclear war.

What are we to make of it when we are told not to panic when the titans of Wall Street have so obviously just panicked?

In the world of finance, confidence is everything. Without it, no one lends anything to anyone, people sit on their savings, and companies don’t build plants or hire workers. That is the dilemma facing the Fed, the SEC, Congress, the banking system, and the financial press. The financial system is broken, but nobody dares say that for fear of making things worse. Instead, they all say that the economy will get back on track in six months. That’s a sliding prediction; in six months, if the economy hasn’t recovered, there will be a new six-month forecast.

Financial reporter: “When I see a recession, I call it a recession.”

Treasury Secretary Paulson: “I am glad to say I have never seen a recession. It is obvious our social spheres have been quite different.”