Recession I over; Recession II will get worse | Notes from Jim Haughey

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Notes from Jim Haughey
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Recession I over; Recession II will get worse

Jim Haughey

RCD Chief Economist

Jan 07, 2009

Recession I was set off by the subprime mortgage problem and ended last summer with the first round of rebates although the economy stayed in recession in July and August due to record high energy costs. Then the credit freeze recession began in September and is now in its fifth month with another five to eight months needed to weed out weak enterprises and rebalance inventories.

For the residential market, both recessions merge together into one long horror. But is it important to separate the two recessions so we can properly measure the timing and magnitude of the current recession.

Recession II was set off by the bursting of the credit bubble and the resulting contraction of available credit worldwide. But as the subprime recession did, it is now spreading to other parts of the economy. Lenders’ heightened risk aversion which is being applied to all borrowers is forcing a surge in defaults in other industries and countries and, more importantly, belt tightening to avoid default. The worst economic conditions are still ahead with several million more jobs to be lost in the US in 2009 and construction activity not returning to the pre-recession 2006 peak until late 2010.

The recession will end naturally when weak enterprises are weeded out and inventories are rebalanced. We can speed up the process a little with fiscal stimulus but have to be careful not to extend the recession by temporarily propping up failed businesses and homeowners in homes they can not afford. We have to endure the spreading of the recession to the rest of the economy and then the several quarters it takes to rebalance inventories. This is the process.

Demand falls for US businesses and inventories rise every time an enterprise somewhere in the world is forced to layoffs or spending cuts. Last fall, several thousand Chinese factories failed and laid off several million workers when they could not get credit to carry them over a sharp drop in export sales to weakening US, European and Japanese economies.

Numerous residential builders and some residential suppliers have closed recently when they lost credit access even though they were willing to increase their debt and wait for a recovering market. More such closures are ahead with some in nonresidential construction and commercial real estate.

Even this weeks’ cutoff of 20% of Europe’s natural gas supply by Russia is recession related. The oil-dominated Russian economy was severely weakened by the collapse of commodity prices. Russia is trying to raise cash and avoid deep spending cuts by boosting natural gas prices.