Sunday, January 4, 2009

The Price of Delaying Pain

Sorry to allow a month to elapse between postings!

Most articles tell people that this is no ordinary recession. In early December, the National Bureau of Economic Research announced something that should have startled no one: we have been in a recession since last December. The longest recession in the last 50 years was 16 months long. As a result of hearing this, the CEO of a prominently backed start-up asked me if that meant things would be turning around in early-mid 2009. My answer was, "absolutely not." Just because this recession is vying for the record of longest is by no means any guarantee that we must somehow get out of it!

On the contrary, I believe this recession has another year of life left in it.

It's odd to me that as much as I have read about the crisis that no one (whom I have read) has written about the relationship between the 2001-2 downturn and the current mess. In my opinion, these two events are somewhat linked.

In the run up to the "tech wreck," "the bubble bursting," or whatever you want to call it, the US (and much of the world) benefited from an enormous stock market bubble. Ordinary Americans became day traders, as people saw the value of their equity investments go up, up and up further still. Those equity riches enabled people to buy all kinds of things ranging from expensive cars, pied-a-terres in New York City, big, fancy houses in expensive cities such as San Francisco and Boston. Real estate values went through the roof all over the country, especially in and surrounding San Francisco, Boston, New York, Chicago and Seattle. Now there are people who disagree with this assessment; there are people who aver that only a small segment (tech) of our economy was truly affected by the tech bubble collapse. I disagree because that tech bubble fueled an incredible amount of individual investing, an enormous influx into institutional investing (hedge funds, mutual funds), investment banking fees, etc. That largess led to the run up in real estate values in many places.

Typically, when the stock market falls, the value of real estate also falls, but it lags. Real estate is much less liquid than equities, so it takes 18-24 months for residential real estate to fall. At the end of 2001, I turned to friends in the Bay Area and suggested that we were in for a housing market correction and that it should be occurring sometime in the next year. People looked at me as if I had two heads. I responded, "We were in a stock market bubble, what makes you think we weren't in a real estate bubble?"

I waited for the correction. It didn't come, and I didn't understand why. I didn't foresee that interest rates on many mortgages would essentially become zero as the real estate industry created exotic, never seen before mortgages that enabled people to pay nothing upfront for the privilege of buying a house. There were also mortgages offering incredibly low teaser rates that would disappear in a set amount of time, but that was in the future... So, people bought big, expensive houses they couldn't afford. Of course we now know how that is playing out.

Finally, the previous recession was not deep enough. I was stunned at how shallow and short it was. Real estate's buoyancy was the enabler of that short recession. People continued to buy many, many things ,ranging from cars to heaven knows what, using their home equity lines. Consumer spending is the key to what kept the economy afloat and prevented the recession from running deep. That's not the basis of a healthy economy in my opinion.

I am a big believer in taking pain early. If you don't face whatever pain is nagging at you, it hurts ten times as much later. This is why I believe the downturn in 01 is linked to what's going on now. Alan Greenspan overplayed his hand, the mortgage industry took advantage, Americans overspent, and here we are today. Is it ten times or a hundred times worse than it would have been if 01 -02 had been as bad as it should have been? We will never know.

1 comment:

sanmateotom said...

It looks like Paul Krugman may share your thoughts about how long this will last. He might be even more pessimistic.

Also, regarding the tech/crash - real estate disconnection. I think a lot of people agreed that prices should go down, but when they didn't they jumped in while ignoring fundamentals.