The following is the second part in a three part series about the US downgrade and the effects it will have on the consumer, investor, and economy.
2008 Part Deux?
Many economists have compared the fallout from the S & P downgrade to the collapse of Lehman Brothers. While there are some similarities, there are some key differences that make this a different type of crisis.
As the crisis worsened in 2007 and then in early 2008, the investment bank teetered on the brink of crashing just as it had done time and time again, only to rebound back even stronger. Lehman, its balance sheet full of sub-prime mortgages saw its trouble come make headway when, on September 8th, the government announced the assumption of Fannie Mae and Freddie Mac. By week end, the government had made it clear that no bailout would be coming for Lehman, but it encouraged others to purchase Lehman.
When Lehman finally filed for bankruptcy on September 15th, the markets were in a spiral. Investors and companies alike saw that “To Big To Fail” was indeed a mantra deserved for those the treasury saw fit to give it to. To the investor, the government was no longer backing their investments. Lehman’s downfall set off massive tremors throughout the market. The uncertainty surrounding the financial world and hedge funds exacerbated the “Crisis of Confidence.”
Essentially, what we’re seeing now is a continuation of this “Crisis of Confidence.” However, while confidence is the key issue, it’s not any longer a question of confidence in the corporate world; it is one of a federal nature.
An American Always Pays His Debts.
When we speak of a “Crisis of Confidence” what we’re really saying is: “A mechanic in the game has changed, we’re not sure what to exactly believe now.” What we’ve seen with the United States downgrade is exactly this. The, previously, unthinkable has happened. The United States has been downgraded, and doubt has entered the market place. Investors call doubt, Risk. And when risk is found in places where it normally was absent a correction in price occurs.
In 2008, we saw the exact same thing happen. The Treasury, under the direction of Henry Paulson, had bailed out numerous American corporations in their time of need. What set the precedent, really, was Bear Stearns. “If the United States bailed out Bear, surely they would bail out Lehman.” And why not? Lehman was a banker’s bank. If Bear had a big market share, then Lehman’s would have been gargantuan. But something happened, the treasury decided to change the game, and reset the rules. It wasn’t going to be in the business of bailing out everyone. It was just “untimely bad luck” that it was Lehman.
So, in the Lehman case, we see the federal government’s lack of will to do anything. Skip ahead three years, and we see yet another “game changer” but this time, the government does not lack the will; it lacks the way. As much as the government may want to, it can’t spend its way back into a AAA rating. In fact, Standard and Poor’s has said that this is the exact opposite of how the government should go about regaining their rating.
Depending upon which side of the fence you may be, this may be a gift or a curse. While the government cannot boost investor confidence by injecting capital into the markets, it also gives the economy time to heal naturally. However, on the other side of the coin, in a slowly mending economy this may take quite a bit of time.
I need more Ammo!
In 2008, the government had quite a few weapons left in its arsenal to keep the economy afloat and stave off a deeper recession. Right now we’re seeing that arsenal as severely diminished. Rates are at historical lows, and there’s nothing the treasury can throw money at to regain investor confidence. The only thing that could regain confidence is something that the government hasn’t been able to do in a long time; balance the budget.
Right now what we’re looking at is the markets giving themselves help, which we’ll talk about in our next installment of this series.
High stakes Chicken
A similarity between the two “Crises of Confidence”, is this sort of betting game. In 2008, we saw it played out between the federal government and solvent banks. Where the government was essentially not giving its guarantee to help with the purchase of Lehman, to see how it played out, hoping that a buyer would surface. They lost that game, and that’s where the crisis came in.
Here again, we see another high stakes chicken game, but this time it’s the federal government on its own (Republican Vs. Democrat). Standard & Poor’s has stated in its report that it is not an issue of the amount of debt, nor is it the financial stability of the United States. It is the issue of the inability of lawmakers to come to a compromise on how the debt should be handled.
The Economy
In 2008, GDP was negative, we were losing jobs, and credit markets were completely frozen. We find ourselves in a, albeit bad but, better climate. GDP is on the positive trend along with Jobs (again, not great). With Quantitative Easing just complete, we may see some tightening, but nowhere near recession levels. Also, companies are at record highs as far as liquidity is concerned, so the need for commercial paper is not there.
Essentially, what we’re seeing that the American economy is in a much better place to heal itself than it was a few years ago. 2008, saw companies highly leveraged with little in the way of meeting payrolls without some sort of outside financing.
In our next section we will look at the ways the United States can set itself up for an Organic Recovery.
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