What is wrong with having a Recession?

A lot of the mess that we are in as a nation is due to the policies directly tied to the US Federal Reserve and US politicians (Read BOTH parties).  The policies I am specifically suggesting are policies tied to always trying to make the United States never experience the downside of the business cycle- a dreaded RECESSION.  OOOO! Such a nasty sounding word.  It sounds negative.  It must be bad right?

Well not really.  Recessions are needed.  They play an important role in the business cycle.  They clear out bad investments, bad managers of assets (abusers of capital), and the overleveraged.  They are the yin to the yang.  You cannot have one without the other.  

During boom periods people, companies, and governments tend to take bigger risks since they are generally in a positive mood because the economy is expanding and they are making more money, have more jobs, and more opportunities.  As time goes on during a period of expansion, most profitable (i.e. lowest priced) assets get purchased and the easier returns have been made.    The low hanging fruit have been picked.  To make similar returns, as the lower priced assets, the purchaser of new assets needs to take on more risk either by increasing leverage or taking on larger or riskier projects. 

Not all investments workout.  Some assets/projects fail.    Naturally at this point in the business cycle humans being lazy humans decide if they cannot easily win they will pick up their toys and play another day.  Without growth from investments the economy normally slows and those that took on too much risk get hammered.  This generally leads to increased unemployment and general unhappiness in the economy.  We as people like to take this unhappiness out on other people and this is where the politicians come in.  During down periods in the economy people want to see change because they do not like the social mood of the economy.  Change for politicians usually means they lose the job to somebody willing to make a change or show a new approach.  Nobody likes to lose their job especially if it is a cushy job with lots of perks.

Recessions are good because the high priced assets tend to be marked down to prices a lot lower than when they were last purchased.  These lower prices lead to larger returns for the new owners who purchased these assets at severely discounted prices.  This is how the business cycle is supposed to run.  The weak businesses and investors go bankrupt or lose their assets and the strong investors purchase them to run them properly and make a profit. This starts the cycle all over again.  

Prediction about where we are now

Since the end of WWII recessions in the US have lasted on average less than a year with only slightly more than a 3% decline in GDP.  3% is nothing compared to the period before the Great Depression where we regularly had recession that had declines greater than 25%.  

Recession year Started	How Long it Lasted	Lasted (yrs)	Between Recession (yrs)
1945	Feb to Oct 1945	0.67	6.67
1949	Nov 1948 to Oct 1949	0.92	3.08
1953	July 1953 to May 1954	0.83	3.75
1958	Aug 1957 to April 1958	0.67	3.25
1960	April 1960 to Feb 1961	0.83	2.00
1969	Dec 1969 to Nov 1970	0.92	8.83
1973	Nov 1973 to March 1975	1.33	3.00
1980	Jan 1980 to July 1980	0.50	4.83
1981	July 1981 to Nov 1982	1.33	1.00
1990	July 1990 to March 1991	0.67	7.67
2000	March 2001 to Nov 2001	0.67	10.00
2007	Dec 2007 to June 2009	1.50	6.08
	Average Since WWII	0.90	5.01

Our last recession ended in June 2009.  Typically we have approximately 5 years between recessions.  Our shortest since WWII was 1 year and our longest 10 years.  We are now slightly more than 2 years since our last recession.  If we follow the average we would expect a recession sometime around 2014.  I do not think that will happen.  I think our next recession will come much sooner.  In fact I put the odds of a recession starting this year at 25% and 75% next year.  My reasoning is quite simple. 

The stimulus that the Fed has been doing since the 1980’s and changes in the law sponsored by both the Congress and the Presidents have built up like plaque in the arteries of our economy.  We have gotten fat by just having sweets of financial engineering instead of healthy long-term beneficial investments.  Our sickly money center banks are allowed to stay on life support instead of being allowed to fail.  The banks realize that anytime they get into trouble they are bailed out.  By not having any negative repercussions from making bad investments, banks are willing to take on ginormous debts and risks to make larger profits. 

This time it will be different because the US government has built up such a large pile of debt that they too are getting sickly.  A lot of the debt occurred during the last recession when the US government had to bail out large banks like Bank of America and Citigroup plus a number quasi government agencies (Freddie Mac and Fannie Mae).  This left a really bad taste in the mouth of the US tax payer that has to ultimately pay for these bail outs.  The next time that banks need to be bailed out by the US government it will more than likely not be able to backstop (financially and politically) the large money center US banks from collapsing.   

In the obese patient it is usually not the last bite of junk food that kills you; it’s the daily doses of junk food they have eaten regularly over the last 20 years.  The buildup of plaque causes the heart attack.  The buildup of debt and risk over the last 20 years will cause the financial heart attack that leads to the next US recession.  

Maybe I should eat a salad tonight.

Full Disclosure

As of August 28^th, 2011 I do not have any positions in any of the companies or US government agencies mentioned.