The end of a recession versus recovery

By Philip Brewer on 17 March 2009 (Updated 21 September 2010) 13 comments
Photo: Philip Brewer

There's an organization that picks the "official" dates for the beginning and ending of recessions. It considers the recession as running from the top of the peak to the bottom of the trough in economic activity. That's a reasonable definition, but it produces a slightly odd result: At the start of a recession, almost everybody is doing great--we are, after all, at the peak. The "start of the recovery" (because it's the trough in economic activity) is often the point of maximum pain.

It's worth keeping this in mind as the recession grinds along. We're all looking forward to the end of the recession--to the point when things quit getting worse--but don't imagine that point as being the end of the pain. Better to think of it as the mid-point of the pain.

In an ordinary recession it's not quite that bad. The economy is full of forward-thinking people, so job losses and stock market losses tend to be at their worst early in a recession--everyone is looking ahead and trying to position themselves to survive the downturn. Then, once the bottom is in sight, people who foresee recovery try to position themselves for that as well--they try to buy cheap stock in companies that'll do well as the economy recovers, and they try to hire great talent when the talent isn't in a position to hold out for top dollar. That means that employment, wages, and stock prices all turn up pretty quickly--often starting to turn up even before the recession officially ends.

This recession, though, is a bit different. Most recessions are kicked off by the central bank raising interest rates to choke off inflation. That's not the case this time. This recession was caused by household balance sheets getting out of whack--too many people spent more than they earned to the point that now their entire disposable income is tied up servicing those old debts. We can't get a real recovery until people's balance sheets have recovered. That means that people need to spend less and pay off debts. Only once that happens are we going to have a recovery worth the name.

This could very likely mean a recession where the bottom is not so much the beginning of the recovery but just the end of things getting worse. The bottom may be only a few months away--at least, Ben Bernanke seems to think so--but I'm afraid that it's a bit of a leap to go from that to recovery.

So, the main point of this post is just to remind you that the end of the recession is not the same thing as a return to the way things were at the peak. It's fine to look forward to the end of the recession and the beginning of the recovery, just don't expect that things will be better immediately. Yes, that's the point at which things start to get better--but only in the sense that it's the point at which things are at their worst.

[Update 20 September 2010: The NBER announced today that the recession ended in June 2009.]

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Guest's picture
Dana

Historically, the stock market is a leading indicator of business cycles. So you are right that an upturn in the market, or an official assessment that the recession is over, may say little about the actual economic climate.

Guest's picture
QOAS

I must agree with what you've said but I also want to think positively regarding this recession times. Hopefully for the better.

Philip Brewer's picture

I agree--thinking positively is great.  (Certainly, negative thinking isn't going to help.)

But I do hope that people aren't falling into the mistake of thinking that the peak of the bubble was the "normal" to which we will inevitably return.  The peak of the bubble was a weird, unnatural state.  Right now we're retrenching--something that positive thinkers can hope will be over soon.  But then the question is, "What's next?"  And to that I don't think the answer is going to be a straight-line path back to the way things were in 2005.  At least, I hope not.  Once was bad enough.

Guest's picture

You touched upon it-- there is opportunity here, if you are positioned to grab it!

A positive attitude never hurts either!

Guest's picture
Dwight

A number of things have happened in the last couple of years that have caused people to be cautious in their spending. For the most part, these things have already happened. There is no reason the think that people will get any more worried than they are right now.

Most people are still working. Most people are still paying down debts and saving money. Those people will eventually have enough money saved that they will feel secure in spending for a few of the things they have been putting off.

Those people who pay attention to price/earnings ratios will tell you that the stock market has been overpriced for a generation. Now, stocks are priced at a discount. Those of us who have been on the sidelines can finally start buying stocks for the long run. That's what I'm doing.

Guest's picture
Guest

By raising the interest rate, The Federal Reserve kicked up the variable rate mortgages which forced the the crisis as people were now overextended. Notice that the primary shareholders of the Federal Reserve just happen to be the same banks that not only weathered the storm, but profited immensely (eg. JP Morgan CHASE).

Don't forget that the Fed is NOT a government owned institution, but a privately held bank. This crisis has been engineered, executed and collected on by The Fed.

Guest's picture
Guest

Ha, Yeah cause citing Ben "Everything is fine all the banks have enough liquidity" Bernanke as a credible source does wonders for your article.

I'd say we're a good 1.5 to 2 years from the end of things getting worse.

Guest's picture
Descolada

I think that was a little disingenuous, to blame this recession on rising credit card debt and overextension of consumers. That was a factor, but I think almost everyone agrees it was the collapse of the CDO market, and through extension, the mortgage market, including variable rate mortgages.

And, btw, there use to be a time honored way for consumers to quickly eliminate credit card debt. It was called bankruptcy. Thanks to Bush and the Republicans, that option is not nearly as available. That'll have a lengthening effect on this recession for sure.

Philip Brewer's picture

@Descolada:

When a household gets itself into a completely untenable situation, where household income can't possibly cover the household's financial obligations, bankruptcy can solve the problem--for that individual household.  However, it turns out that it doesn't solve larger problem for the economy when households as a group no longer have enough disposable income that they can afford to take on an ever increasing debt load.

I lay out the reasons in my post on peak debt that I linked to above (and of course the math is worked out in detail in Ron Laszewski's peak debt paper).  But, briefly, the problems with bankruptcy as a solution for the economy are:

  1. The bankrupt's benefit is the creditor's loss, so there's no net gain to the economy.  Yes, the former debter is more likely to spend than the creditor, so there's some net gain in realized purchasing power, but it's just not big enough to matter.
  2. The former bankrupt's credit rating takes a hit (along with, very possibly, his willingness to climb back on the debt treadmill), so even after the household's cost structures are bought back in line with household income, the household doesn't reliably resume taking on debt at an accelerating rate.

As you say, the changes to the bankruptcy code make things worse, but it's a bigger problem than that:  no foreseeable bankruptcy scheme, even in combination with more extreme practices like debt holidays or large-scale debt forgiveness programs, turn out to solve the problem.

Guest's picture

I think you hit the nail on the head. Back to the peak is just a dream and if it does happen it will be some years away. The end of recession means it is at the end of the worst, but even so the worst may not be over for individuals well past this point.

Guest's picture
Guest

The original author stated:

"This could very likely mean a recession where the bottom is not so much the beginning of the recovery but just the end of things getting worse"

If you hit a cusp (e.g. -- the actual bottom, not a local min) then by definition you are recovering (.e. -- positive derivative). The statement above does not make any sense. Restated, the end of things getting worse is the same as things getting better (e.g. -- recovery)

Another poster stated:

"And, btw, there use to be a time honored way for consumers to quickly eliminate credit card debt. It was called bankruptcy. Thanks to Bush and the Republicans, that option is not nearly as available. That'll have a lengthening effect on this recession for sure."

I suppose it would be too obvious to point out that consumers filing bankruptcy does not eliminate credit card debit, it just transfers it from one party to another. This sort of borrowing mentality is largely responsible for why the real estate crash happened in the first place. If the borrowers learned how to read and had any financial sense, they could:

a) Realize they were in a variable ARM that could balloon in their face
b) Realize that sound financial practice dictates that mortgages should not be more than 35% of monthly income.

The combination of these two simple techniques would protect consumers. Sure, the banks are responsible for giving money out to people who could not afford it, and in an ideal capitalistic world, their reward would be no more business and completely depleted resources, instead of mortgaging taxpayer dollars to pay their debt.

Unfortunately both reading comprehension and common sense, along with personal responsibility seem to be in short supply in our country. Witness how our beg borrow and steal works... we are effectively allowing the "banks" to file for bankruptcy at the taxpayer expense, but the taxpayers need to borrow from other nations and increasing our national debt to pay our banks. If you're curious what a real depression will look like, it will happen when we try to get money from other countries and they start saying "no".

Philip Brewer's picture

@Guest:

People often use the shapes of letters to describe the shape of recessions:

  • The "V" shaped recession has a sharp bottom where the economy bottoms out and then growth promptly resumes.
  • The "U" shaped recession has a decline that bottoms out, but then remains at that low level for some period before growth resumes.
  • The "L" shaped recession has a decline that bottoms out, but then remains at a low level for an extended period--long enough that people wonder if growth will ever resume again.

My statement about the bottom merely being the end of things getting worse was intended to warn of the possibiity of the U or L shaped recessions.

Guest's picture
Guest

For the clarification. I got caught up in the local minimum; last explanation was helpful.