US Recession

BY SHARIQ SHEIKH
http://prochow.blogspot.com
 Introduction
• The fear of a recession looms over the United
States.
• And as the cliche goes, whenever the US sneezes,
the world catches a cold. This is evident from the
way the Indian markets crashed taking a cue
from a probable recession in the US and a global
economic slowdown.
• Weakening of the American economy is bad
news, not just for India, but for the rest of the
world too.
 What Is Recession ?
• A recession is a contraction phase of the business cycle.
• The official agency in charge of declaring that the economy
is in a state of recession is the National Bureau of Economic
Research (NBER).
• They define recession as a "significant decline in economic
activity lasting more than a few months“, which is normally
visible in real GDP, real income, employment, industrial
production, and wholesale-retail sales.
• For this reason, the official designation of recession may
not come until after we are in a recession for six months or
even longer.
• Some economists also suggest that a recession
occurs when the natural growth rate in GDP is
less than the average of 2%. Typically, a normal
economic recession lasts for approximately 1
year.
• American newspapers often quote the
rule of thumb that a recession occurs when real
gross domestic product (GDP) growth is negative
for two or more consecutive quarters. This
measure fails to register several official (NBER
defined) US recessions
 What Causes Recession ?
• An economy which grows over a period of
time tends to slow down the growth as a part
of the normal economic cycle.
• An economy typically expands for 6-10 years
and tends to go into a recession for about six
months to 2 years.
• A recession normally takes place when
consumers lose confidence in the growth of
the economy and spend less.
• This leads to a decreased demand for goods
and services, which in turn leads to a decrease
in production, lay-offs and a sharp rise in
unemployment.
• Investors spend less as they fear stocks values
will fall and thus stock markets fall on
negative sentiment.
 Recession Or Not ?
• According to numbers published by
Bureau of Economic Analysis in May 2008, the GDP
growth of the previous two quarters was positive. As
one common definition of a recession is negative
economic growth for at least two consecutive fiscal
quarters, some analysts suggest this indicates that the
U.S. economy was not in a recession at the time.
• However this estimate has been disputed by some
analysts who argue that if inflation is taken into
account, the GDP growth was negative for the past
two quarters, making it a technical recession
• A study released by Moody's found two-thirds
of the 381 largest metropolitan areas in the
United States were in a recession.
• The study also said 28 states were in recession
with 16 at risk. The findings were based on
unemployment figures and industrial
production data
 Causes Of US Recession
• The general consensus is that a recession is
primarily caused by the actions taken to
control the money supply in the economy
• The Federal Reserve is responsible for
maintaining an ideal balance between money
supply, interest rates, and inflation.
• When the Fed loses balance in this equation,
the economy can spiral out of control, forcing
it to correct itself.
• Relaxed policies in lending practices making it
easy to borrow money
• The economic activity became unsustainable
resulting in the economy coming to a near
halt.
• Recession can be caused by factors that stunt
short term growth in the economy, such as
spiking oil prices or war.
 Crisis In The US
• The United States entered 2008 during a
housing market correction, a subprime mortgage crisis
and a declining dollar value
• In February, 63,000 jobs were lost, a 5-year record.
• In September, 159,000 jobs were lost, bringing the
monthly average to 84,000 per month from January to
September of 2008.
• On September 5, 2008, the
United States Department of Labor issued a report that
its unemployment rate rose to 6.1%, the highest in five
years
• The defaults on sub-prime mortgages
(homeloan defaults) have led to a major crisis
in the US.
• Sub-prime is a high risk debt offered to people
with poor credit worthiness or unstable
incomes. Major banks have landed in trouble
after people could not pay back loans.
• The housing market soared on the back of easy
availability of loans.
• The realty sector boomed but could not sustain
the momentum for long, and it collapsed under
the gargantuan weight of crippling loan defaults
• Foreclosures spread like wildfire putting the US
economy on shaky ground. This, coupled with
rising oil prices at $100 a barrel, slowed down the
growth of the economy.
 Liquidity Crisis
• In early July, depositors at the Los Angeles
offices of IndyMac Bank frantically lined up in
the street to withdraw their money.
• On July 11, IndyMac - the largest mortgage
lender in the US - was seized by federal
regulators.
• The mortgage lender succumbed to the
pressures of tighter credit, tumbling home
prices and rising foreclosures.
• During the weekend of September 13–14,
Lehman Brothers declared bankruptcy after
failing to find a buyer
• Bank of America agreed to purchase
Merrill Lynch, the insurance company AIG
sought a bridge loan from the Federal Reserve
• and a consortium of 10 banks created an
emergency fund of at least $70 billion to deal
with the effects of Lehman's closure
• The biggest bank failure in history occurred on
September 25 when JP Morgan Chase agreed
to purchase the banking assets of
Washington Mutual
• The year 2008 as of September 17 has seen 81
public corporations file for bankruptcy in the
United States, already higher than the 78 in
2007
• Lehman Brothers being the largest bankruptcy
in U.S. history also makes 2008 a record year
in terms of assets with Lehman's $691 billion
in assets all past annual totals.
• The year also saw the ninth biggest
bankruptcy with the failure of IndyMac Bank
• On September 29, Citigroup beat out
Wells Fargo to acquire the ailing Wachovia's
assets will pay $1 a share, or about $2.2 billion.
• In addition, the FDIC said that the agency
would absorb the company's losses above $42
billion; in exchange they would receive $12
billion in preferred stock and warrants from
Citigroup in return for assuming that risk
 How The Government Tackles
Recession
• Tax cuts are the first step that a government
fighting recessionary trends or a full-fledged
recession proposes to do.
• The government also hikes its spending to create
more jobs and boost the manufacturing and
services sectors and to prop up the economy.
• The government also takes steps to help the
private sector come out of the crisis.
• In the current case, the Bush government has
proposed a bailout package.
• Initial estimates of the cost of the Treasury
bailout proposed by the Bush Administration's
draft legislation (as of September 19, 2008) were
in the range of $700 billion to $1 trillion U.S.
dollars.
• President George W. Bush asked Congress on
September 20, 2008 for the authority to spend as
much as $700 billion to purchase troubled
mortgage assets and contain the financial crisis.
• The crisis continued when the United States
House of Representatives rejected the bill.
• The bill was eventually passed by the Senate
and the House but the stock market continued
to fall nevertheless
 Impact On India
• A slowdown in the US economy is bad news
for India.
• Indian companies have major outsourcing
deals from the US.
• India's exports to the US have also grown
substantially over the years.
• Indian companies with big tickets deals in the
US are seeing their profit margins shrinking.
• More people have sold the shares in the indian
share market than they bought in the recent
weeks. This has added to the fall of sensex to
lower points.
• One danger meanwhile is of a dip in the
employment market. There is already anecdotal
evidence of this in the IT and financial sectors,
and reports of quiet downsizing in many other
fields as companies cut costs.
• More than the downsizing itself, which may not
involve large numbers, what this implies is a
significant drop in new hiring -- and that will
change the complexion of the job market.
• Many companies has laid off their staffs, the
number of tourists inflow to india has come
down, companies have cut down compensations
and perks etc, government and other private
companies are reluctant in starting new ventures
and starting new projects etc.
• Projects that are halfway to completion, or
companies that are stuck with cash flow issues
on businesses that are yet to reach break
even, will run out of cash.
• one of the casualties this time could be real
estate, where building projects are half-done
all over the country and in this tight liquidity
situation developers find it difficult to raise
finances.
• The only way out of the mess is for builders to drop
prices, which had reached unrealistic levels and
assumed the characteristics of a property bubble, so as
to bring buyers back into the market, but there is not
enough evidence of that happening.
• Consumers are also frozen in this sudden glare of the
headlights.More expensive money means that floating
rate loans begin to bite even more; even those not
caught in such a pincer will decide that purchases of
durables and cars are not desperately urgent.
• At the heart of the problem lie questions of
liquidity and confidence.
• What the RBI needs to do, as events unfold, is to
neutralise the outflow of FII money by unwinding
the market stabilisation securities that it had
used to sterilise the inflows when they
happened.
• This will mean drawing down the dollar reserves,
but that is the logical thing to do at such a time.
• If done sensibly, it would prevent a sudden
tightening of liquidity, and also not allow the
credit market to overshoot by taking interest
rates up too high.
• Meanwhile, there is an upside to be considered
as well.
• The falling rupee (against the dollar, more than
against other currencies) will mean that
exporters who felt squeezed by the earlier rise of
the currency can breathe easy again, though
buyers overseas may now become more scarce.
• Overheated markets in general (stocks, real
estate, employment-among others) will all
have an element of sanity restored.
• And for importers, the oil price fall (and the
general fall in commodity prices) will
neutralise the impact of the dollar's decline
against the rupee.
 Thank You

http://prochow.blogspot.com