US Recession

by hitesh sahni
http://www.hiteshsahni.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