Thursday, September 10, 2009

The Shape of the Recovery: Lopsided W

I'm making my prediction for what this recovery will look like. Here goes: lopsided "W."

In other words: the economy takes a dip (the first sliding line of the "W"), makes a brief upward surge (the crest in the middle, which is where we are now), then slides downward again, even deeper, before we begin climbing out of the hole.

Why "lopsided": I think the "green shoots" happy talk and the stock market's inexplicable lunge higher are going to wither and blow away ... leaving us in a state of renewed fright that will drive the economy lower than before. By this view, the next leg down will be the harsher one, thus creating a lopsided "W."

I hope I'm wrong. I really do. But the big problem, from where I sit, is that we haven't really stared down the beast that got us into this mess. We have changed little at the heart of our financial system, prosecuted few of the bad actors and avoided acknowledging how much rot still plagues the balance sheets of the big banks.

That brings me to today's must read, by guest blogger George Washington at naked capitalism: The Economy Will Not Recover Until Trust Is Restored.

The author's thoughts closely mirror my own and capture the broad reasons for my pessimism about this economy. The piece is a good roundup of how trust has broken down -- investors don't trust the stock market, big banks don't trust each other, citizens don't trust the government -- and why this lack of trust is, to be perfectly blunt, like a cancer that is keeping us ill.

Some highlights summarized:

1. The Fed's policy of flooding the financial system with money is misguided, eminence grise Anna Schwartz tells us (again). The Fed is treating the financial mess as one of liquidity (shortage of money). But it's actually a crisis of trust -- banks don't have faith in the reported soundness of each other's books. They are reluctant to lend to each other because they can't tell who really is and isn't solvent.

2. Robert Reich: "The trouble, in a nutshell, is that the financial entrepreneurship of recent years — the derivatives, credit default swaps, collateralized debt instruments, and so on — has undermined all notion of true value." So again: investors have trouble "trusting" the price tag on a range of complex products.

3. This, from the author: "I would argue that our economy is not fundamentally stabilizing (notwithstanding a couple of temporary “green shoots”) because the government and the financial giants are taking actions and releasing data which encourage more distortion and less trust. The crisis will deepen unless honest and transparent accounting is used, investments become transparent and understandable again, and the government stops gaming the system for the benefit of the big boys."

4. Americans have suffered the psychological wounds from a betrayal of trust. Regulators that were supposed to protect us from greedy financiers running amok were nowhere in sight. Psychologically, the trauma of loss that citizens experienced is compared, perhaps a bit hyperbolically, to the devastating blow of Sept. 11.

5. Obama's team is simply trying to restore confidence instead of trying to address the underlying issues that caused the erosion of that confidence. This will backfire, Yves Smith predicts. If the economy does make a second, more pronounced dip, people will be more warier when the government starts talking again about "green shoots" and "recovery," having been burned once. That distrust will act to hamper the actual, real recovery.