What does a Depression look like? It’s been a long time since we had one, so it’s hard to tell exactly. The main feature is that a tremendous amount of money that was once in the system evaporates, leaving a huge shortage of resources to carry on the normal functions of the economy. If that seems unlikely, consider some of the things which happened last week on Wall Street:
* Legg-Mason, a major mutual fund manager, saw their stock fall 14% on the week as short interest (the number of shares borrowed and sold in anticipation of further declines) doubled.
* Merril-Lynch is writing off another $6 billion in bad debt
* Morgan Stanley had their bond rating cut by Moody’s to near junk status in anticipation of large losses ahead.
* Goldman Sachs declared Citibank to be a good short candidate, meaning they are very confident of a major fall.
What do all these little tidbits mean? I’ll start with the last one, because I think it shows the change in direction. Wall Street financial giants never, and I mean never, go after each other. They offer honest opinions and make downgrades, yes, but I’ve never seen one large house advise shorting another. They might as well have pulled their schooner up alongside and affixed the grappling hooks for boarding; this is something akin to piracy. Why did they do it? My guess is that they didn’t just see it as a good call, they saw it as a screamingly obvious call. It’s now every investment house for themselves.
The other item that may be very important is the fall of Legg-Mason, which is the home of mutual fund legend Bill Miller. Stock in the overall company has been cut in half since October, largely because it has heavy exposure to building and real estate companies. Its $11B is also invested in a lot of tech companies, and they are the largest shareholder in Amazon. They get this money from 401(k) funds and other people who invested in what’s been one of the hottest mutual funds around. What happens when Baby Boomers, median age 56 and climbing, see major losses on their statement? They will start “preserving capital”, which is the fancy way of saying they’ll put everything they have into someplace safe. Safe means “not Wall Street”.
When the financial institutions are in this kind of meltdown, the possibility of a major loss of money is very real. That means that a Depression is a distinct possibility, too. If we start going down this path, it’ll take a lot more than “economic stimulus” to correct it. More like “Economic CPR” will be in order.
Before we go any further with this thinking, we have to look at what happened the last time we hit a Depression. Contrary to popular belief, the stock market crash of 1929 was not the start of the Great Depression but the end of the beginning. The real problem started with major unemployment fueled by a sharp decline in manufactured exports (we used to make stuff in the USofA). When crops failed across the Midwest, a number of banks failed and started the incineration of wealth that led to the collapse on Wall Street.
Will it happen that way again? It’s hard to say. We don’t have the manufacturing base we once did, and a tremendous amount of our wealth is tied up in Wall Street, not the First State Bank of East Podunk. But regional banks are worth watching, if for no other reason than to see how the problems on Wall Street reverberate through the nation.
It is looking a lot like a Depression is coming unless something is done about it. I expect that something will be done, so I am not predicting a Depression. But exactly what we can expect to be done depends a lot on how all of this shakes out in today’s economy. It’s something like watching a train wreck in super slo-mo, except that we’re all on the train together. I hope we remember that.