Q&A – What’s the Current Recession Risk?
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Today’s Entry: Brian, I’m now worried we’re already in a recession and it's just not being reported yet. I’ve heard you briefly float the idea a few times. If I heard you correctly, the last time I heard you discuss the possibility, you mentioned something about Bear Stearns being a tipoff to 2008’s recession. Can you please explain what you meant by that? Also, I’d like to hear your best case for why we might already be in a recession right now and your best case for why we might avoid going into a recession.
Bottom Line: Somewhat ominously in terms of the timing of this question, it was 14 years ago today CNBC’s Jim Cramer declared Bear Stearns was fine and that investors should keep their money in Bear Sterns stock. It was just six days later, March 17th of 2008 that it collapsed. It was the “black swan” event that confirmed my suspicion that we were in a recession but just hadn’t realized it yet. For those who don’t know, my background outside of radio is in business (though I was working in radio at the time as well). I founded my first company, Maui Smoothies, at 17 and later the investment firm Poplar Bloom. When I was relocated from Georgia to South Florida by iHeart in 2005, my experience and background in business and financial analytics led to me being brought on as a financial analyst for the purpose of my on-air contributions. While much of my reporting focused on South Florida’s housing market leading up to the crash – including identifying the peak of the early 2000’s housing boom in May of 2006 – a year and a half earlier than the onset of the Great Recession - the Bear Stearns event became a flash point. The kind I look for when attempting to determine whether we’re experiencing recessionary conditions.
Bear Sterns, like many financial firms at the time, was heavily involved in the business of buying, bundling and reselling complicated financial products, commonly involving mortgages. In order to do this they leveraged their balance sheets with lots of debt to buy the mortgages and other financial products that they’d then bundle and resell. With home prices continuing to rapidly appreciate, and with there being no shortage of buyers of the packaged products, it was easy to make money doing this provided there were mortgages being originated and buyers for the bundled products on the other end. The first sign of trouble came in 2007 with rising default rates by homeowners who had been placed in mortgages they couldn’t afford to sustain. Financial companies tended to look the other way because even foreclosures often came at a profit for these companies as they could sell the homes at ever higher prices. However, as default rates continued to rise into early 2008, and having already identified that while real-estate had still been appreciating across most of the country (it'd already peaked nearly two years previously in South Florida - the one-time hottest housing market in the country); I began to voice concerns because that behavior wasn’t sustainable. However, analysts like Cramer, and economists kept creating excuses as to how it’d somehow work out. Then the Bear Stearns collapse happened. The biggest tell in the Bear Stearns collapse is that they were profitable on the day they collapsed. You might wonder how it is that a company could be profitable and yet collapse. Exactly, that was the point.
The Bear Stearns business model had become so reliant on leverage and the timing of cash flow that they couldn’t afford even minor blips in the timing of transactions closing to sustain their model. To keep the ball rolling they needed to constantly be buying wholesale mortgage products that they could then bundle to sellers they already had ready to buy on the receiving end. The reason Bear Sterns collapsed when they did is that the timing didn’t work out that particular day. Liquidity needed from their bundled sales didn’t come through on schedule and the business was so leveraged, they had a liquidity crisis and literally couldn’t fund that day’s business operations with resources on hand. Every company engaged in similar practices was set for failure. It was at that point I stated we were almost certainly in a recession though we didn’t realize it and systematically identified financial companies and banks which were exposed and likely to fail. By June I began to warn on-air that any investors who needed money for the next several years should get to the sidelines in the stock market – the only time in my career I’d said anything to that effect. This was all months in advance of the full fledged financial crisis which became realized in the fall of 2008.
The takeaways from the Bear Stearns example are applicable right now. Most economists and analysts are wrong at key inflection points because they analyze data after its already happened as opposed to analyzing what’s happening right now but hasn’t been documented. You need look no further than the bad joke that inflation was to only be “transitory” all throughout last year as it rose ever higher. The Federal Reserve and economists only admitted it wasn’t after eight months of data and 40-year high inflation. Honestly, and it's not to pump myself up, but these people really suck at what they do – so the last thing I do is rely on their guidance and take what they say at face value. By definition a recession is six consecutive months of an economic decline. That means it's not even possible to define a recession until we’ve already been in one for at least seven months. By then it's too late for people who needed to make adjustments to in their lives, spending habits and investments to do so without suffering the consequences of being caught in the same cycle as everyone else.
The reason I’ve brought up the ‘r’ word, starting in January, and this is my best-case recession argument (as you put it), comes down to these realities.
- Small businesses have fired more than they’ve hired in 2022
- Wage growth has been 5.1% year over year. Inflation has been 7.9% year over year
- The gap between income growth and inflation is widening
- 75% of Americans are now adjusting consumer behavior due to gas/prices inflation
It’s not complicated. Despite good overall job gains so far in 2022, it's been all about large companies hiring. The headline numbers hide the fact that small businesses, which are the most economically sensitive, went from saying they couldn’t hire enough people to keep up with the demand in their businesses just a few months ago to laying people off in January and February. That alone would have my attention but then there’s all the other obvious stuff about inflation. It’s like this. 70% of the US economy is consumer spending. If we start spending less on discretionary purchases because the basic cost of life continues to rise faster than our income that’s a huge problem. It’s the wage gap / inflation argument that’s being attempted to be explained away by the oft wrong economists and analysts that’s the most concerning. It’s not complicated. If inflation continues to rise faster than wages the story won’t end well. Period. The average American has 2.8% less buying power today than they did a year ago. Nothing about that suggests economic growth. The only reason there has been and could potentially continue to be is related to my best-case argument for why there won’t be a recession:
- Strong job gains from previously locked down/restricted parts of the country continue to recover
- International travel/demand continues to increase after essentially two years of not having access to the US
- Potential for peak inflation this month
The idea goes like this. The strong job gains in still recovering parts of the country, in conjunction with improving international travel and demand for US destinations, provides enough new economic fuel for the economy to offset the loss of buying power of the average American who had already been in the workforce. Those trends hold until inflation recedes below the rate of income growth. Additionally, should the Ukraine war prove to be the biggest inflection point in the cycle, there’s the potential for inflation to peak this month putting less pressure on the economy going forward.
So, there you have it. I’ve reported and now you can decide what you think is most likely to happen. I’m not personally convinced one way or the other yet. There’s not been a “Bear Stearns” type of event yet. But then again there doesn’t have to be something so dramatic because every recession is different and that one in-particular was the 2nd worst in American history. The reason I occasionally mention it, is because it’s very possible in this environment and I don’t want you to be stuck learning the hard way five months from now.