Our Current Dilemma and Modern Recession History

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A Comment written by Rich Marino

Whenever I’m home, I am always more than amazed at the political debates that take place in my country. At this point in time, both the Senate and the House are at odds about the size and scope of the Obama stimulus package. On the Republican side, there seems to be some disagreement in Obama’s stimulus message to “buy American” which they say is nothing more than protectionism. On the other hand, some members of the President’s party disagree with the sheer size of the package.

All of this squabbling, wrangling and child-like behavior begs the pertinent question: whatever happened to common sense? Obviously if the intent of the stimulus package is to create American jobs, and it’s paid for by the American taxpayer, we have no other choice than to create jobs for Americans which in this case has nothing to do with protectionism. In essence, the unemployed American is buying himself a job! In terms of the size, in my opinion $850 billion may not be big enough.

Given the fact that roughly three weeks after he’s been in office the media has proclaimed the end of President Obama’s honeymoon, and some have even written his political obituary, I thought that it would be more than appropriate to learn about the history of recessions in America from the 1960s to 2001, but more importantly, I wanted to try and understand how American recessions impacted the rest of the world through the lens of an historical perspective.

American stimulus legislation has been enacted in five of the last seven recessions: 1964, 1971, 1975, 1981, and 2001. The stimulus efforts made in the 1960’s and 1970’s were proven ineffective for a number of reasons mainly because the political landscape was too slow to react. If anything our political leadership over the years has learned that if it’s their intent to reverse or stave off a deeper recession, they have to act expeditiously. “The policy was baked in the cake before we knew we were in a recession”, says Pete Davis, president of Davis Capital Investment Ideas. In the past, Davis has worked for both sides of the aisle in Congress creating stimulus packages. Furthermore, he claims that: “if we’re going to do it let’s do it quick.”

I can personally make the case that the recessions of 1981 and 2001 were more of a walk in the park compared to what the world faces today. On the surface, it appears that there is always a precursor in the form of a financial calamity or a great misfortune which in turn becomes the catalyst for an upcoming recession. In this instance in 1980, Congress with all of its infinite wisdom passed the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) which reduced the restrictions on banks with respect to their lending practices, i.e. cash reserves, speculative loans, mortgage loan due diligence, and so on.

By 1980, the United States had just come out of a decade that was for the most part out of control by the oil and energy crises which resulted in stagflation (a stagnant economy and high inflation: 13.5% 1980) and very high interest rates which in turn helped create the 1981 recession. The 1981 recession wreaked havoc and exacerbated the ongoing savings and loan debacle which from its very beginning replicated more of a modern day “Madoff Ponzi Scheme” where the customers in many instances became the shareholders, and most management knew absolutely nothing about running a savings and loan. The lure for the savings and loan investor (shareholder) was the “safety” found in the federal funds overnight rate (20% 1981). Sounded fine until someone realized that in order to be a savings and loan, you had to make loans! Most savings and loans especially in California were ill-equipped in terms of management appraisals to make prudent, reliable loans.

Consequently, The Federal Savings and Loan Insurance Corporation (FSLIC) which later merged with the Federal Deposit Insurance Corporation (FDIC) exercised its authority, and expeditiously, sold off the insolvent savings and loans to financial organizations with a proven history of financial experience and a sound balance sheet plus the FDIC protected the depositor up to $100,000 per account. In 1981, a large part of the stimulus package was based on the estimate required to eradicate the S&L problem loans plus it provided the necessary capital for the S&L survivors to make the transition from savings and loans to mainly savings banks. Does any of this sound familiar?

Indirectly, the 1981 recession was for the most part an economic and political spillover from the United States to the rest of the world. In order to offset high inflation rates, most governments created an anti-inflationary monetary policy.

Following along with my precursor theory and as illogical as this may sound, there was a very sophisticated Connecticut based hedge fund named Long Term Capital Management (LTCM) who had as part of its principal management two Nobel Prize winning economists: Myron Scholes and Robert Merton. Moreover, the executive management of the firm was handled by John Meriwether, former head of Salomon Brothers and David Mullins, a former Vice Chairman of the Federal Reserve. In 1994, this blue-ribbon team of scholars and high level financial practitioners devised a derivatives trading strategy that in the beginning produced incredible profits (annualized returns of over 40%) for its investors for the years 1994-1997, but in 1998 the international banking system overwhelmed the strategy to the point that it began to unravel, and it almost caused a complete and utter world financial collapse not unlike the financial disaster of today. In 1998 under the guidance of the Federal Reserve Chairman and in an attempt to circumvent an international financial collapse, LTCM was taken over by a consortium of the largest banks in the United States. The collapse of LTCM unfortunately helped usher in and exacerbate the 2001 recession. Ironically, the 2001 recession has many of the same characteristics found in the world financial calamity of today, but with much less severity.

Unfortunately for all of us, what’s taking place today could have been avoided if not for a blind eye and the inherent greed found at the very heart of the world financial community!

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