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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
• 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
• 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
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
• 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
• 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

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