From WSJ 12/28/2009
It was a year when the most dire financial predictions finally came true.
After years when the housing bubble inflated, American credit-card debt soared and global stock markets set record highs, everything was brought back to earth in 2008.
The Dow Jones Industrial Average, off 36% year to date, is on pace for its worst return in 77 years. European stocks have done even worse, and once-high-flying emerging markets lost nearly half their value over one four-month period this year.
That left panicky investors with few secure options, other than retreating to the safety of U.S. government debt, where one-month notes sold in December yielded essentially nothing. Also this month, the National Bureau of Economic Research declared what many business executives and consumers already felt intuitively: The U.S. is mired in a recession, which the NBER says began in December 2007.
Over the Brink
Has there ever been a year when so many once blue-chip financial companies were pushed to the brink, and in some cases over it?
Shortly after Labor Day, the federal government seized mortgage giants Fannie Mae and Freddie Mac, sticking the American taxpayer with billions of dollars in losses from bad home loans.
The 158-year-old brokerage firm Lehman Brothers Holdings received no such help when it couldn't raise cash, and was forced to file for bankruptcy protection. Insurance giant American International Group narrowly avoided the same fate by agreeing to hand over control in exchange for an $85 billion loan from Washington.
While AIG survived to live another day (and borrow even more taxpayer money), the net effect of these meltdowns was to cause the credit markets to freeze up further, preventing businesses across the country from borrowing money to meet even basic operating needs, like payroll.
Economists now fear that financial-industry disasters could splash across the industrial sector. Already, the auto industry has required government loans to stay afloat. These loans can be recalled if General Motors and Chrysler don't demonstrate by March 31 that they are financially viable.
Several forecasters are now suggesting the U.S. is in the midst of the worst economic downturn since the Great Depression. But even if the overall prognosis is for more belt-tightening, job losses and bankruptcies, there's at least some reason for hope buried underneath much of the obvious gloom.
Start with the U.S. economy. In November, the U.S. lost more than half a million jobs -- the largest one-month drop since 1974, which brought total job losses this year to nearly two million.
Economists say with near certainty that the U.S. is in the most protracted recession since the end of World War II. The country also faces the worst housing market in generations. One out of every 10 mortgage holders is in arrears or has had his or her home repossessed.
Washington Rescue
Don't expect the Federal Reserve to ride to the rescue by cutting interest rates, as it did during the emerging-market crises in the late 1990s and earlier this decade. With the Fed's target interest rate between zero and a quarter percentage point, it can hardly do much more.
So whatever help Washington can bring will likely be on the fiscal side, through more spending or tax relief. President-elect Obama has pledged a $1 trillion stimulus package. To put it in perspective, that sum would exceed, in inflation-adjusted dollars, government spending on the New Deal, the savings-and-loan crisis and the Marshall Plan combined, according to Bianco Research.
Questions abound about how effective Mr. Obama's strategy will be in reviving the economy.
But there is already popular sentiment that the new president's plan to jump-start growth by rebuilding crumbling bridges and roads, extending the nation's broadband reach and increasing energy efficiency could have positive long-term effects, even if these projects don't shorten the recession. At least, more so than modest tax-refund checks sent earlier this year.
If there's been any obvious benefit to the economic slowdown, it has been the collapse in the price of oil, which has made filling up the gas tank less painful and even led some airlines to recently cut their fuel surcharges.
Oil bulls saw triple-digit prices as here to stay, arguing that demand from the expanding middle class in China and India alone would maintain price pressure. A Goldman Sachs analyst famously predicted $200-a-barrel oil. Crude peaked at $147 a barrel in July. Now even OPEC output cuts can't seem to stem the price declines.
Other commodities, like copper and grain, have also fallen hard, victims of a global recession that economists now believe will envelop even the fast-growing economies of the developing world.
The downside? Low fuel costs will likely blunt any sense of urgency to develop alternative energy sources, and many analysts see oil prices shooting back up as the world economy grows again.
No Quick Rebound
Most equity strategists don't foresee a powerful rebound in the stock market in 2009. But for investors with a longer-term horizon of a decade or more, there's unusual agreement -- ranging from legendary investor Warren Buffett to perpetual bears like Jeremy Grantham, chairman of money-management firm GMO -- that stocks look attractively priced and now is a good time to buy.
U.S. investors have shown an even greater aversion in recent months to foreign stocks: Mutual funds that invest overseas suffered their worst outflows in more than a decade in October, reversing record inflows from previous years. Even so, returns for emerging markets are expected to surpass those in the U.S. over the next couple of decades, making them solid candidates for long-term holdings.
For weeks, the U.S. dollar shrugged off the financial crisis and rebounded powerfully against the euro and many emerging-market currencies. It turns out traders still look to the dollar in crisis periods, even ones of America's own making, especially at a time when the rest of the world looks troubled, too.
A stronger dollar has a wide range of implications for financial markets, from making foreign stock and bond returns lower when translated into dollars to boosting American purchasing power of foreign goods.
Borrowing Hurts Dollar
But the dollar's sudden strength is now being put to the test. Washington's stepped-up borrowing spree and rock-bottom U.S. interest rates, which give investors little incentive to hold dollar securities, have led to a recent selloff.
Much of the stimulus package will be financed by Treasury debt sold to foreign investors. With economic growth slowing dramatically in China -- which in September became the largest holder of U.S. Treasurys, with securities valued at $585 billion -- will there be enough foreign demand for U.S. government debt? If not, the dollar could continue its tailspin just as other U.S. assets start to stabilize.
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