- The Washington Times - Sunday, March 8, 2009

Wall Street’s monumental sell-off last week, with major stock indexes falling to levels not seen in a dozen years, reflects a rapid unraveling of the economy that was spawned by the collapse of the biggest credit bubble in history.

Credit is needed by every player in the economy from consumers to businesses to investors and the government, much like a body needs oxygen, economists say. When the oxygen is cut off, the patient goes into a coma, and survival is in question. That is what has happened to the economy since a severe credit crisis broke out in September, and the markets are reflecting the patient’s waning vital signs.

The alarming free fall of the economy is wreaking havoc on American consumers, businesses and markets. Within months, it has sent the jobless rate soaring to its highest point in a quarter century and driven consumer confidence to record lows, while chopping half the value off a typical investor’s stock portfolio. It has imperiled people’s retirement, as well as their employment.

Credit markets are in disarray - with some having died altogether in recent months. The stock market is experiencing its worst bear market since the Great Depression. The Dow Jones Industrial Average ended last week a little above its lowest levels since April 1997, while the Standard & Poor’s 500 index registered a 13-year low of 683 during the week.

“The economy is suffocating,” said Sung Won Sohn, professor at California State University, Channel Islands. “The stabilization of the credit market is a prerequisite for stopping the hemorrhage in jobs” as well as producing a recovery in the stock market, he said. “The government must present a clear blueprint detailing how the financial market will be stabilized.”

Wall Street analysts say the massive deleveraging of the U.S. and global economy in the wake of an unprecedented worldwide credit bubble is mostly responsible for huge stock losses. But a grim bear market psychology also has set in that is taking a toll, especially on struggling financial firms and other stocks hit hard by the credit crunch.

An army of short-sellers has focused on wounded companies like Citigroup and General Motors Corp., for example, driving Citigroup’s stock below $1 for the first time Thursday. So many former blue-chip stocks have fallen below $1 recently that the New York Stock Exchange has loosened its rules to avoid having to delist them as “penny” stocks.

GM shook markets Thursday with a report from its auditors stating that the company is insolvent and will not survive without more government loans. GM’s stock, also a target of short-sellers trying to profit from the downturn, plummeted more than 15 percent to $1.86.

Another corporate giant victimized recently by the credit crisis is General Electric Co., an icon of industry that was once considered a model of how to succeed as a large multinational firm. A large share of GE’s most profitable business in the past was financial, but GE’s stock has plummeted from $30 to $6.66 as credit losses mounted at its finance arm, GE Capital. GE is one of a handful of corporations worldwide with a AAA credit rating, and the company’s troubles securing credit recently has raised worries of a first-ever downgrade.

The troubles of such corporate titans have added to the market’s grim psychology. Investors not only are grappling with monumental losses in what were once blue-chip stocks, but they cannot foresee which, if any, corporate giants will rise in their place to lead the market forward in the future.

“Talk of depression is fashionable, and many are now giving up hope” in the stock market, said Richard Berner, chief economist at Morgan Stanley. But he said the market’s downturn is justified by the turn for the worse in the economy this year, and it may need to go still lower.

Despite the deep cuts in production and jobs that already have been announced, more cuts are needed to bring production in line with extremely weak demand from consumers and businesses, Mr. Berner said. Consumers are only willing to open their wallets for the direst necessities right now, like heating their homes and buying food, he said.

Consumers and businesses alike are having great difficulty obtaining credit since the collapse of the worldwide credit bubble. But the economic problems have gone well beyond that. Perhaps the most telling sign of how weak the economy is came last week, Mr. Berner said, when GM and other auto companies reported that even aggressive financing incentives they were able to offer with government aid last month didn’t help to spur buying or prevent a 27-year low in sales.

Because of these dark developments, investors should not rush back into stocks, despite their enticingly low levels, Mr. Berner said.

“Now that equities stand at 14-year lows and 55 percent below their October 2007 highs, they do reflect a lot of bad news - but maybe not quite enough,” he said. “The further slide in production that we expect suggests that the near-term risks for earnings point down, and a rapid turnaround seems unlikely.”

David Kelly, chief market strategist at JPMorgan Funds, said worries about the economy and banking system have sent investors fleeing into safe-haven investments like gold and Treasury bonds, renewing the downturn in stocks after a brief respite around Christmas.

“Uncertainty about the economy, the banking system and the direction of government policies have all made investors extremely wary of putting money to work, leading to a big buildup in cash accounts,” he said. Consumers also are stashing their money in savings accounts for the first time in years.

“It is as if investors and consumers alike have drawn in their breath,” Mr. Kelly said. “While this is very negative for the economy and markets right now, it does suggest the possibility of a sharp rebound in markets when the economy finally shows signs of improvement and investors and consumers feel able to exhale again.”

There are a few optimists. Dan North, chief economist at Euler Hermes, a leasing firm, sees all the extreme bearishness on Wall Street as a good sign because it suggests that the stock market may be nearing a bottom and the recession may be close to an end.

Pointing to headlines in the Wall Street Journal about an “unending nightmare” for investors, he noted that “this is the kind of ‘I give up’ attitude which presages a bottom.” Typically, stock prices start rising after investors “capitulate,” and a sustained rise in the stock market often presages a recovery in the economy.

“If you use the stock market as a harbinger of the overall economy, then a turnaround could be on the horizon,” Mr. North said.

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