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The "R"-Word and the Perfect Storm

Written By Brian Hicks

Posted November 26, 2007


Of all of the most overused phrases on earth these days, "The Perfect Storm", has be the absolute king of them all.

But when it comes to the current economic mess that we find ourselves in, it is probably the most appropriate nonetheless.

Because as the readers of the book know all-to-well Sebastian Junger’s title phrase perfectly described what happened when three relatively disparate weather systems collided with one another in October 1991.

The result was nothing less than "The Storm of Century."

It was used again yesterday by Lawrence Summers.

From the Financial Times: Wake up to the dangers of a deepening crisis

" Three months ago it was reasonable to expect that the subprime credit crisis would be a financially significant event but not one that would threaten the overall pattern of economic growth. This is still a possible outcome but no longer the preponderant probability.

Even if necessary changes in policy are implemented, the odds now favour a US recession that slows growth significantly on a global basis. Without stronger policy responses than have been observed to date, moreover, there is the risk that the adverse impacts will be felt for the rest of this decade and beyond.

Several streams of data indicate how much more serious the situation is than was clear a few months ago. First, forward-looking indicators suggest that the housing sector may be in free-fall from what felt like the basement levels of a few months ago. Single family home construction may be down over the next year by as much as half from previous peak levels. There are forecasts implied by at least one property derivatives market indicating that nationwide house prices could fall from their previous peaks by as much as 25 per cent over the next several years.

We do not have comparable experiences on which to base predictions about what this will mean for the overall economy, but it is hard to believe declines of anything like this magnitude will not lead to a dramatic slowing in the consumer spending that has driven the economy in recent years."

"Banks and other financial intermediaries will inevitably curtail new lending as they are hit by a perfect storm of declining capital due to mark-to-market losses, involuntary balance sheet expansion as various backstop facilities are called, and greatly reduced confidence in the creditworthiness of traditional borrowers as the economy turns downwards and asset prices fall."

And to think, it all started when Alan Greenspan and his buddies thought that it was a good idea to take the Fed Funds Rate to 1% and leave it there for a year.

So much for the smartest guy in the room.