What If America Goes Into Another Recession?

Unemployment could jump to 13%, recalling the breadlines of the 1930s. The Dow Jones industrials might plunge 50% to 5,668, a level last reached before the dot.com boom in the mid-1990s. Output might shrink at an 8% annualized rate, wiping out two whole years worth of growth. And anyone lucky enough to have a job or cash left after the carnage could snap up a home at November 2000 prices.
Stella Dawson reports for Reuters, Nov. 23, 2011, that the dire picture is what the Federal Reserve wants U.S. banks to imagine when they test their balance sheets for resiliency against a major economic shock.

Photo by Shannon Stapleton, Reuters

(A recent Zogby Poll found that the percentage of U.S. adults who believe it is possible for themselves and their families to achieve the American Dream has dropped to 50%, down significantly from the 68% who said the same in November 2008.)
The Fed last year began running banks through annual “stress tests” to measure how their balance sheets and capital buffers would cope with conditions in the consensus economic outlook, plus a major shock. On this past Tuesday, it announced details of how it will conduct its round for 2012 release.
The dire picture painted by the Fed sounds shocking, but it’s based upon actual experience of severe recessions, such as 1973-75, 1981-82 and the firestorm that swept through the United States after the shock bankruptcy of investment bank Lehman in September 2008, which ushered in the worst recession since the 1930s.
Next time around, however, damage could be even worse because the U.S. economy would enter in a weakened state. It is still healing from the last recession and a second blow could be crippling.
The Fed also notes risks from overseas. “An outcome like the supervisory stress scenario, while unlikely, may prevail if the U.S. economy were to experience a recession while at the same time economic activity in other major economies were also to contract significantly,” it said.
If the United States were to enter a deep recession in the fourth quarter of this year, the Fed’s worst-case scenario envisages the euro zone hit hard, suffering almost two year’s of contraction until mid-2013, while output shrinks by a more than 6% annualized rate at its depths.
Few economists predict a U.S. recession, though uncertainty is rampant. A Reuters poll earlier this month put the risk at 25%, down from 30% the prior month, and recent U.S. economic data has slightly improved.
The Fed’s latest stress test is tougher than the last — little wonder, noted Nomorua Equity Research, given Europe sliding back into recession, China slowing, financial markets in turmoil over the euro-zone sovereign debt crisis and an uncertain U.S. fiscal picture.
But Richard Bove, a banking analyst at Rochdale Securities, says it is irresponsible to put 31 U.S. banks through a worst-case scenario. A stress test this tough risks forcing banks to prepare for the worst, possibly creating what regulators fear.
Bove told Reuters Insider Television: “This is a really stupid stress test. They [banks] are going to dump loans, they are going to stop lending and they are going to put us into the recession that the government wants to know how they will function within.”
Srinivas Thiruvadanthai, director of research at the Jerome Levy Forecasting Center, disagrees. He welcomed the Fed’s move, saying it will hasten a shrinkage of bank balance sheets that is much needed to match a slower-growing economy.
See also “Why the Collapse of MF Global Should Frighten You.”

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8 years ago

We haven’t gotten out of the first recession yet.

8 years ago
Reply to  Dave

Too, too true! Those who fear bank defaults can buy an inverse ETF to financial failure: the worse it gets, the more you profit. You must take profits in a timely way: this is a “musical chairs” era, those who stay in too long may get burned. In Canada I use HFD [Horizons Financial Down] there are identical in the US, likely several to choose from. I use HB S&P/TSX CP FN BEAR, 500 shares bought at C$ 8.20, now @ $9.60. I had another 500 which were bought at $ 7.70, but I took profits and bought more Continental… Read more »

8 years ago

“Few economists predict a U.S. recession, though uncertainty is rampant.” What do economists know? Very little. They are 100% accurate about the past and can’t predict the future worth a devalued dollar.

8 years ago
Reply to  walthe310

In “Lighting Out for the Territory Ahead”, my central essay on the realities we live under, which was posted by DINL as their premier article when their new website was created, now a fine, international Conservative success, I used the example of Dr Samuelson’s standard college economics textbook, and his dreadful mindless “reasoning” that physical materiality is able to expand infinitely to accommodate an endlessly growing economy. Such God-like hubris has rarely been known, but leave it to an economics professional to “know it all”! Does the good Dr really believe that we can pull three more planet Earths from… Read more »