Is A 'Greater Recession' Inevitable?

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The global volume of debt carrying negative yields now stands at $17 trillion. Under the circumstances, it hardly qualifies as a bold prediction that bond investors will incur substantial losses at some point down the road. Neither does it represent outside-the-box thinking for self-styled truth-tellers to declare that the eventual interest rate rebound that inflicts those losses will be followed by a recession.

That series of events would amount to a fairly ordinary economic/market cycle.  For institutional investors, periodic, severe hits to their portfolios come with the territory. A saving grace is that having a major hedge fund go bust now and then may very well promote market stability in the long run. It reminds the others that leveraged speculation entails risk.

There is a considerable leap, though, from the uncontroversial assertion that interest rates will someday rise, producing bond losses, to the conclusion that the next recession will be worse than the Great Recession of 2008-2009.

That is what investment strategist Peter Schiff recently predicted. Along with certain other pundits who contend that the Bond Bubble they perceive will end in disaster, Schiff can point to a record that make him worth listening to. Prior to 2008 he was prescient in warning that a collapse in housing prices would have devastating economic effects.

Challenges to the Doomsday Scenario

It is essential, though, to remember that what differentiated the Great Recession from previous post-1930s economic contractions was a full-fledged financial crisis. If not for massive government intervention, Lehman Brothers would have been merely the first in a series of bankruptcies by leading investment banks. At the low point, money center banks were fearful of lending overnight to one another, not knowing what the morrow would bring. To make a persuasive case for a Greater Recession in the next year or two, forecasters must explain why the banking system remains as vulnerable as it was in 2007, despite substantial tightening of bank regulations since then.

Note, too, that the market commentators who were vindicated by the last recession’s severity are by no means unanimous in claiming that the worst is yet to come. Nobel economics laureate Robert Shiller is perfectly willing to sound an alarm when warranted. Like Schiff, he foresaw the housing collapse that led to the Great Recession. In a recent interview with Bloomberg News, Shiller was asked whether the next U.S. recession would be major or mild.

Far from exclaiming, “Major, obviously!” he replied, “The question is what would make it bad. It would be some kind of scary narrative that comes back with new force, like a Great Depression narrative, or even the 2008 narrative coming back.” Shiller did not come close to indicating that the return of such a narrative was inevitable. “In the U.S., confidence has held up pretty well,” he said. “It hasn’t been growing rapidly, but it’s still up there so people are not scared.”

An Edge in the Debate

It is impossible to disprove a claim about events that have not happened yet.  Until events play out, prophets of doom enjoy a tactical advantage over anyone who questions their predictions.  Playing on investors’ fears, the doomsayers can successfully stigmatize the questioners as naïve optimists who are burying their heads in the sand.

The financial press magnifies the advantage enjoyed by heralds of the apocalypse. They capitalize on the fact that “It Will Be Worse Than 2008!” generates more online hits than “Run-of-the-Mill Recession Coming.” If the latter headline ultimately proves more accurate, the super-bears will undoubtedly be far less vocal about their miscalculation than they were about their correct call circa 2007.

Conclusion

Until the next recession has come and gone, no one can validly classify it as less severe or more severe than the last one. Business people and investment managers who must make decisions today can only judge on which side of the argument the preponderance of evidence lies. To be persuasive, the prognosticators who argue the more pessimistic case must fill in a missing link: How will major securities losses, a feature of every recession since the Great Depression, morph into a near-death experience of the financial system, which was a feature of only the most recent one?

Martin Fridson is editor of Forbes/Fridson Income Securities Investor.

Check out my website.

I am the chief investment officer of Lehmann, Livian, Fridson Advisors LLC and editor of Forbes/Fridson Income Securities Investor. I have written six books on finance

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