Thursday, June 3, 2010
How bad can things be if over 60% of service sector businesses report seeing rising activity (the message of the above chart)? That was par for the course back in the go-go late 1990s, but today the market is plagued by concerns that the economy is about to slip into a double-dip recession, so good news apparently doesn't count, because bad news lurks around the corner. Once again the market is climbing a wall of worry.
Recessions, however, are pretty hard to trigger; they require big and largely unexpected changes in monetary and fiscal policy (mostly monetary policy), or (as was the case with the last recession) events which call into question the world's most deeply-held assumptions (e.g., the solvency of the world's banks). To be sure, many today worry about the solvency of the European banking system. This shows up as 2-yr Euro swap spreads that today reached 86 bps, and credit default swap rates of 250 bps on Spanish government debt and 740 bps on Greek government debt.
I have no reason to argue against the possibility that Greek debt will be significantly restructured (resulting in substantial losses), but I don't see the parallels between the potential for sovereign defaults in a handful of European countries and the massive panic triggered by subprime mortgage-related paper. Back then, it was a lack of transparency that sparked a panic. The value of trillions of dollars worth of mortgage-backed paper was suddenly called into question. Ultimately the value depended on the price of millions of homes—whose prices were in virtual free-fall—and things were further complicated by the way that thousands of securitized deals were structured, and by the fact that large institutional investors all over the world held substantial amounts of the paper.
Today the facts aren't too difficult to discern: only a handful of debtors are likely to default; in a worst-case scenario the losses will be a very small fraction of outstanding global debt; and those who are significantly exposed to the losses (mostly the larger European banks) are relatively few. Plus, today's concerns about sovereign debt defaults are taking place against a backdrop of a strengthening global economy and accommodative monetary policies, whereas the unravelling of subprime debt and residential real estate occurred against a backdrop of a weakening global economy and tightening monetary policies. I just don't see the ingredients here for a replay of the global panic recession of late '08.
Posted by Scott Grannis at 9:53 AM