Credit rationing and depressionomics | FT Alphaville

Credit rationing and depressionomics

With hindsight, will it be seen as tempting fate to have had the world’s foremost authority on the Great Depression as chairman of the Federal Reserve?

Selected lowlights from Citi’s US economy analysts on Monday. Be warned, the below material is rather bearish:

Post-World War II highs in corporate credit spreads, extreme disruptions in money markets, and credit rationing have broken the bounds of any previous, merely cyclical event. The negative feedback loop of tightening financial conditions, weakening economic activity, and further tightening in credit has not yet been severed.

The credit tightening suggests a more severe recession, while a path to recovery requires functioning credit intermediation. On the assumption that traction is eventually regained, we have still cut our full year 2009 US forecast to -0.8% and expect contraction in U.S. GDP over the four quarters ending in 2Q 2009. We believe large company profits will now fall 27% peak-to-trough, and the unemployment rate to peak above 8 1/2%.

In 2009, we expect the weakest nominal GDP growth rate since 1954.

It gets worse. The truly worrying thing is actually to consider how terribly markets have performed – and are performing – in light of unprecedented government interventions.

The Fed funds rate has fallen 375bps since the onset of the credit crisis last year and still there is no sign of risk appetite returning. Banks might be stabilised but they are crippled institutions. The signs of this, say Citi, will only show themselves in the coming months. What is emerging is a violent negative feedback loop, which policy actions are already too late to avert.

Sadly, some risk exists that financial events could still unfold like a proverbial “dam break.” This might leave policymakers treating very serious and lasting damage to the financial system, rather than preventing further erosion.

With no desire to exaggerate, this might be considered the “financial pre-conditions of a depression” as improving financial conditions are a pre-condition of a cyclical recovery.

Which makes the below graph, from Alphatrends, via the prophetic Michael Panzner, rather germane.

The performance of the US stock market during the Great Depression: