The Different Stages of Recessions

As it is the current recession is already very hard to understand for the average Joe. What is worst than not understanding the current problems faces is to not know how to prepare for what is to come in the future. Fortunately for us, recessions are actually a very normal part of the economy and always follow certain phases. The only thing that is unpredictable is the timing of the stages. In this article I am going to explain to you the phases that we have experienced and also what to expect in the short to medium term.



Stage 1: Credit and Housing Deflation: A rapid write-down on housing prices caused the burst of the housing bubble. The burst sent market prices for houses tumbling and also the collateralized debt products that were sold by banks and financial institutions suddenly having their asset backing value slashed by a similar margin as housing prices. The over-spending, over-leveraging, over-consumption of easy credit meant that housing prices were in such a bubble that once burst sent shock-waves across the whole economy.



Stage 2: The Credit Crisis: It all started with the collateralized debt products that banks and financial institutions bundled up and sold to investors suddenly having their 100% asset backed guarantee basically being flushed down the toilet due to the housing bubble burst. The toxic debt products sold were so far reaching and resold and repackaged to many times that a very wide range of investors suddenly saw their portfolio value drop a large degree overnight sparking fears of holding similar products. Banks and financial institutions suddenly started fearing one another and soon stopped lending to one another thus seizing up the secondary mortgage markets. Now capital for whatever loan or mortgage is almost impossible to obtain as market players re-evaluate their assets and go into "price discovery" mode.



Stage 3: Application of Stimulus: The government recognizes that the credit crisis is extremely dangerous to the economy the Federal Reserve drops rates to stimulate spending. The government had tax rebates legislated, bailouts and rescues are arranged on the banks so they don't get swallowed up by the increasing number of loan defaults that they are plagued with currently.



Stage 4: Loss of Confidence: With the huge bail-outs and news of the credit seizing up normal investors and consumers start to loose confidence. Investors will be presented with corporations that issue notes or bonds at very high rates but with little takers as the situation looking forward doesn't look very promising.



Stage 5: Equity Collapse: Stock markets in the US and around the world start their collapse with plunges as much as 30% - 50%. This is one of the biggest and most apparent indicator of the health of the overall economy. The plunge is due to obvious fears of a deep and long recession which even until now show no signs of abating. Overall confidence takes a further fall.



Stage 6: Redemptions / Margin Calls & Forced Unwinding of Trades: Due to the initial selling pressure, momentum builds and hedge funds are forced to meet redemption requests and margin calls due to the falling stocks and are also forced to reduce their positions drastically. This works like a vicious cycle until all the stocks are unwound to a price level where investors have sufficiently confidence with the price that has uncertainty already priced into the stocks.



Stage 7: Economic Data: Confidence is further eroded when lagging economic indicators finally confirm the worst. Exports nose-dive, GDP contracts, unemployment rises and manufacturing contracts shrink.



Stage 8: Capacity Reduction / Budget Crises / Main Street Blues: It is at this point that the normal everyday people start feeling the pinch of the economic situation. Due to the nature of the recession and its credit based origin, this phase will be much longer than other recessions. Households will have to react to increasing redundancies, increase saving and reduce consumption. Industrial capacity is reduced to adjust for the slowing demand, this trend will feed on itself until consumer sentiment and consumer spending increases again.



Stage 9: Government Regulation: With the credit seizure, recession and use of public money for bail-outs and rescue packages the government is forced to look into the regulation of the credit and financial markets. Neo-liberal credit practices will seize and regulation of all financial practices will be much tighter in the hope that this will improve the level of confidence in the markets and get investors investing again.



Stage 10: Treasury Market: Due to the huge bail-out and government measures to curb the recession from getting worst, the Federal Reserve is forced to fund the its financial deficit by issuance of treasure notes that are bought up by foreign countries who are dependant on the US. The treasury market is at the end-game of its 20 year boom and it isn't wrong to predict that treasuries will start to take a fall when foreign countries start to become weary of buying US treasury notes. The fall in demand for US treasury notes will first be accompanied with an increase in Federal Reserve rates then also be accompanied with a fall in the US dollar.



Stage 11: Inflation: As a side affect to the huge amounts of money that the government has injected into the market and the predominantly low rates all the factors are set for inflation to increase dramatically when consumer and business sentiments increase again. This however should not be a problem for the next 1 to 3 years as the recession is likely to deepen further before any change in consumer and business confidence is expected.



2009 will basically see Stages 6-9 coming into play with the end of 2009 being a progression into Stage 10. We have to be aware that this recession is going to take a long time to get out off. The fundamental reason that we are in the recession is due to the banks. Any recession that is due to banks and causes deflation in the banks will take a long time to recover.

About the Author

Ryan Parker is the financial associate of Dcredit.net which specializes in bad credit loans and other sub-prime financial products.

Author Profile: rparker@asiadeep.com

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