Thursday, October 9, 2008

Will Wall St Meltdown Affect Your Small Business?

I'm concerned that so many small business owners are confident that the economic distress currently gripping Wall Street won't spread to them. While optimism is the hallmark of an entrepreneur, it is exactly the wrong attitude to take into a financial crisis.

The first step must be to accurately assess the risks and protect yourself. Only then can you start creating your response to your new situation. What I want to get across in this post is that the likelihood is that the entire economy will contract over the next few years. Now is the time to define your safe harbor in the storm that is coming...and start moving toward it.

Forecasts I've read recently call for a severe two-year recession AND a dial back of the Dow to 7000. Since most forecasters missed the financial meltdown, I take these economic bears very seriously.

What follows below is a post describing a 12-step descent into financial hell in the American economy. Interesting, it was written in February of this year. The author, Professor Nouriel Roubini of NYU's Stern School of Business, is the only analyst to have been bearish enough to be remotely right.

This full post is in the subscription-only section of his blog, but I repost it here. If you will slowly read through all the steps, I think you will begin to get a fuller picture of the severity of the situation we are in. And only then can you start devising realistic strategies for your own business and personal well-being.

Nouriel Roubini
February 2008
(Notes are mine.)

, this is the worst housing recession in US history and there is no sign it will bottom out any time soon. (Note: Check!)

, losses for the financial system from the subprime disaster are now estimated to be as high as $250 to $300 billion. (Note: Check!)

Third, the recession will lead - as it is already doing - to a sharp increase in defaults on other forms of unsecured consumer debt: credit cards, auto loans, student loans. (Note: starting....)

Fourth, while there is serious uncertainty about the losses that monolines will undertake on their insurance of RMBS, CDO and other toxic ABS products, it is now clear that such losses are much higher than the $10-15 billion rescue package that regulators are trying to patch up. (Note: bailout of AIG, bankruptcy of Lehman Bros. foretold)

Fifth, the commercial real estate loan market will soon enter into a meltdown similar to the subprime one. (Note: quiet so far)

Sixth, it is possible that some large regional or even national bank that is very exposed to mortgages, residential and commercial, will go bankrupt. (Note: Wachovia is the latest)

Seventh, the banks losses on their portfolio of leveraged loans are already large and growing. The ability of financial institutions to syndicate and securitize their leveraged loans - a good chunk of which were issued to finance very risky and reckless LBOs - is now at serious ri)sk. (Note: this is what the bailout/rescue is dealing with now.)

Eighth, once a severe recession is underway a massive wave of corporate defaults will take place. (Note: many of these are our clients.)

Ninth, the "shadow banking system" or more precisely the "shadow financial system" (as it is composed by non-bank financial institutions) will soon get into serious trouble. This shadow financial system is composed of financial institutions that - like banks - borrow short and in liquid forms and lend or invest long in more illiquid assets. (Note: the shadow banking system has essentially disappeared).

Tenth, stock markets in the US and abroad will start pricing a severe US recession (Note: recent sharp drops in the market.)

Eleventh, the worsening credit crunch will lead to a dry-up of liquidity in a variety of financial markets, including otherwise very liquid derivatives markets. (Note: further slowing corporate growth)

Twelfth, a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices will ensue leading to a cascading and mounting cycle of losses and further credit contraction. (Note: how a credit based recession that starts in the financial sector spreads to Main Street.)


If you have stuck with it this far -- please ask questions and make comments! I'd like to have a discussion that starts with a sober look at what is really going on.

1 comment:

The Prophet said...

OK, so I have a funny name and not a native born citizen, I don't hold a degree in economics. The mess we are in is because of three things only,which ofcourse led to the rest (1) the federal deficit spending, and (2)keeping the interest rates too low to keep the interest payments on the deficits low also, (3)the so called consumer economy, which in turn leads to "deficit spending" by the "consumer". I have blogged on it, wrote to the president and my senator for over past five years, if you did not see it coming you were not looking