As if a reminder were needed, a variety of asset classes are once again
frothy and it feels a lot like 2008. Just 7 years ago, the markets were
partying like there was no tomorrow—ignoring the bubbles that had developed,
having failed to learn lessons from the plethora of previous financial crises,
and pretending that if they just kept saying everything was fine long enough,
everything would indeed be just fine. Yet, after all that has happened, it
appears that investors, lenders, and the markets have learned little. August’s
mini-China crisis is ample evidence of that. It is just a matter of time until
the next market crash, recession, or financial crisis emerges.
While Wall Street’s natural inclination is to cheer the ongoing evisceration
of Dodd-Frank, it should know that it is in the Street’s own interest to have
legal boundaries in place to prevent financial institutions from succumbing to
their historical propensity toward greed and excess. How can the repeal of
Dodd-Frank and a return to the days of boundless excess be in Wall Street’s—or
the country’s—long-term interest?
Four basic ingredients were required to enable the Great Recession to occur:
greed, lax risk management, inadequate regulatory enforcement, and short
memories. Greed certainly hasn’t disappeared and, as is abundantly clear,
people still have short memories. Although risk management procedures and
regulatory enforcement mechanisms have definitely improved, the propensity to
water them down has gained momentum as time has passed. So, the stage would
appear to be set for a recurrence of the precursors that led to the Great
Recession, and the plethora of financial crises before it.
Overdue for a Recession
According to the National Bureau of Economic Research, which tracks
recessions on a monthly basis going back to 1854, the United States is already
overdue for another recession. Between 1854 and 1919, there were 16 economic
cycles, the average recession lasted 22 months, and the average economic
expansion was 27 months. From 1919 to 1945, there were 6 cycles, recessions
lasted an average of 18 months, and expansions for 35 months. And, the period
from 1945 to 2001 saw 10 cycles, recessions lasted an average 10 months, and
expansions an average of 57 months. So, recessions got shorter and expansion
periods longer over time.
Since the third quarter of 2009, the US economy has expanded for 21 of the
past 23 quarters, and is poised to continue the trend through 2015. Given that
the US economy is once again the de facto engine of the global economy (given
China’s slowdown), far outpacing Europe and most other developed economies,
there would appear to be little reason to believe that there are two
consecutive quarters of negative growth or real GDP are in our near-term future
(which would constitute the beginning of a recession).
If we assume that the final two quarters of 2015 will see positive growth,
the most realistic prospect for the onset of a new recession will be in 2016,
meaning that the current period of economic recovery will have lasted a minimum
of 72 months (6 years). By post-war standards, by that time, the United States
will have been overdue for another recession by 2 years. As things look now, it
certainly appears possible, perhaps even probable, that a recession will either
begin, or be well under way, in conjunction with the US presidential
Managing Post-Recession Risk
This time, we don’t have the traditional tools in our toolkit that allow us
to combat the next recession. The Fed can only lower rates as much as it
may raise them in the interim, and the printing of money can only go
on for so much longer. So, risk managers must expect that it is possible that
the next recession will be more severe than would otherwise be necessary, and
must take precautions to help ensure that their firms are not more adversely
impacted than necessary in the process. Here are some ideas for how to soften
- Decision making: Revise internal processes to allow for
more nimble and faster decision making. This can make a real difference when
times get tough.
- Prioritize initiatives: Put costly and/or time consuming
initiatives on the back burner until such time as circumstances allow them to
be put back on the front burner.
- Maintain flexibility: In order to enhance responsiveness
to fast-moving conditions, enhance the company’s flexibility to respond so
that risk may be reduced and costs contained in the process.
- Review your business continuity plans: Are they current,
and are they appropriate for present and future events? If not, modify
- Manage your costs: Increased pressure on budgets will
make it all the more important to select lower cost inputs and service
providers. Shift the mix as quickly as possible.
- Alternative suppliers: Should a critical supplier be
negatively impacted by the recession or unable to adequately supply your
business, do you have alternatives?
- Key person insurance: Does your firm have key person
insurance in place should one or more people critical to the operation of the
firm be made redundant?
There are of course as host of other considerations that can make the
difference between success and failure, or even survival, in times of
recession. The job of the risk manager becomes even more critical in times of
adversity. Thinking ahead and anticipating risks, needs, and required outcomes
is not only desirable, but essential.
History tells us that 2016 will see a recession. Governments’ ability to
manage it through traditional monetary means will be limited, which implies
that the recession could be worse than anticipated. That it may coincide with
the US presidential election implies that policymakers will want to try to
soften the blow through extraordinary means, such a fiscal policy measures.
Given the way Washington tends to work, risk managers are likely to derive
little comfort from any initiatives that may be undertaken, however, which are
in any event likely to take months to put into effect. That means that risk
managers will be on their own—at least out the outset. Better buckle your
Daniel Wagner is CEO of Country Risk Solutions and author of the book
"Managing Country Risk".