September 26th, 2008

In the biggest bank failure in U.S. history, the Federal Deposit Insurance Co. seized Washington Mutual’s assets Thursday. The FDIC then quickly sold most of WaMu  (that’s assets and liabilities) to JPMorgan.

Simply put, WaMu was victimized by a classic “run on the bank.” Customers withdrew $16.7 billion in a 10-day period following the bankruptcy of Lehman Brothers, leaving WaMu “with insufficient liquidity to meet its obligations,” its regulators determined.

A longer explanation is WaMu was victimized by mismanagement and misguided bets on exotic (and toxic) instruments such as option adjustable-rate mortgages.

The deal has major ramifications for JPMorgan and the banking industry as a whole, as Henry and I discuss in a forthcoming segment.

For the vast majority of people who bank at WaMu, which had 2200 branches and $188.3 billion of deposits as of June 30, the important thing to remember is your deposits are insured up to $100,000, and the Federal government will go to every extreme to make sure it’s available.

“There will be no interruption in services and bank customers should expect business as usual come Friday morning,” FDIC Chairman Sheila Bair told reporters last night.

The sobering truth, however, is that repeated declarations about the sanctity of FDIC insurance from Bair, President Bush, Treasury Secretary Paulson, Fed Chairman Bernanke and others failed to quell concerns among WaMu’s customers. That suggests more “bank runs” could be in the offing unless the government moves quickly to restore confidence.

Recessions in US History

* Panic of 1907 (1907 - 1908), begins with a run on Knickerbocker Trust Company stock October 22nd 1907 sets events in motion that will lead to a depression in the United States. Duration: 13 months
* Post-WWI recession - marked by severe hyperinflation in Europe over production in North America. Very sharp, but also brief.
* Great Depression (1929 to late 1930s), stock market crash, banking collapse in the United States sparks a global downturn, including a second but not heavy downturn in the U.S., the Recession of 1937. Durations: 43 and 13 months respectiviely.
* Recession of (1945) Duration: 8 months
* Recession of (1948 - 1949) Duration: 11 months
* Post-Korean War Recession (1953 - 1954) - The Recession of 1953 was a demand-driven recession due to poor government policies and high interest rates. Duration: 10 months
* Recession of (1957 - 1958) Duration: 8 months
* Recession of (1960 - 1961) Duration: 10 months
* Bond Inversion of (1965 - 1967) no recession materialized
* Recession of (1969 - 1970) Duration: 11 months
* 1973 oil crisis (1973 - 1975) - a quadrupling of oil prices by OPEC coupled with high government spending due to the Vietnam War leads to stagflation in the United States. Duration: 16 months
* 1979 energy crisis - 1979 until 1980, the Iranian Revolution sharply increases the price of oil
* (1981 - 1982) Duration: 16 months
* Early 1980s recession - 1982 and 1983, caused by tight monetary policy in the U.S. to control inflation and sharp correction to overproduction of the previous decade which had been masked by inflation
* Great Commodities Depression - 1980 to 2000, general recession in commodity prices
* Early 1990s recession - 1990 to 1992, collapse of junk bonds and a credit crunch in the United States leads to one quarter of US GDP decline, and therefore not an official recession.

Early 2000s recession

The U.S. economy shrank in three non-consecutive quarters in the early 2000s (the third quarter of 2000, the first quarter of 2001, and the third quarter of 2001). Strictly speaking, the U.S. economy was not in recession during this period — the common definition being “a fall of a country’s real gross domestic product in two or more successive quarters.”

Those using a less traditional definitions of the term deem part or all of this period to have been a recession and there remains some debate over the start and end dates. The initial report by the National Bureau of Economic Research (NBER), declares arecession that lasted from March 2001 to November 2001 (Someone add an application of an AD-AS model for ECO 202), as real gross domestic product dropped during this period by 0.2% total from the fourth quarter of 2000. However, even this definition is in doubt. Several members of NBER’s business cycle dating committee have said that revised data indicates arecession actually began some time within the final months of 2000. Committee members suggest they are inclined to move the date.

NBER President Martin Feldstein said:

“It is clear that the revised data have made our original March date for the start of the recession much too late. We are still waiting for additional monthly data before making a final judgment. Until we have the additional data, we cannot make a decision.”

Controversy over the precise dates of the recession led to the characterization of the recession as the Clinton Recession, if it could be traced to the final term of President Bill Clinton. A move in the recession date in a 2004 report by the Council of Economic Advisors to several months before the one given by the NBER was seen as politically motivated.

Using the stock market as a benchmark, a recession began in March 2000 when the NASDAQ crashed following the collapse of the Dot-com bubble. The Dow Jones Industrial Average was relatively unscathed by the NASDAQ’s crash until the September 11, 2001 attacks, after which the DJIA suffered its worst one-day point loss and biggest one-week losses in history. The market rebounded, only to crash once more in the final two quarters of 2002. In the final three quarters of 2003, the market finally rebounded permanently, agreeing with the unemployment statistics that the recession lasted from 2001 through 2003.

What is a Recession?

In economics, the term recession is generally used to describe a situation in which a country’s GDP, or gross domestic product, sustains a negative growth factor for at least 2 consecutive quarters. I say generally because recession can be defined differently by different economists. Just as there is an agency to define the measure of inflation; the official agency in charge of declaring that the economy is in a state of recession is the National Bureau of Economic Research (NBER). NBER’s definition of recession is a bit more vague than the standard one that was described above; they define recession as a “significant decline in economic activity lasting more than a few months”. For this reason, the official designation of recession may not come until after we are in a recession for six months or even longer. Some economists also suggest that a recession occurs when the natural growth rate in GDP is less than the average of 2%. Typically, a normal economic recession lasts for approximately 1 year.

Causes of Economic Recession

This is another staunchly debated topic; but the general consensus is that a recession is primarily caused by the actions taken to control the money supply in the economy. The Federal Reserve is responsible for maintaining an ideal balance between money supply, interest rates, and inflation. When the Fed loses balance in this equation, the economy can spiral out of control, forcing it to correct itself. This is precisely what we have seen in 2007, where the Feds monetary policy of injecting tremendous amounts of money supply into the money market has kept interest rates lower while inflation continues to rise. This, coupled with relaxed policies in lending practices making it easy to borrow money; the economic activity became unsustainable resulting in the economy coming to a near halt. It is also said that recession can be caused by factors that stunt short term growth in the economy, such as spiking oil prices or war. However, these are mostly short term in nature and tend to correct themselves in a quicker manner than the full blown recessions that have occurred in the past.

Effects of a Recession
An economic recession can usually be spotted before it happens. There is a tendency to see the economic landscape changing in quarters preceding the actual onset. While the growth in GDP will still be present, it will show signs of sputtering and you will see higher levels of unemployment, decline in housing prices, decline in the stock market, and business expansion plans being put on hold. When the economy sees extended periods of economic recession, the economy can be referred to as being in an economic depression.