Top ten predictions for the 2009 global economy

In my most recent post, I gave a fairly comprehensive retrospective of the year that was.  Near the end of that post, I listed a number of posts I wrote in October and November which point to how I see 2009 shaping up.  Let me give you a more direct assessment here.  I will finish it off with my top ten predictions for 2009.

2008 was a disaster.  The subprime meltdown actually started in February 2007, giving policy makers plenty of time to act. However, inaction proved fatal as the subprime crisis metastasized into a global credit crisis that did not take full form until this past year.  In so doing, it revealed a number of inherent weaknesses in the global financial system which I believe will play out in 2009.

Banking weakness

The first problem to note is global banking fragility.  It bears noting that after the Japanese banking crisis, many prognosticators pointed to the weak capital structures at Japanese banks as a cause for the crisis.  I felt then and still do today that they had it backwards.  Poor lending practices made institutions in Japan that previously seemed well-capitalized into capital weaklings.  This will be very much the case globally in 2009.

In the U.S., Ireland and the U.K. in particular, there are significant loan losses that have yet to be taken.  This is part due to the fact that loans are carried at book value until the borrower cannot pay.  On the other hand, freely traded securities like Mortgage-backed securities must be written down immediately to reflect market values.   That has meant that institutions which have credit risk held in the form of marketable securities have taken the lion’s share of the pain.  I expect that to change in 2009.

Going forward, real economy problems i.e. default and bankruptcy will become an issue.  That means that those hidden loan losses will have to be taken.  You should note that I am definitely suggesting the following: had loans been traded in the same way that mortgage-backed securities were, we would have seen a tidal wave of losses here already.

Which countries and which asset classes are vulnerable?  From a country perspective, one could look first to the first bubble economies to pop as canaries in the coalmine: Ireland, Spain, the U.K. and the U.S.   I will not make any predictions about Spain, but I will say that I do expect to see horrific loan losses in the other three countries.

Asset Class Weakness

From an asset class perspective, here is my thinking:

  • Residential Property – In the U.S., Alt-A payment resets approach and recession will start to hit through unemployment. Therefore, expect to see Alt-A loans go sour as their subprime brethren did before.  This class includes those exotic mortgage types like no-payment, option ARM, and negative amortization loans to prime borrowers.  As there are many Mortgage-backed securities  of the Alt-A variety, these loan losses will lead to writedowns at those same banks that have had massive writedowns already, further impairing their capital base.  The subprime crisis is less of an issue at this point.In the U.K. and Ireland, property prices will decline in 2009 and unemployment will rise. This double whammy will mean mortgage defaults will rise and loan losses will increase at those institutions most levered to the residential property markets.
  • Commercial Property (CRE) – I was way too early on this asset class, expecting to see major losses in 2008.  But, CRE will be front and center in 2009.  Why?  It stands to reason that in recession, businesses are hit as consumption growth slows or goes negative.  This will depress demand for commercial property, driving down lease prices. Simultaneously, retailers will struggle and this will increase defaults.  That means much less income and huge loan losses for CRE REITs and commercial property-oriented financial institutions.  This will be true in the U.S., Ireland and the U.K. at a minimum.  However, although I am not making a forecast here, I am also hearing much the same across the Eurozone.
  • Leveraged Loans and High Yield – These asset classes are sporting record yields because credit quality has deteriorated significantly across the board. For instance, at the tail end of the boom, there were many more low quality single B rated bonds. Leveraged loans are those loans given to finance higher risk, leveraged buyouts. High-Yield is simply a moniker used for lower quality bonds. It stands to reason that poorer asset quality loans and bonds will be hit first during a downturn.  That means leveraged loans and high yield will suffer before any other corporate bond and loan class.  This is going to be true in the U.S. and in Europe across the board.  (See Wikipedia’s entry for High yield debt).
  • Credit Card and Auto Loans – Here is another class that will implode the balance sheets of major banks because of tradeable asset-backed securities (ABS).  We have already seen credit card chargeoffs increase significantly.  Even American Express, generally considered the highest card quality provider, has been experiencing increased loan losses.  Now, remember, there are boatloads of auto and credit card ABS bonds trading in the open market.  These securities will be severely impaired and writedowns will be enormous.  I predict some institutions will fail as a direct result of these writedowns.
  • Eastern European loans – Countries like Ukraine, Hungary, Latvia, Estonia and Poland are going to see major downturns.  Unfortunately, this will mean currency weakness.  That has a major impact on debtors in those countries as they have borrowed in Euros (much like Icelanders had).  Combine the currency impact with recession and you have the makings of a debt crisis. The banks loaning Eastern European corporates and homeowners these funds are situated in countries like Austria, Germany, Denmark, and Sweden.  Therefore, expect to see significant writedowns at major European institutions as these loans sour.  Will this be Europe’s equivalent of the Latin American debt crisis of the 1980s. Yes.
  • Other asset classes – We are talking about prime mortgages, ordinary bank loans, and corporate loans. These will suffer impairment because of the recession, but the problems here should be much less than in the asset classes I identified above.

Currency Weakness

It is extremely difficult to call currencies.  In 2009, it will be especially difficult because there are potential trouble spots everywhere.

However, on the whole, one should expect the British Pound and the U.S. Dollar to be weak currencies as their central banks are going to resort to quantitative easing in order to forestall depression.  The ECB is less likely to do so despite the problems in Ireland, Spain and Greece.  At its core, the ECB is an institution controlled by the Germans, French, and Belgo-Dutch.  These hard money types will be reluctant to resort to ZIRP (a zero interest rate policy) or quantitative easing.  So, I expect the Euro to be strong.

Why the Yen remains strong is beyond me because the Japanese are about to engage in quantitative easing and ZIRP.  They have experienced a very hard landing.  But, the carry trade is no longer as appealing because foreign interest rates are falling as other central banks cut rates. So the desire to unwind carry trades is supportive of the Yen.  I expect a strong Yen.

I’ll leave it at that for currencies, except to say that Latvia will be a test case for Eastern Europe as the IMF did not require a competitive currency devaluation there as part of a bailout package.  It remains to be seen how that will play out.  I reckon we will see economic pain followed by capitulation and devaluation.  Russia is doing the right thing in devaluing, although that reduces the standard of living (through high import prices) and invites civil unrest.  Let’s wait and see.


Ten Predictions for 2009

So, now it is time for me to lay it on the line and make my ten predictions.  Here they are:

  1. The Obama Administration will not be a significant change from the status quo economically.  As a result, they will drag their feet on offering a comprehensive banking solution, leading to another (fatal) banking crisis in 2009 from ABS losses.
  2. The Obama Administration will satisfy cultural liberals by re-regulating the banking industry heavily and by massive spending on public works.  Liberals will be ecstatic about American jurisprudence: Obama will appoint at least two liberal Supreme Court justices to the bench as Ruth Bader Ginsburg and John Paul Stevens step down.
  3. The Obama Administration will be faced with a state government bankruptcy. They will bail out the state and promise to do the same again, much to the liking of liberals and municipal bond holders.
  4. Eastern Europe will face depression, much as Asia did in 1997.  The result will be civil unrest and a near collapse of the European banking system.
  5. The Irish banking system will suffer a crisis of confidence as the Irish will come to be seen as the next Iceland: oversized banking sector, huge loan losses.  The European Union will bail out the entire Irish banking system.
  6. Oil prices will sink to $25 a barrel before rising back to $55 by the end of the year.
  7. China, damaged by a huge decline in export demand, will undergo a massive stimulus campaign.  It will not be enough.  GDP growth will drop to 2% and civil unrest will ensue.
  8. Tariffs, export subsidies and currency devaluations will roil the desire for free trade.  Initially, countries will seek relief at the WTO (World Trade Organization) but later they will begin to act unilaterally.  The U.S. will be the first to unilaterally retaliate.
  9. U.S. house price declines and subprime defaults will slow.  Prime and Alt-A defaults will increase.  Meanwhile, Irish and U.K. mortgage defaults will increase dramatically.
  10. The U.S. will begin initiate detente with Venezuela, Cuba or Iran.  The moves will be heralded as a foreign policy coup on the lines of the Sino-American detente under Nixon.  Obama’s status abroad will be boosted.

So, there it is.  My ten predictions.  I think this set of ten is pretty bold, actually.  So I expect to be very wrong on many of them.  Hopefully, it gives you food for thought.  Please feel free to call me out on a especially good/bad prediction or opine on your own predictions in the comment section.

  1. Terry says

    This is third forecast for 2009 I've read this morning by what I consider to be excellent evidence-driven (vice view-driven) economic/market bloggers. All three (you, Kedrosky, & Merkel) are very pessimistic about the economy & markets for next year and David Merkel is anticipating a US economic catastrophe by the end of a decade as US debt blows up.

    I agree that next year is going to be ugly for the economy and investment, but I have to wonder at what point our views about them are becoming more shaped by emotion than empiricism. Things are bad, but I think we'll wend our way out of this situation in 3-5 years. Heck, maybe we can even return to budget surpluses by then and begin to pay off the huge national debt we are accumulating!

  2. Edward Harrison says

    Hi Terry, I am feeling pretty upbeat right now given that a new year is upon us. If anything, I need to keep my upbeat emotions in check. So, when I write a downbeat forecast, it is based upon the facts as I see them unfortunately. If you factor in likely protectionist responses the facts speak to Depression, honestly. But, I am hopeful that we can avoid worst-case scenarios.

    Your brief commentary does seem about right though:

    I agree that next year is going to be ugly for the economy and investment, but I have to wonder at what point our views about them are becoming more shaped by emotion than empiricism. Things are bad, but I think we'll wend our way out of this situation in 3-5 years. Heck, maybe we can even return to budget surpluses by then and begin to pay off the huge national debt we are accumulating!

    I would actually say I am more bullish about investments than you though. There are mountains of value investments accumulating. In bear markets, value increases. So, I am pretty bullish about good stock pickers being able to do well. The broader market is another story. There it is less certain.

    As for getting out of trouble in 3-5 years, you should note a post called Beware of deficit hawks I wrote about deficit hawks like myself trying to get out of debt before a sustainable recovery has shaped up. Think 1937 in the US or 1997 in Japan. I'm looking at 10 years, but I might be surprised. I would normally be more hawkish but I do think the banking system is very very fragile.

  3. mL says

    Money must come from somewhere. Tax, foreigner countries buying treasury bill, or printing press.

    I guess
    1. the bond market bubble may bust next year. US dollar rally will end early next year.

    2. More and more retails companies get into trouble, esp. the luxuries ones.

    3. Because of the large dual deficit, U.S. allows some high tech companies to export its core technologies.


    1. Edward Harrison says

      mL, I like where your head is at! The money must come from somewhere indeed? And the question is where; hence your list. The third one on high tech exports is nice. great outside the mainstream thinking. Consider this duly noted.

  4. Jeremy says

    Thanks for sharing your forecast. Experts I spoke with for a story made some predictions for '09 specifically related to credit cards, including that it will become tougher to borrow using plastic and that fees associated with credit cards will increase. You can read them all here:

  5. Stevie b. says

    Ed – how about a prediction for the yield on the long bond by year-end? I wont hold you to it, but it would be nice to know what your gut-feel is. Thanks and a happy, edge-of-the-seat New Tear! ( now that was indeed a Freudian slip!)

    1. Edward Harrison says

      Stevie, wishing you a happy new year too. I'm going to go aggressive with the long bond. I say the U.S. pumps money like mad and avoids outright depression but the economy is so weak that money keeps piling in to Treasuries. This is a "Treasury bubble gets bigger" scenario. So, let's call the 30-year at 2%. Ho's that for an outside the box call? And I'll stick to that scenario because, although I see a bubble, I see malaise too and that is supportive of Treasuries.

      1. John Creighton says

        If I did my math right and the 30 year yield falls to 2% you stand to make 21%

        However, the interest rates can go up much more then they can go down.

        1. Edward Harrison says

          21% is quite a return, isn't it? So, obviously I am making a case for some serious bubble-like upside in treasuries. The problem is the one you noted: the downside is much more severe for bondholders than the upside. But, when you can make 20% in treasuries, it is quite intoxicating, so the risk will be taken.

  6. Carlomagno says

    On Eastern European depression leading to “near collapse of the European banking system”, I’d like to see the numbers on this. Here are some ball-park figures:

    – the combined GDP of the CEE EU10 is about 5-10% (give or take, depends whether you use market exchange rates or PPPs) of the “old” EU15’s GDP. I’ll grant you that that doesn’t include non-Baltic ex-USSR nor most of ex-Yugoslavia. I also ignore Turkey, which although often included in “emerging Europe” is not eastern Europe;

    – credit-to-GDP ratios in this region are typically modest, I would guess about 50% on average;

    This should put the overall potential impact on the EU banking system into context.

    There are admittedly some EU banks that are particularly exposed to CEE, e.g. Erste, Raiffeisen, Unicredit and Swedbank. But would even they be taken down if their CEE-related assets went bad? For example, could Unicredit withstand the BK of its Austrian BA-CA subsidiary (through which the group manages its CEE business)? Or could Raiffeisen survive the loss of its international subsidiary (ditto)? I don’t know the answer BTW. Swedbank admittedly looks shaky (as noted by John Hempton).

  7. Adam Smith says

    A Specific Application of Employment, Interest and Money


    This tract makes a critical analysis of credit based, free market economy, Capitalism, and proves that its dysfunctions are the result of the existence of credit.

    It shows that income / wealth disparity, cause and consequence of credit and of the level of long-term interest-rates, is the first order hidden variable, possibly the only one, of economic development.

    It solves most of the puzzles of macro economy: among which Business Cycles, Stagflation, Greenspan Conundrum, Deflation and Keynes' Liquidity Trap…

    It shows that no fiscal or monetary policy, including the barbaric quantitative easing will get us out of depression.

    It shows that Adam Smith, John Maynard Keynes, Karl Marx and Alan Greenspan don't contradict each other but that they each bring a meaningful contribution to a same framework for understanding macro economy.

    It proposes a credit free, free market economy as a solution that would correct all of those dysfunctions.

    In This Age of Turbulence People Want an Exit Strategy out of Credit, an Adventure in a New World Economic Order.

    Read It.

  8. Edward Harrison says

    Carlomagno, thanks for the question. That is good back-of-the-envelope analysis on what the loans to Eastern Europe could mean to Western banks.

    The problem with the European banks is that their capital ratios are so low that loan losses will quickly eat into their reserves. The Scandinavians and the Austrians seem most exposed because of their relatively small size. Germany may be less of a problem.

    John Hempton is right about Swedbank in Latvia. I have also heard a good deal about Danish banks in the Baltics as well. I will have to look for some good publicly available source material from the Austrian, Swedish and Danish newspapers and post a translation.

    I just looked through my bookmarks and nothing comes to hand immediately. But, I will post when I find a good link.



  9. Edward Harrison says

    Jeremy, the banks are cutting credit lines like crazy. Barry Ritholtz posted a story about his own dealings with credit card companies.

    I recently heard from Citibank UK this past month that they were going to terminate my card because I was not resident in the UK any longer. That’s funny because I haven’t lived in the UK for 8 years. Obviously, they were looking for any and every way to reduce their loan loss exposure and this was one of the ways: cutting credit lines to non-UK resident account holders.

    This is just anecdotal but it seems to be a trend in both credit cards and home equity loans.

  10. bena gyerek says

    i am quite bullish on cee eu10 simply because i think market expectations will ultimately be stabilised by a show of meaningful support from the eu big hitters. and i don't buy the banking losses channel because as others have noted the losses are concentrated in a small number of not-systemically-critical banks (possible exception of unicredit).

    on the other hand, if your oil price scenario plays out (i personally think brent stays in the 30s up to year end), then the outlook for russia is pretty catastrophic.

  11. Edward Harrison says

    Carlomagno, I have one good Austrian link that confirms the magnitude of the losses we are talking about here:

    Immofinanz, which has said it needs 110 million euros ($156.4 million) by the end of the year to keep afloat, reported a loss before interest and tax (EBIT loss) of 1.85 billion euros compared with 431.6 million euros profit a year ago.

    Losses before tax (EBT loss) dropped to 2.65 billion euros in the first half of 2008/2009, Immofinanz said.

    Earlier this month Immofinanz presented its six main creditor banks with a plan to restructure the company. It said on Monday the banks had agreed in principal to grant the necessary financing but are still evaluating the measures.

    On top of the money it needs before the end of 2008, the company has said it also needs another 150 million euros by the end of April to avoid a liquidity crunch.

    An earlier version of the article said: "Immofinanz unit Immoeast, which focuses on central and eastern European markets, this month posted a 1.8 billion euros pretax loss in its second quarter to October, triggered by downward revaluations in its real estate portfolio and writedowns due to halted development projects."

    This is an Austrian real estate company that is about to go bust because of loans to Eastern Europe. There are scads more like this lurking.

  12. Jeremy says


    Thanks for sharing your story. It's always interesting to hear how creative banks are getting in an effort to reduce the likelihood of additional charge-offs. Wonder what we'll see next?


Comments are closed.

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