All Clear?

We are months into the credit crisis that began last summer, triggered by the meltdown in U.S. sub-prime lending. The crisis has been much deeper, much wider and longer than most market participants have expected. Yet, until the failure of Bear Stearns last month, no major financial institution had suffered. This crisis and the concomitant recession have been marked by an absence of major bank failures or corporate bankruptcies despite the apparent systemic risks at hand.

If one thinks back to each major financial crisis and recession since the breakdown of Bretton Woods (and it does seem that the breakdown of Bretton Woods was the trigger event for a crisis-ridden global financial system), there has always been a major bankruptcy. So, with this crisis seemingly long in the tooth, the question becomes now: Can we give the all clear signal?

Unfortunately, the answer is no. Major effects on the real economy in the U.S. have yet to reach a peak. Moreover, the multiple feedback loops between the U.S. and the global economy, the financial and the real economy have also yet to play out. Ireland, Spain and the UK are each going through nasty housing bubble deflations. Each had housing prices more inflated than the U.S. and none have seen the level of real economy distress witnessed to date in the US. So, the coast is not clear.

I’ll leave with this thought from an article from Stephen Roach of Morgan Stanley.

Financial markets have breathed a sigh of relief that the worst may now be over. Maybe that is the case for the crisis, itself.

But do not confuse that possibility with an all-clear sign for the real economy, stock markets or the political cycle. As the U.S. slips into recession, a chain of increasingly powerful feedback effects is likely to follow. The after-shocks of this crisis will shape the landscape for years to come.