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By Sean Silverthorne

Niall Ferguson: Forget Gloom -- Think Doom!

By Sean Silverthorne

September 23rd, 2008 @ 10:37 am

11 Comments

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Categories: Research

Tags: Financial, Financial Accounting, Finance, Sean Silverthorne

Niall Ferguson, the widely respected and controversial Harvard Business School economist and historian, has just penned in the Financial Times a rather gloomy prognosis for the US economy.

In short, Ferguson suggests that even as US lawmakers mull a $700 billion government-backed shoring up of the financial sector, there are six more shocks potentially coming to the economic system. The result? Forget recession — that’s a given. The question is, can we avoid a depression?

Here are some potential events on the horizon that could make today’s situation worse, according to Ferguson:

  1. The possibility of more bank deaths, especially if the government plan is held up in debate.
  2. Credit default swaps market could seize up.
  3. Unaffected parts of the financial industry could still yet get sideswiped. To wit, “There are hundreds of billions of dollars in losses looming on corporate debt – almost as much as has already been lost on mortgage-backed securities,” Ferguson writes.
  4. A likely US recession, beginning in the fourth quarter and continuing into 2009. Oh, and the dollar is probably going to weaken again, Ferguson says.
  5. The economic slowdown could become a global phenomenon, leading to violent financial reactions in emerging markets such as Russia.
  6. The presidential election will continue to unleash harsh rhetoric about the economy, further undermining investor confidence.

OK, so things are a little on the pessimistic side these days. But another Great Depression?

“There has certainly been a 1930s feel to this month’s events,” says Ferguson. “The nationalisation – or ‘conservatorship’ – of Fannie Mae and Freddie Mac (the former a creation of the Depression era), the bankruptcy of Lehman Brothers (which traces its history back even further), the takeover by Bank of America of Merrill Lynch and the US government rescue of AIG, the country’s largest insurer: a single one of these would have constituted a big financial crisis in the 1980s or 1990s.”

He also says the fact that the US has gone 80 years without a depression “is in itself remarkable.”

You may have seen Ferguson recently on the PBS documentary The War of the World: A New History of the 20th Century,  which he wrote and narrated.

 
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  •  
    1

    vrsarti

    09/23/08 | Report as spam

    RE: Niall Ferguson: Forget Gloom -- Think Doom!

    Mr. Ferguson is correct in that things will get worse before they get better. In addition to manipulation of oil prices that will further strain the economy and perhaps create shortages, you'll see the Russians mounting more computer hacker attacks for financial gain. They won't be doing it for fun like some people do.

    With the collapse of the Russian economy, look for them to make more military moves. They need to give the people something since their economy is failing. And a military victory to acquire more resources might be it.

  •  
    2

    marzanus

    09/23/08 | Report as spam

    RE: Niall Ferguson: Forget Gloom -- Think Doom!

    Prof Ferguson should be well advised to stick to his forte - history and the past. Gloom and doom always attract more attention than positive indicators and solutions. This is primarily a global financial crisis, and of course linked to the global economy and other global forces, but wise minds know that the underlying world economic forces are sound. Rather look at the dinosaurs - companies and institutions - that should disappear. Some good and necessary pains will happen, but depression can be avoided if well handled by especially the major Western governments. This is what we would expect from prof Ferguson - solutions, not getting onto the scary media-hype for attention.

  •  
    3

    geigersd

    09/24/08 | Report as spam

    RE: Niall Ferguson: Forget Gloom -- Think Doom!

    Would someone please explain to me why it matters if the "credit default swap" market fails? I don't have any money in there!

  •  
    4

    darinp

    09/24/08 | Report as spam

    Don't forget some of the more entertaining conspiracy theories!

    I work in the financial sector and we are constantly defining scenarios so that we can react to them. Niall is hitting on a lot of the concerns that many people who are in the middle of this mess still have. However, he is not talking about some of the theories that I find more entertaining.

    For example:

    The government is taking steps that can erase much of the national debt and take ownership of the country back from China. While many of the assets that the government is buying up appear to be worthless, they are actually far from it. Even if we hit full-scale depression real estate is still an asset that will never disappear (there is only so much of it to begin with). It will go down in value, but it will never fully depreciate to zero. The bail-out fund would allow the government to put together a reverse auction and purchase mortgages for 20% - 40% of their face value. Will the value of those properties drop 60% - 80%? Not even close. And if we hit significant inflation the base cost will rise of each house, further increasing the government's assets. This is the same ploy that has so many investors buying up pools of mortgages from banks at steep discounts. Banks need to solidify their balance sheets (unleverage them) so they are having fire sales. The government will be competing with those investment groups directly (and the government clearly has more buying power overall). Then the government will make money on servicing of the loans. As each person makes payments on the houses that the government now owns the mortgages for, the government makes a peice of that payment that would have gone to a private servicing company. If the family cannot afford the existing loan (i.e. they were scammed or ignorant when going into a subprime or over-reaching lending situation), then the government can refinance them using Fannie or Freddie's lending authority. Points will be made on every refinance.

    The government can make money off of the refinancing, servicing, and after inflation works its magic, on the sale of these mortgages. That should help with the payment of government bonds and T-bills that China bought so that we would keep buying things from China. We can restore some of the lopsided economics that we created through our rampant consumerism and economic bandaids. However, in the short-term we must pay the price for holding back the dam of reality. Economic cycles are natural and we cannot prevent the downturn forever...

    What other fascinating theories are out there? I would like to hear more of them.

    Darin

  •  
    5

    darinp

    09/24/08 | Report as spam

    Credit Default Swaps

    In simple, plain English you can think of credit default swaps as insurance policies against a borrower not paying back a loan. If bank A loans company X money, it is expected that company X will pay that money back plus interest (the bank has extended credit to the company). However, sometimes companies (and people) don't pay back the money that they owe (they may even declare bankruptcy). If that money was lent without any collateral (e.g. a building or equipment that the bank can repossess), then the loan is far riskier because company X does not have any skin the game, they don't have much to lose if they walk away (other than reputation and a credit hit for a few years that may prevent them from borrowing more money).

    So bank A decides that they don't want to shoulder all of the risk of the unsecured loan that they chose to make. (The loans are often secured, but not in this example.) So they find an investor that is willing to 'insure' the bank against company X's default (lack of payment). Investor M and bank A enter into a "credit derivative contract" (insurance policy) that requires bank A to pay investor M a portion of every monthly payment that company X makes to bank A as the loan is repaid. Investor M may take the money that is passed from company X to bank A and then on to investor M and invest that money somewhere in order to make it grow. If the company does not pay the bank (defaults on the credit) then the investor uses the payments plus interest on the payments to pay the bank the money that the company did not pay back. The investor believes that the company is going to make their payments on the loan so they are very comfortable that they are going to make a lot of money and never have to pay it back (at least, not much of it).

    Now, there are a lot of smart people out there that have figured out how to use other people's money to make money (leverage). They started selling shares of the "credit derivative contracts" that they had entered into with

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    • Blogger Thumbnail Sean Silverthorne Sean Silverthorne is the editor of HBS Working Knowledge, which provides a first look at the research and ideas of Harvard Business School faculty. Working Knowledge, which won a Webby award in 2007, currently records 4 million unique visitors a year. He has been with HBS since 2001. Silverthorne has 28 years experience in print and online journalism. Before arriving at HBS, he was a senior editor at CNet and Executive Editor of ZDNet News.... more »

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