Myths of the Global Recession

Remember "decoupling"? It was the notion that emerging economies had detached themselves from the developed world, and that Asian consumers could make up for falling demand in the rich world. An Indian steelmaker would not only fail to sneeze at the first sign of a cold in the United States, but might even hold the key to a cure.

So much for that theory—emerging market stocks have plummeted 52 percent in the past year, even further than the S&P's 40 percent nose dive. Decoupling was a powerful myth, but only one of many in this global recession. The crisis is moving so fast, and in so many different directions at once, that the shelf life of conventional wisdom is shrinking exponentially. Just a few weeks back, analysts were saying the worst had passed for the financial sector; today Citigroup is imploding. Throughout 2008, forecasters predicted the demise of the dollar. Now it's the euro and sterling that are falling. What's behind these and other recession myths, and why haven't they come to pass? Below, we investigate.

The end of the credit crisis:
Because headlines had been free of major bank failures for a few months, many experts had begun to breathe a sigh of relief. "We have probably seen the worst of the credit crisis from the standpoint of the banking balance sheets," said Bill Gross, manager of PIMCO, the world's largest bond fund, in mid-January. The TED spread, a carefully watched measure of risk, had fallen to more normal levels by mid-January, a sign that banks had begun lending to each other again. Most promisingly, in the first full week of January, companies sold $153 billion of debt to investors—the highest volume since the beginning of 2008.

Unfortunately, those numbers were misleading. The five biggest corporate debt sales in early January had government support. General Electric, for instance, tapped into a Federal Reserve program to borrow $9.9 billion. Last week, the TED spread started marching upwards again. Meanwhile, Bank of America's current woes provide a highly visible reminder that 2009 holds the potential for another fiery financial-sector crash. The company booked a stunning $15 billion loss last quarter, the result of major indigestion after absorbing troubled investment bank Merrill Lynch. The federal government had to step in with a $142 billion bailout in January. Citigroup, too, has gone hat in hand to the government moneymen recently; its once lauded chairman Robert Rubin has left with his reputation damaged and the company—once the poster child for bigger-isbetter banking—is splitting itself in two.

Globally, banks have already absorbed about $1 trillion in losses on mortgages and other bad debt holdings according to Jan Hatzius, chief U.S. economist for Goldman Sachs. That's a startling figure, but his group's models indicate the financial-sector meltdown hasn't even reached the halfway point: Goldman expects another $1.1 trillion in losses. Until that bad debt is accounted for, the memory of the collapse of Lehman Brothers will stay fresh. Indeed, last Tuesday, bank stocks slid nearly 17 percent amid fresh worries about write-downs and bailouts to come.

Unhealthy balance sheets:
What's more surprising is that outside the financial sector, things don't look half bad. A common myth trotted out in times like these is that corporate balance sheets across all industries are increasingly beleaguered. That was certainly the case in the 2001 downturn. In the years leading up to that recession, companies borrowed heavily to take advantage of new technologies and upgrade their IT infrastructure. The spending binge meant corporations had just $352 billion in cash when clouds gathered in 2001—clearly not enough to weather the storm, as the bankruptcy rate soared to 10.6 percent that year.