Mapping the COVID-19 Recession
Until there is a better sense of when and how the COVID-19 public-health crisis will be resolved, economists cannot even begin to predict the end of the recession that is now underway. Still, there is every reason to anticipate that this downturn will be far deeper and longer than that of 2008.

Apr 7, 2020 KENNETH ROGOFF

CAMBRIDGE – With each passing day, the 2008 global financial crisis increasingly looks like a mere dry run for today’s economic catastrophe. The short-term collapse in global output now underway already seems likely to rival or exceed that of any recession in the last 150 years.


Even with all-out efforts by central banks and fiscal authorities to soften the blow, asset markets in advanced economies have cratered, and capital has been pouring out of emerging markets at a breathtaking pace. A deep economic slump and financial crisis are unavoidable. The key questions now are how bad the recession will be and how long it will last.

Until we know how quickly and thoroughly the public-health challenge will be met, it is virtually impossible for economists to predict the endgame of this crisis. At least as great as the scientific uncertainty about the coronavirus is the socioeconomic uncertainty about how people and policymakers will behave in the coming weeks and months.

After all, the world is experiencing something akin to an alien invasion. We know that human determination and creativity will prevail. But at what cost? As of this writing, markets seem to be cautiously hopeful that a recovery will be fast, perhaps starting in the fourth quarter of this year. Many commentators point to China’s experience as an encouraging harbinger of what awaits the rest of the world.

But is that perspective really justified? Employment in China has rebounded somewhat, but it is far from clear when it will return to anything close to pre-COVID-19 levels. And even if Chinese manufacturing does rebound fully, who is going to buy those goods when the rest of the global economy is sinking? As for the United States, returning to 70% or 80% of capacity seems like a distant dream.

Now that the US has failed miserably to contain the outbreak despite having the world’s most advanced health system, Americans will find it exceedingly difficult to return to economic normalcy until a vaccine becomes widely available, which could be a year or more away. There is even uncertainty about how the US will pull off its November 2020 presidential election.



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For now, markets seem to be comforted by massive US stimulus programs, which have been absolutely necessary to protect ordinary workers and prevent a market meltdown. Yet it is already clear that much more will need to be done.

If this were just a garden-variety financial panic, a massive injection of government demand stimulus would absolve a lot of sins. But the world is experiencing the most serious pandemic since the 1918-20 influenza outbreak. If another 2% of the global population were to die this time, the death toll would come to roughly 150 million people.

Fortunately, the outcome probably will not be that extreme, given the radical lockdowns and social-distancing measures that are being adopted worldwide. But until the health crisis is resolved, the economic situation will look exceedingly grim. And even after an economic restart, the damage to businesses and debt markets will have lingering effects, especially considering that global debt was already at record-breaking levels before the crisis began.

To be sure, governments and central banks have moved to backstop broad swaths of the financial sector in a fashion that seems almost Chinese in its thoroughness; and they have the firepower to do a lot more if necessary. The problem, however, is that we are experiencing not just a demand shock but also a massive supply shock. Propping up demand may contribute to flattening the contagion curve by helping people stay locked down, but there is a limit to how much it can help the economy if, say, 20-30% of the workforce is in self-isolation for much of the next two years.

I have not even touched on the profound political uncertainty that a global depression can spark. Given that the 2008 financial crisis produced deep political paralysis and nurtured a crop of anti-technocratic populist leaders, we can expect the COVID-19 crisis to lead to even more extreme disruptions. The US public-health response has been catastrophic, owing to a combination of incompetence and neglect at many levels of governance, including the highest. If things continue the way they are, the death toll in the New York City area alone could rival that of Northern Italy.

Of course, one can imagine more optimistic scenarios. With extensive testing, we could determine who is sick, who is healthy, and who is already immune and thus able to return to work. Such knowledge would be invaluable. But, again, owing to several layers of mismanagement and misplaced priorities stretching back many years, the US is woefully short of adequate testing capacity.

Even without a vaccine, the economy could return to normal relatively quickly if effective treatments can be swiftly implemented. But, absent widespread testing and a clear sense of what will constitute “normal” in a couple of years, it will be difficult to persuade businesses to invest and hire, especially when they are anticipating higher tax bills when it’s all over. And it is possible that stock-market losses so far have been less than those of 2008 only because everyone remembers how values shot back up during the recovery. But if that crisis does turn out to have been a mere dry run for this one, investors shouldn’t expect a quick rebound.

Scientists will know a lot more about our microscopic invader in a few months. With the virus now racing across the US, American researchers will have direct access to data and patients, rather than having to rely only on Chinese data from Hubei province. Only after the invasion is beaten back will it be possible to put a price tag on the economic cataclysm it left in its wake.


KENNETH ROGOFF
Writing for PS since 2002
Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. He is co-author of This Time is Different: Eight Centuries of Financial Folly and author of The Curse of Cash.


Will ‘The Great Cessation’ be worse than the Great Recession? Here’s what we can tell so far

BY SHAWN TULLY March 25, 2020 FORTUNE

Which is moving faster: the spread of the coronavirus, or the damage to the U.S. economy?

That’s the question on the minds of tens of millions of American workers, small-business owners, managers, and investors. And as the economic effects pile up, many are wondering: Are we on the cusp of the kind of yearslong descent that began in 2008?

Never in recent decades has America suffered a deterioration in our economic outlook as swift and shocking as the tremors of the past five weeks caused by the coronavirus crisis. The 30% drop in the S&P 500 since its all-time high in mid-February is the fastest slide on that scale in its history; since Valentine’s Day, $10 trillion in shareholder wealth has vanished. The short-term funding that’s the lifeblood of corporations is freezing up as folks withdraw cash from money-market funds to pay for rent and groceries. An economy that was rebounding a few weeks ago after President Trump called a trade war truce is now universally viewed as heading for what could be the steepest one-quarter contraction in history.

Why 2008 was so terrifying

Americans are looking to crashes of the past for a prognosis on how sick the coronavirus will make our economy. And the one that’s top of mind is the most recent, the Great Recession, or what I'll simply call “2008.” The Great Recession is such a terrifying precedent because it was both extremely deep, and it was long—a full recovery took not a quarter or two, but years.

GDP shrank by 4% over six quarters, bottoming in mid-2009, and national income didn't rebound to late 2007 levels for 14 quarters, until mid-2011.

In the depths, unemployment spiked to nearly 10%. Yields on investment grade debt hit 9%, and junk bonds fetched 13.4%. The S&P 500 plunged 58% by the spring of 2009; it took five years, until the close of 2012, for equities to regain the summit of late 2007, the level first reached in 1999.

So far, it appears that the U.S. isn't threatened by a fundamental fissure that will crack and wrack the economy for years to come, like the housing bubble that caused the Great Recession. “This doesn’t seem to be another Great Depression or Great Recession,” economist and Nobel laureate Robert Shiller told Fortune. “The story isn’t the same. It seems to be a virus story and a stock market story, not like the housing story of 2008.”

But in some ways, this crisis is more serious than 2008. That’s because the early devastation hit much faster, and caused far more damage, than in 2008. To prevent an economic contagion that parallels the virus’s rampage, the federal government needs to provide emergency funding for beleaguered businesses at a speed, and size, never before achieved. The paramount threat isn't the kind of ticking time bomb—the subprime mortgage crash—that caused 2008. It’s the danger that America’s credit markets, already under severe stress, freeze up, sending cash-strapped companies into bankruptcy and causing cascading layoffs that deprive workers of cash, triggering more failures and layoffs. If the Fed, Treasury, and Congress don't deliver a gigantic package within days making the government the lender of last resort, America could experience another Great Recession even in the absence of a ticking time bomb like the subprime craze.

Mark Zandi, chief economist for Moody's Analytics, compares the current shock to a heart attack. “The heart of the economy is the credit markets, and it’s under attack because of the fear of lending,” he says. “We've got to do an angioplasty or valve surgery, or the heart will shut down.” He says that what makes this crisis so dire is the lack of time. “In 2008, it took months for the credit markets to dry up.” Now, he says, the U.S. has only days to act before the economy goes into cardiac arrest.

The Fed and Treasury have already taken important steps to bolster short-term funding. But the failed Senate vote on a $1.7 trillion package on March 22 undermined confidence and sent debt markets into a tailspin. We could be facing another onslaught of volatility in the quicksilver credit markets if Congress doesn't quickly pass the emergency funding measures in the augmented, $2 trillion bill agreed to by the Senate and White House on March 24.

That’s because America is experiencing a completely new phenomenon, the nearly total shutdown of large swaths of the economy. It’s as if the 9/11 attack that brought America to a standstill for a few days has morphed into a kind of Groundhog Day in which Americans awaken to the sight of empty streets and shuttered stores that shows no signs of ending. “In 2008, it wasn’t as if we didn’t go to restaurants and the gym,” says Jared Franz, an economist at asset management giant Capital Group. “People went about their daily lives. Now, businesses are completely shut down, or close to it.”

Franz notes that the virus is attacking the backbone of the U.S. economy, services that account for over two-thirds of GDP. He points out that around half of the 20% economic activity contributed by restaurants, airlines, in-store shopping, live entertainment, and hospitality is totally shuttered. “If you had to invent the perfect takedown of the U.S. economy, this would be it,” says Franz.

Delta Airlines predicts that its second-quarter revenues will drop by $10 billion, or 80%. JetBlue collected $4 million from customers in March, versus its average of $22 million. Marriott’s global hotel business has dropped 75% below normal, prompting CEO Arne Sorenson to label the current situation “worse than 9/11 and the financial crisis combined.” Analysts predict that Nike's sales will drop by one-third in its Q4 ending in May, and the suspension of the NBA and English Premier football league schedules is depriving the footwear colossus of crucial promotions. On March 19, GM and Ford shut down all production in the U.S., Canada, and Mexico until further notice.

The economy was already fragile when the coronavirus hit

To understand where we are now, you have to go back to the aftermath of the Great Recession, when the U.S. economy shifted into a slogging new normal, delivering slower growth and fewer new jobs than in the preceding decades. That trend reversed in Donald Trump’s first two years as President. Business confidence revived, and growth jumped to over 3% from mid-2017 to mid-2018. But although job growth remained robust and the stock market notched peak after peak, the economy entered 2020 back on its heels. The pandemic that would have weakened a strong economy is decimating a weak one.

To assess where the economy is headed, it’s crucial to review its more than yearlong downshift. Fearing that that overheating would stoke inflation, the Fed lowered its benchmark rate four times from December of 2017 through September of 2018. But a signature Trump onslaught was already tapping the brakes: the trade war. Starting in early 2018, Trump slapped tariffs on over $300 billion of U.S. imports from China, raising prices for consumers and businesses. “It was the trade war that was mainly responsible for sucking out growth,” says Zandi. Nevertheless, in December, the Fed made the mistake of imposing yet another rate increase, an ankle weight that further slowed the already halting jog.

Through much of 2019, big parts of the economy, notably farming, energy, and manufacturing, all hit by the trade conflict, sat mired in a downturn. By midyear, the U.S. seemed headed for recession. In July, the Fed reversed course, slashing its benchmark three times through October. “Then Trump connected the dots and called a truce,” says Zandi. Late last year, Trump announced a deal that would roll back some duties on Chinese goods and suspend other planned tariffs.

The gambit worked, at least in part. In January and February, business and consumer confidence was rising. The Fed forecast mediocre expansion of 2% for 2020, slowing to 1.8% by 2022, but no recession. The 10-year Treasury yield had fallen from 3% in mid-2018 to 1.5%, a signal that GDP could well wax more slowly than the Fed predicted. “If not for the pandemic, we might have muddled through,” says Zandi. “But it would have been a struggle. Manufacturing was still in recession. The economy was already fragile, and vulnerable to a shock that could send it into a tailspin.”
How deep will the next recession be?

Experts’ predictions on how deep this recession will go must be setting records given the distance from the depressing best to the previously unimaginable worst. What most economists at the banks, brokerages, and research firms have in common is that they’re positing that the shutdown lasts another nine to 12 weeks or so, and that a sharp recovery begins in the third quarter. Once again, that “this isn’t 2008” scenario hinges on heroic action to keep credit flowing.

According to most forecasts, the deep devastation hits in the second quarter. Just about the most optimistic outlook comes from Steven Blitz of TS Lombard, who foresees a fall of 8.4% in Q2. At the other extremes, Goldman Sachs sees a 24.5% drop in the three months from April through June, and Bank of America is just as pessimistic at 25%. Jim Bullard, president of the St. Louis Fed, warned GDP could crater by 50% without drastic emergency action from Congress, the Fed, and the Treasury. The contractions predicted by other notables: UBS at 10%, Oxford Economics at 12%, and JP Morgan Chase at 14%. Here’s a guide to how fast the numbers are deteriorating. On March 16, Goldman called for a decline of 5% in Q2 and four days later upped the number almost fivefold.

With the forecasts worsening so rapidly, it’s hard to find a middle range that could provide a reasonable view of how much the economy could shrink. Right now, the median appears to be around –15%, and that’s optimistic, since it’s been heading lower. Most banks also expect shrinkage in Q1 in single digits—a ballpark number would be 2%. Goldman is typical in projecting a strong rebound in the second half, foreseeing plus 12% in Q3 and 10% in Q4.

Where do those negative 3% and 15% predictions, followed by the Goldman-posited rebound, take us by year-end? By Fortune’s calculations, GDP for 2020 would shrink by over $1.3 trillion to $20 trillion, and decline 6.3%. As we’ll see, that’s more than half again the total shrinkage in the Great Recession. The difference is that the Q2 fall would be a passing hangover, since the economy would be recovering strongly moving into 2021.

The rolling lockdown of businesses, however, is already creating a job crisis. The week beginning March 3, 211,000 Americans filed unemployment claims. Just two weeks later, the number, by Goldman’s estimates, jumped to a staggering 2.25 million. Morgan Stanley predicts an average unemployment rate in the April to June period of 12.8%, more than triple today's 3.6%.

Aid to families and industry

On March 25, the Senate and the Trump Administration reached agreement on a colossal relief package providing $2 trillion in aid to businesses and families, and make as much as $4 trillion in emergency loans available for all types of large businesses from brokerages to automakers. Single adults making up to $75,000 a year would get a one-time payment of $1200, and couples making $150,000 or less would receive $2400, as well as $500 per child. Those amounts would be reduced for earnings above the $75,000 and $150,000 thresholds. On the business side, the bill earmarks $58 billion in aid for airlines. A crucial plank is a $367 billion infusion targeting America's 30 million small businesses that account for half our economy and employ 58 million workers.

The plan would provide “retention loans” available to all enterprises with 500 employees or fewer. Restaurants, flower shops, printing outfits, and the like would deploy the funds to pay their employees wages for the next two months. If they meet that test, the Treasury would forgive the loans. The program provides a crucial bridge so that small businesses can keep employees on the payroll so they’re ready to go when folks can finally get back to shopping. Right now, a long extension to prevent a cycle where wave after wave of workers lose their paychecks and clamp down on spending, causing big-company revenues and capital expenditures to keep shrinking, triggering still more layoffs that send us into another 2008.

Fortunately, the Senate and the White House also moved to forestall a credit crisis that would unleash armageddon. The Senate bill provides a $500 billion facility that would cover losses on loans provided by the Federal Reserve. The Treasury's backstop would enable the Fed to lend as much as $2 trillion to corporations that either can't obtain loans or refinance bonds in the private markets, or could only borrow at super-high rates.

Still, it's unclear when a final bill will pass so that the sorely needed cash will start flowing. In the House, Speaker Nancy Pelosi in championing a substantially different, $2.5 billion measure. It's unclear if she'll put the Senate version to a vote that would probably assure quick passage, or demand a compromise that would prolong getting that sorely needed cash to families and businesses. The stock market's 10% plus leap on March 24 was a reaction to the a huge infusion of liquidity was on the way. More days of squabbling in Congress could kill that show of confidence.
Growing risks in repos and commercial paper

What could turn a damaging but temporary storm into a hurricane requiring years of rebuilding is that aforementioned lockdown in credit. The danger lies in both of two distinct sectors of the credit markets. The first is the short-term financing provided by two types of vehicles: repurchase agreements, known as repos, and commercial paper. Repos aren't exactly a household name, but they constitute one of the world’s biggest debt markets; the average amount of repos outstanding stands at $3.9 trillion, one-fifth the size of the U.S. economy.

Repos are ultra-short-term loans, usually asset-backed, mainly provided by money-market mutual funds. The borrowers are financial institutions that aren’t funded by deposits like the big banks, nor do they rely on those banks for quick financing; the money market’s chief customers are brokers and hedge funds. The broker, say, sells the money-market fund, which has lots of cash to invest, a contract enabling it to borrow $100 million overnight, and the next day buys back the contract at a slight premium, giving the fund a fraction-of-a-basis point return. The brokerages use the cash to back equity and bond trading, and the hedge funds can deploy the funds to quickly acquire securities without selling parts of their portfolios.

As security, the hedge fund or broker furnishes Treasuries or Fannie Mae or Freddie Mac “agency” bonds. The major commercial banks do a thriving “clearing” business ferrying contracts, cash, and collateral between lenders and borrowers, and handling custody.

In almost all periods, repos are a supersafe vehicle for the money-market lenders. But in rare times of extreme volatility, they turn away borrowers, and the market seizes up. The money-market funds fear that hedge funds are taking big losses, are desperate for cash, and that the value of even the Treasuries supplied as collateral is fluctuating so fast that they may not get repaid. That’s what’s been happening intermittently for the past few weeks. In addition, money-market fund customers are taking out the cash, creating a shortage of funds available to borrowers.

If hedge funds and brokers face a liquidity crunch, the former will dump their Treasuries and other bonds to raise emergency cash, and the latter won’t have the funds to ensure a smoothly working fixed-income market. The freeze will send prices plummeting and yields soaring, further tightening the vise on credit.

A second critical source of funding is commercial paper, short-term IOUs that all kinds of companies obtain to finance inventories or receivables. That flow of ample, cheap cash enables the likes of automakers or restaurant chains to pay bills without liquidating their fixed-income holdings, and once again, the fear contagion virtually shut down the market briefly in mid-March.

It’s the Fed’s role to keep the repo and commercial paper markets liquid, and so far, it’s stepping up. In mid-March, the Fed stood in for the money-market funds and purchased $1 trillion a day in repos, averting a cash crunch for brokers and hedge funds. The Fed also is dusting off the Commercial Paper Funding facility from its 2008 playbook, agreeing to buy up to $1 trillion in the IOUs from corporations, bolstered by a big backstop from the U.S. Treasury, that can't get funding from money markets. Keep an eye on these two crucial funding sources. Only if the Fed continues to fill the role of the fleeing lenders, and only if the Fed pledges to keep doing so no matter how bad it gets, can America weather the crisis without a catastrophe.

Looming stress in corporate bonds and loans

In the recovery from the financial crisis, U.S. companies steeply increased their leverage and shrank their safety cushion. “For 11 years, everyone had a big appetite for risk,” says Alicia Levine, chief economist at BNY Mellon. “Companies gorged on debt. In 2008 the banks’ balance sheets were at risk. Now, corporate America’s balance sheets are threatened. We have a potential liquidity crisis not in the banks, but in the corporate sector.”

The jump in leverage was especially pronounced in such sectors as energy, notably fracking, utilities, and materials. Franz of Capital Group reckons that U.S. enterprises have borrowed a total of $5 trillion in high-yield, leveraged loans used in LBOs, and BBB-rated corporates, the lowest Moody's level above junk status. That’s an increase of well over 100% in the past decade, says Franz.

The junk bond market is already flashing red: Yields have catapulted from under 5% to around 6.1%. Companies are constantly refinancing the waves of maturing corporate debt. As the business lockdown raises the risk of defaults, yields could rise so high that companies can borrow only at ruinous rates, if private lending doesn’t shut down altogether.

To make matters worse, big asset managers are banned by their charters from holding bonds rated lower than BBB. So if those securities are downgraded to junk, mutual funds will dump them in bushels, once again, sending yields skyward.

It now appears that over the next few months, the shrinkage in cash flows will become so severe that private lenders retreat from the market or demand rates that drive corporate America to even deeper losses, causing a spillover into job losses and bankruptcies.

Once again, the government needs to provide credit that will bridge corporate America through the crisis. The Fed is barred from taking credit risk, so it’s the Treasury that must take the lead. Fortunately, the Senate bill allows Treasury to partner with the Fed to provide that $2 trillion in liquidity.

But that $2 trillion still isn't available. That's because the House has yet to pass the Senate bill, or a comparable measure, that includes that relief. Time is short. Any surge in bad news could spook the debt markets. More delays in Congress could provide just that disastrous shock.
The outlook beyond the crisis

Of course, it’s unknowable at this point whether the U.S. will emerge from this dark tunnel into the sunlight by spring or summer. Keep in mind that even the forecasts that get us to a shrinkage of 6% of GDP by year-end, a figure seldom seen, assume that folks will be back on the streets and offices by late spring or early summer.

Assuming we get to the other side, the outlook, frankly, isn’t great. Since stocks looked wildly overpriced prior to the crisis, it’s likely that a lot of the wealth families had in stocks isn’t returning. High tariffs that weren’t hurting us two years ago will probably be a permanent feature—no matter who’s elected President. That’s a major negative for growth. The exploding public deficits and debt can only be addressed with much higher taxes that would impose still another burden.

So the best bet is that we’d return to the same old, same sub-2% growth we were expecting before the crisis hit. It’s not the animal spirits of the early Trump days.

But it’s sure a lot better than 2008.