The stock market correction started on February 24th. We were busy preparing for and then flew to Hawaii for our vacation. It was surreal to watch this doom-filled volatility from the beautiful, sun-lit hotel pool in Hawaii with tall palm trees all around.
A couple of days later, the stocks bounced. Nevertheless, I told my wife that this is going to be worse than 2008, but it will not go in a straight line. There will be many “head fakes”, “sucker rallies” and “dead cat bounces”.
Fast forward to today and we have a full blown crisis, where both the U.S. and Canada had announced aid packages:
- White House pushed for $1 trillion package.
- Canada announced $82B aid package.
These will not be enough. It’s likely that these governments will increase this or announce another package.
This recession is going to be worse than the 2009 recession. Here is what caused the 2009 recession:
- U.S. government enacted CREA (Community Reinvestment Act), which pushed banks to lend to low-income borrowers, in order to increase home ownership.
- Fannie Mae and Freddie Mac bought mortgages from banks, in order to get banks to lend out more mortgages. They ended up with half of the country’s mortgages.
- Wall Street jumped on board and sold mortgages to earn commissions. They sold to high risk, low-income borrowers because Wall Street was not the lender and therefore didn’t take the risk.
- This fuelled the housing bubble.
- Bubble burst
- Homeowners stopped paying banks.
- Banks were on verge of bankruptcy and stopped lending.
- Tightening credit caused recession.
What most people do not realize is that it was the government that created the housing bubble and ultimately the crash and recession. The bail outs of Fannie Mae and Freddie Mac were much bigger than for AIG or the banks.
Consequently, the stock market dropped by as much as 10% in day, on multiple days.
During this deep recession in 2009, credit was tight, but people were still able to consume or produce. In May, 2009, Hawaii was dirt cheap, so my wife and I took a 10 day vacation for $2,200, which included hotel and flights.
This recession is much more different. Even if Hawaii vacations are selling for $100, you cannot buy one. People are told to stay home, self-isolate or stay in quarantine. Borders are closing. You cannot fly to Hawaii from Canada even if you offered $1 million to the airlines.
In 2009, you still saw people in restaurants, bars, movie theatres, etc. Today, you see no one.
In 2009, people still bought TVs, computers, electronics, etc. Today, Apple’s stores are closed.
The stock market has already dropped by 10% in a day, on multiple days.
In 2009, once credit loosened, the economy could recover. Today, the virus is still growing exponentially. To slow this down, the government is clamping down the people, which is clamping down the economy. If the government lets people go back to normal activities, the virus will flare up again, which will prompt the government to clamp people down again. This can happen repeatedly until the vaccine comes out in 12-18 months. Until the vaccine comes out, the economy might be kept in a coma.
In addition to the devastating impact on health and lives, this virus will wipe out trillions of dollars of wealth around the world. Bankruptcies will soar. Millions of jobs will be lost. The number of people on welfare will go up.
The crisis will eventually subside. Things will eventually go back to normal, once the vaccine comes out. Social distancing is going to be very boring. During this process, you will become poorer. To prepare, make sure that you have a budget and have enough of a buffer to pay for several months of expenses.
Note that the aid packages will come from you. You will pay for them. The government cannot create wealth. It can only take it from you to give to somebody else. Therefore, the country’s wealth will be the same as without the aid packages, and the country will still be poorer than before the virus.
Governments will likely bail out companies. Despite being an investor and shareholder, I object to this, and so should you. Many of these companies, such as the airlines and Boeing, were making billions of dollars of profits for many years. Instead of stashing this money into their bank accounts, they used it to buy back shares. This juiced the stocks, which benefited shareholders, but more importantly, it increased the executives’ stock options and bonuses. Now that their companies are losing money, their companies should sell shares to raise money. That’s the main purpose of the stock market: enable companies to sell shares to raise money.
If governments bail them out, they will be “Privatizing Profits and Socializing Losses”.
Some people might blame capitalism for these bail outs. This is socialism, not capitalism. Capitalism advocates that incompetent businesses should die and disappear. Socialism advocates that governments help businesses. “Socializing Losses” is socialism.
Similarly, the problem with Wall Street in 2009 was socialism, not capitalism. Bailing out Wall Street firms is socialism. Furthermore, it was the government that created the housing bubble. (Similarly, Canada’s government created its housing bubble, but that is another long discussion.)
Some people might argue that compensating executives with stocks is the source of the problem. I disagree. If the government does not intervene with bail outs, these executives will learn the hard way for their mistake of stock buy backs and for not stashing enough money in the bank. Now that their stock price is low, these executives will not make bonuses. When they get their company to sell stock, they will continue to forgo bonuses, but they will prevent their company from going bankrupt.
This is the punishment and lesson that executives should endure and learn, but will not if the government bails them out.
You, as a taxpayer, should not pay for their mistake of not stashing their profits into their bank accounts.
Even if you bail out these companies, it does not prevent them from declaring bankruptcy. Governments forced taxpayers to give billions of dollars to GM in 2008. It still declared bankruptcy anyways.