Business Week: Special Report on the Economy & the Markets

The 2/4/08 edition of Business Week arrived in the mail today, and it has a an excellent Special Report section on the economy, the markets and what's important to know that I highly recommend reading. Following are links to the different sections and some selected text:

How real was the prosperity?

The rule for a prudent individual is simple: Don't spend more than you make. For a long time, the U.S. economy obeyed that rule. As far back as the 1960s, personal spending, adjusted for inflation, has basically tracked the overall growth of the economy, as measured by gross domestic product. Sometimes consumers would get ahead of the economy for a few years, and sometimes fall behind, but never for very long.

That pattern changed in the 1990s. As of the third quarter of 2007, the 10-year growth rate for consumption was 3.6%, vs. GDP growth for the same period of 2.9%. This difference represents an enormous gap. If consumer spending had tracked the overall economy over the past decade as it has in the past, Americans today would be spending about $600 billion less a year. The extra spending has amounted to a total of about $3 trillion since 2001.

Where did we spend the money? On housing and health care, of course. But outsize gains also came in clothing, furniture, recreation equipment, motor vehicles, and consumer electronics—all areas where prices have fallen and imports have surged.

The question now is how much of that extra $3 trillion we will have to give back...

What could cage the bear?

This is what you need to know: We're in a bear market. Bear markets are painful. Some end quickly, others grind on for years. There's little use trying to predict what will happen or when, because full recoveries are apparent only in hindsight. Selling can be just as risky as buying, because there's no telling when an explosive rally will add 500 points to the Dow Jones industrial average in a day. Oh, and there are head fakes that will break your heart...

So what might pull the U.S. out of the bear's maw this time? A good guess is that an aggressive Federal Reserve and quickening globalization will somehow point the way forward. But the prices to be paid for the next bull run could be steep...

For better or worse, the trade-off for the next bull market could be that the U.S. turns into a happy hunting ground for foreign players. "Everything is very global," says Scott Martin, managing director of investments for Chicago-based Astor Asset Management. "There is a lot of money out there."

The banks: too big to fail

It's the question bank regulators dread: Should they bail out a crucial bank if it collapses?

With economic and market conditions sliding precipitously, risk is rising fast that at least one major institution could implode, endangering the financial system with it. The way the Federal Reserve and other government watchdogs deal with a blowout could determine how much damage is left by the current credit crisis.

With banks getting battered on a number of fronts, the odds of an outright failure are higher than they've been in years. Troubled ones are discovering that the protection they bought from bond insurers, including Ambac (ABK) and ACA Capital, for subprime and other securities is inadequate...

Banks may face more pain from commercial real estate loans, credit cards, and corporate loans, all of which show signs of weakness. Loans to highly leveraged hedge funds that bet heavily on global stocks are also in jeopardy...

...one thing is certain: Central bankers hate bailouts. In particular, they loathe helping an individual institution even more than they dislike creating general economic bailouts via interest rate cuts and increased government spending. Both, in effect, ratify the excesses that lead to a bust and encourage more wasteful behavior in the future. But deals for specific banks are especially bothersome because they pardon individuals for bad decisions.

The downside of a quick fix:

Here's the good news: Congress and the Bush Administration are working with remarkable speed to pass a fiscal stimulus package. Tax rebate checks could start hitting mailboxes by June. Observers have been impressed with the alacrity of the political Establishment. "I don't know if it will keep the U.S. out of recession, but if there is a recession, it should shorten its stay and limit its duration," says John Lonski, chief economist of Moody's Investors Service (MCO).

The danger is that election-year pressures could tilt the package too far toward boosting consumer spending at the expense of business or public works investment. Giving cash to consumers could jolt the economy like a strong cup of coffee, then rapidly fade by late 2008...

By trying to engineer a brief consumption spurt, Washington could do too little for a seriously impaired economy. "You could have a bad first half of the year, get a temporary pop through the stimulus, and then go back to negative growth," warns Nigel Gault, chief U.S. economist of forecaster Global Insight. That's something a longer-term stimulus package could help guard against.