Larry Summers Provides View on US Downturn and Future Prospects

Larry Summers, a former Treasury Secretary under Clinton and the former and controversial President of Harvard University, just published his view of the economic downturn and the economies prospects in an article in the Financial Times. I respect his opinions and therefore took particular note when reading the article.

His prognosis is pretty grim.

He starts off by saying:

"What is most remarkable and troubling about our current difficulties is that all these elements – supply shocks, financial dislocations and concern about rising underlying inflation – are present at once. Moreover, the crisis is global in scope. Concerns about recession are spreading from the US to much of the industrialised world. Significant slowdowns appear more likely in a number of emerging markets, with inflation concerns worldwide at their highest level in more than a decade. There is a growing consensus that the west is facing the most serious financial crisis since the second world war."

Yikes, that's pretty bad but it's also true. I remember when the financial crisis started last summer and most economists thought housing prices and the economy would have recovered within months. They were clearly wrong and failed to understand that what we are experiencing is the unraveling of a whole economic system based on obsecene amounts of credit and dubious assets.

Here's another doozy from Summers:

"The point can be put in another way. Four vicious cycles are simultaneously under way: falling asset prices are forcing levered holders to sell, driving prices further down; losses at financial institutions are reducing their ability to finance investment, which in turn reduces asset values, causing further losses; the weakness of the financial system is reducing growth, which in turn weakens the financial system; and falling output is hitting employment, which in turn leads to reduced demand for output.

Without active efforts to interfere with these mechanisms, there can be no basis for confidence that the American economy will recover even in the medium term."

I think the last line, which I've bolded is particularly scary. No recovery in the medium term? What does that mean? Are we stuck with this crappy economy and financial crisis forever?

He also feels that the entire banking system is pretty much shot. Here's what he has to say:

"In all likelihood, the financial system will require very substantial capital infusions over the next year or two if it is to remain healthy. It is not clear where the capital will come from. Most of those who have provided financial institutions with capital over the past year have been badly burned. As valuations fall, it becomes increasingly difficult for financial institutions to raise capital necessary for them to retain market confidence, leading to further declines in valuation and yet another vicious cycle."

Based on this, it sounds like he is almost guaranteeing more large scale bank and investment bank failures. Af ter all, if they can't get access to capital, and their balance sheets are being destroyed then insolvency is only a matter of time.

Of course, the government will probably step in at some point, but when they do, expect the shareholders of these financial institutions will take a beating:

"Consideration should be given to whether the government should establish a mechanism for purchasing assets from stressed banks in return for warrants or other consideration."

To me, it sounds like a sober, realistic assessment of the pitfall the global economy faces. Times are going to be tough for the next couple of years. Greed and incompetence has virtually gutted Wall Street and it will take many steady hands to guide the economy back to good times.