by Gary North
by Gary North
Something in the range of 34,000 pink slips — "You're fired" — have been handed out by Wall Street firms over the past nine months.
Firms laying off the employees include Citigroup, Lehman Brothers Holdings, and Morgan Stanley. These are major investment banks. They are closely linked to the housing market.
The last time that the economy produced this level of firings was in 2001, a recession year. That was the year following the peak in the stock market indexes (March, 2000). Stocks fell until mid-2003. During that period, Wall Street lost 90,000 jobs.
"This crisis is much worse than 2001 and we don't know how long it's going to last," said Jo Bennett, a partner at executive search firm Battalia Winston International in New York. Job cuts "could be more than 100,000 in a few years."These layoffs are more serious for some firms than others. Citigroup has cut 1.7% of its work force, while Lehman has fired 18%. Morgan Stanley has laid off over 6%, while Merrill Lynch has cut 4.5%
We see the Dow Jones Industrial Average bouncing up and down between 11,700 and 12,700. It does not break out of this trading range for long. Investors are divided as to whether to stock market is heading into bull market territory or bear market territory.
I think the pink slips tell us where the stock market is headed: down. If Wall Street firms' managers were convinced that this is the bottom, they would not be firing workers. It will be expensive to enter the job market and find replacements. The new people must be trained, which is expensive. If there were any way financially not to let existing people go, management would not let them go.
THE FINANCIAL SECTOR
We are seeing the early stages of a decline in demand for the services of people in the financial industry. The first people to be hit are those in the real estate mortgage sector. The layoffs began last July because of rising delinquencies by home owners. This was an early warning signal of the international credit crisis that hit in August. In August, investors began to sense danger in the subprime mortgage markets. That danger soon proved to be real.
When Bear Stearns' stock fell from $68 (Monday, March 10) to $10 (Friday, March 15), this sent a message to Wall Street: the leverage factor can be devastating. The CEO told the public on Monday that there was no liquidity problem with the company. The stock rose from $60 to $68 that day. By Friday, the firm faced bankruptcy.
The TV crews on Friday showed Bear Stearns workers loading up their cars with boxes of papers taken from their offices. They were the initial victims. By Sunday, the New York FED and J. P. Morgan arranged to sell Bear's shares to Morgan for $2 a share, with the FED guaranteeing Morgan a $30 billion line of credit to cover write-downs.
Lesson: watch the early pink slips for signs of more bad news to come.
Anyone who suggests that Bear Stearns was an anomaly, and that there will not be another Bear Stearns event, is singing the same song that Bear Stearns' then-CEO was singing two weeks ago: "No problem!" I suggest that you pay zero attention to all such assurances for the next year, and maybe two years.
If these people knew what they were doing, we would not have seen the financial carnage that began last August. The experts did not see this coming. Some of them have been fired, although after receiving huge bonuses. There will be more firings to come.
Pink slips get handed out to lower-level people before the crisis hits a company. After it hits, the CEO gets his pink slip. So far, six CEO's, eight presidents or other officers, and at least 19 division heads have lost their jobs as a result of the subprime meltdown.
What about the firms' revenue? Standard & Poor's released an estimate on March 21 that revenue is likely to fall by 30% in 2008. This would be a major hit. Very few firms can suffer that kind of loss and not lay off workers.
That 90,000 workers get laid off is indicative of the general direction of the financial world, but it is not a disaster by itself. The problem is that the capital markets are at the heart of the economy. When the financial sector is hit with falling revenues, this means that investors are being hurt by the investments that the financial sector created and then recommended to its clients.
When clients' investments are falling, clients move into other, less creative, less risky, more traditional sectors of the financial world. These sectors generate lower returns. They also provide lower revenues for the financial sector.
So, my assessment of the economy is that it is in the early stages of a recession. This recession will escalate.
FIRST THEIR PINK SLIPS, THEN YOURS
In most recessions, most people keep their jobs. If they are married and have five years of tenure with a firm, they are safe. I don't want to spread fear where the risks are relatively low. But risks do rise, and income does fall. Companies fire newly hired people first. Then they fire people who don't work on commission. They keep commissioned salesmen because the market tells management exactly how much these employees are worth. Their income falls when sales fall. So, they keep their jobs, but they suffer lower income.
If you are salaried, and you have been with the company for five years, you are comparatively safe unless your company gets bought by a rival. In a merger, the people at the swallowed firm are at risk. Consider Bear Stearns' employees. J. P. Morgan is a competing firm with its own staff and a separate corporate culture. Senior managers at Morgan will fire Bear Stearns' employees before they fire Morgan employees.
It is important for you to be aware of the operational condition of your employer. You may be high on the totem poll in your department, but your department may be expendable.
One major risk is the company's line of credit. In a recession, banks cut lines of credit to companies that have become dependent on these credit lines. This can be devastating for the company that is dependent. Its managers scramble, looking for alternative sources of funding. This happens at a time when lots of companies are scrambling.
If your employer is a publicly traded firm, it has published an annual report on its overall condition. If you can read a balance sheet, do so. If you can't, hire an accountant for an hour and have him look it over. Ask him to look for credit lines. Then sit down with him and talk over any problem areas that he sees. This will cost you anywhere from $100 to $300. When your career is at stake, this is money well spent. Not many employees ever do this.
There is an old rule of thumb: the longer the disclaimer posted by the accounting firm, the more risky the condition of the audited company.
Another major risk is the sector of the economy. Does it sell something that is essential? If so, your risk of getting fired is low. If it's part of people's discretionary income, you may have a problem. If it sells to poor people, this is risky. If it sells to middle-class people, it's less risky. If it sells to newly rich people, no problem. There will always be newly rich people.
It's safer to be in retail sales than in capital equipment. The more specialized the capital equipment, the riskier it is if the industry that buys such equipment is connected to discretionary spending. So, a company in the restaurant equipment business is in a high-risk sector. A company that sells medical equipment that is used in non-discretionary surgery is much safer. No one passes up a heart bypass operation just because the economy is in recession.
I suggest that you get an interview with an old-timer who went through the 1991 recession. He may still be with the company. If not, can you find out who was on staff back then? What you are looking for is advice on how to maintain your income in a recession. If your income does not fluctuate with buyers' demand, find out what things you can do to move to the top of the "don't fire" list. When your income isn't directly determined by the market, then your job is at risk in a downturn. It becomes a target of cost-cutting. The inflexibility of payment makes it an all-or-nothing target on the accounting department's list of sacrificial lambs.
I return to this theme often. What have you done in the last three months to make you too important to fire? This need not be something spectacular. If your department is doomed, then you need something on your résumé to make you stand out. If your department is vital, not every employee is equally vital to the department. You must take steps to persuade the person who draws up the list on "no-fires" to put you on it.
THE LENGTH OF THIS RECESSION
In a March 17 interview with billionaire investor Mort Zuckerman, he speculated that this recession will be deep and long: maybe two years. He thinks it will be the worst one in his career.
The investing public is not prepared for anything like this. The last recession lasted 6 months and was overcome by inflation by the Federal Reserve. It did not frighten anyone much, yet the stock market had already begun its decline over a year earlier. The S&P 500 declined by almost 50%.
Investors are unprepared to deal with any recession that lasts two years. Neither are consumers. They will not be able to tap into home equity to maintain their spending habits.
The upward moves of the stock market are telling us that there is not going to be a recession at all. The best investment minds say that the worst is behind us. Then it turns down again. The inability of investors to decide which way this market is going reflects their confusion about the state of the economy.
The FED is maintaining a tight-money policy. The FED's decision makers are not taking steps to inflate their way out of a falling stock market. They are adopting alternative strategies, most notably the swap of Treasury debt for the banks' piles of mortgage debt.
Either they think this recession will be much milder than the 2001 recession, when the FED inflated, or else they do not believe in Ludwig von Mises' perspective on the boom-bust cycle, namely, that a prior boom will turn into a bust when the fiat money creases to grow. Maybe they believe both.
My position is that the FED policy has subsidized debt on a massive scale, and that there is uncertainty built into the capital markets on an unprecedented scale. A company can be solvent on a Monday and be bankrupt a week later, or else owned by a competitor. This is the lesson of Bear Stearns.
This may seem far-fetched, but the speed of Bear Stearns' demise sent a message that the stock market's best and brightest do not take seriously.
I am persuaded that tight money has long-term effects. It forces a reallocation of capital that had been invested unwisely during the FED's expansion phase.
The leverage of contemporary finance is greater than ever before. What is called counterparty risk is extremely high. Promises cannot be fulfilled, and solvent companies can topple within days because of margin calls.
The extent of the damage under Greenspan's FED is appearing in front-page headlines.
Today, liquidity is crucial. Those who have it will be able to buy at distressed prices over the next two years. This is a time for patience.
This is also a time for going the extra mile for your boss. Fund out what he expects and do more.
Be aware of his position, too. Don't go down with his ship.
March 27, 2008
Copyright © 2008 LewRockwell.com