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Moody's Talks - Inside Economics
Recession Lessons
Mark Zandi: Welcome to Inside Economics. I'm Mark Zandi, the Chief Economist of Moody's Analytics. And this is a special evergreen podcast, sort of evergreen. We're talking about recessions. And evergreen in that we're not going to actually talk at length about any of the statistics that have come out, economic statistics, but just about recessions, the history of recessions, causes, leading indicators, what goes to the severity of recessions, policy responses. And then ultimately we'll bring it all back to the current situation and the high probabilities of recession. Talk a little bit about that. Joining me in this discussion are my two co-hosts, Ryan Sweet. Ryan is the Director of Realtime Economics and Chris. Cris deRitis is Deputy Chief Economist. And we're all here in suburban Philly waiting for a storm. Ryan was telling me that your kids got out of school early because of the storm.
Ryan Sweet: Yeah, it was supposed to be a pretty bad storm, but I have empathy for weather forecasters. We all should being economists. So if we don't get a storm, I'm not going to blame them.
Mark Zandi: Well, I mean, there is a front going through, so there is thunderstorms. I guess the question is, where are those going to actually hit, right?
Ryan Sweet: Right.
Mark Zandi: That's a [inaudible 00:01:36].
Ryan Sweet: I'm looking out the window and it looks pretty nice outside right now.
Mark Zandi: Oh, it looks like it's a little drizzling here, but certainly nothing to be all that worried about. Well, I guess we'll see how it goes. And Cris [inaudible 00:01:48].
Cris deRitis: I thought you were getting metaphorical on us there.
Mark Zandi: How so?
Cris deRitis: "We're waiting for a storm." Right? We're talking about recessions and-
Mark Zandi: Oh, that would've worked.
Cris deRitis: Yeah.
Mark Zandi: Could have definitely gone down that path for sure. And I had all kinds of comparisons economist weathermen, but I thought that's pretty hack neat.
Cris deRitis: Yeah.
Mark Zandi: Yeah. Do you-
Cris deRitis: We exist to make them look good, right?
Mark Zandi: Yeah, that's the standard joke.
Cris deRitis: That's the classic.
Mark Zandi: Yeah. Any other good jokes? Economist jokes? Actually, it's very funny. I was going to give, I can't remember for what, I had to give a speech and they wanted me to talk a little bit about economics. And I said, "Okay, I'll tell an economist joke." They're not easy to find. I Googled economist jokes. We're a pretty boring bunch I think.
Ryan Sweet: We are extremely boring.
Mark Zandi: There's no such thing as a good economist joke. There was one. I can't remember what it was, so it couldn't have been that good, because I can't even remember it. But I spent an hour looking for an economist joke and I just gave up, I couldn't find one.
Ryan Sweet: The only one I heard recently was, what's the difference between accountant and an economist?
Mark Zandi: What?
Ryan Sweet: An economist is an accountant with a sense of humor.
Mark Zandi: Oh, there you go.
Ryan Sweet: I was like, "All right. That's about it. The well is dry now."
Mark Zandi: Yeah. Right. Very good. And I should say, in this discussion, we are going to play a game, although it's not going to be the statistics game. Oh, I guess it is a statistics game, but it's going to be around recession statistics. Not a real time economic statistic. Okay. Recessions. Okay. How do we define recessions? You want to take a crack at that, Ryan? How do you define a recession?
Ryan Sweet: So I'll give you the NBER's definition. I'm paraphrasing, but essentially-
Mark Zandi: For the folks out there. NBER.
Ryan Sweet: Yeah. The National Bureau of Economic Research. So essentially a bunch of economists get into a room and they define where we are in the business cycle. And they define a recession as a significant decline in economic activity that is broad based and lasts for more than a few months.
Mark Zandi: I never heard that last bit. More than a few months.
Cris deRitis: Yeah. I think you're tacking that on.
Ryan Sweet: I am not.
Mark Zandi: Is that your own? You added that.
Ryan Sweet: All right. Hold on.
Mark Zandi: Well, hold up because the pandemic recession was two months. Is that not a recession?
Ryan Sweet: Scott Hoyt, one of our colleagues, him and I had this debate. It was like, "If it's just a few months, can it be really... But it was so significant that they had to call it a recession."
Mark Zandi: Well, it was a recession.
Ryan Sweet: Well, I know. But here you go. On the NBER's website.
Mark Zandi: Okay.
Cris deRitis: All right.
Ryan Sweet: All right. What is a recession? The traditional definition of a recession is a significant decline in economic activity that is spread across the economy and that lasts for more than a few months.
Mark Zandi: Oh, that is news to me. I did not know that. I think they must have added that since the last time I looked 25 years ago.
Ryan Sweet: So that definition is different than what we learned in principles of macro-economics.
Mark Zandi: Well, okay. Well, they violated that definition then, right?
Ryan Sweet: I would assume so.
Mark Zandi: All right. I mean, I would just say paraphrasing that, this is how I describe it. A broad based persistent decline in economic activity. That's a recession, right?
Ryan Sweet: That's the NBER's definition without a few months.
Mark Zandi: That's right. No, but mine's much clearer, uses less words, which is always a good thing. Very clear. Okay. A broad based-
Cris deRitis: I would say it's just a general decline in output or activity.
Mark Zandi: You wouldn't say broad based?
Cris deRitis: Yeah. General. That's broad based.
Mark Zandi: Yeah.
Cris deRitis: Keep it short and sweet.
Mark Zandi: As opposed to broad based, you'd use the word general you're saying?
Cris deRitis: Yeah. General.
Mark Zandi: Okay. All right. General. I like broad based, but okay. General.
Cris deRitis: All right.
Mark Zandi: Okay, but that blows out of the water kind of the standard way people... If you talk to most people to say a recession is two consecutive quarters of negative GDP, right?
Ryan Sweet: Correct. That's what we learned in principles of macroeconomics.
Mark Zandi: You learned that... Well, geez. Where'd you go to school, buddy? Don't answer that question.
Ryan Sweet: I teach at Westchester. In the textbook that we use it says-
Mark Zandi: No. Really? No.
Ryan Sweet: Yes, yes. I will bring the textbook in and show you.
Mark Zandi: Oh, my goodness.
Ryan Sweet: That's why when I teach it, I'm like, "All right, ignore that definition because at least in the US, it's not what a recession is."
Cris deRitis: All right, we're going to have to write our own book.
Mark Zandi: I think the 2001 recession that came after the blowing up of the Y2K equity bubble, that wasn't two quarters of negative GDP, right?
Ryan Sweet: No. GDP barely fell. Yeah.
Cris deRitis: Right. They were alternating.
Mark Zandi: Yeah. Well, I don't even think that would've been labeled a recession if not for 9/11, right? Because it declined, one quarter seemed to be coming... We seemed to be coming back out of the doldrums then obviously 9/11 was devastating. It took us right back in. Yeah.
Ryan Sweet: Yeah.
Mark Zandi: Okay. Take right now in current situation. We saw a negative GDP number for the... And GDP, for everyone, is gross domestic product. The value of all the things that we produce. That fell in the first quarter of this year. And it's actually right now your GDP track, and correct me if I'm wrong, Ryan, is pretty soft for Q2, right?
Ryan Sweet: Yeah. Given the decline that we got, it's only projecting 2.2% increase in the second quarter.
Mark Zandi: Okay. But it's conceivable that that actually goes negative too, right?
Ryan Sweet: Oh, yeah. Yeah.
Mark Zandi: So let me ask you this. Suppose we had two quarters of Q1 decline and let's just say, for whatever reason, trade or inventories or whatever. Say another wave of the virus comes back and so forth and so on. We have a negative quarter in Q2. Would you consider this a recession?
Ryan Sweet: No.
Cris deRitis: And unemployment remains low.
Ryan Sweet: Everything else is fine.
Mark Zandi: Yeah. Everything else is fine like it is now in the Q1. We saw a negative GDP, but everything else was fine. Jobs, unemployment.
Ryan Sweet: It doesn't fit the definition. It's not broad based because the decline in GDP is inventories and trade. Everything else is fine.
Mark Zandi: That makes sense, right?
Cris deRitis: Okay.
Mark Zandi: So I think I like broad based to describe that. Not general. Oh, I guess general's okay. All right.
Cris deRitis: The general theory of relatively, they don't call it the broad based theory of relativity.
Mark Zandi: The general theory of relativity. Yeah, that's a good point. That's a great point. All right. Well, maybe I'll adopt that. In other countries in the rest of the world... Oh, and that's one other weird thing about defining recessions. It's not the federal government or a government that says, "Hey, you're in recession. Hey, you're out of recession." It's a group of academic economists that are at the National Bureau of Economic Research that formed this business cycle dating committee. We know a lot of them like Jim Stock. And I think Christi Romer. I'm not sure... Bob Gordon. These guys who follow the business cycle very carefully. All absolutely fabulous academic economists. And I didn't mean it that way. They're absolutely fabulous economists. But I guess they're academic because unbiased. There's no bias. There's no political influence on these folks when they make a decision. How do they do it overseas? Do you guys know? I'm sure it varies country to country, but what do the British do? Do you guys know? Or the Canadians? Or Germans? Or Japanese?
Ryan Sweet: Japanese use... They call it a technical recession, which is two consecutive quarters of declining GDP. And I think many countries use that.
Cris deRitis: I thought that was the same for the UK as well.
Mark Zandi: Oh, that's an interesting distinction. So you could say if I have two quarters of negative GDP, it doesn't have to be a recession. You could label it a technical recession.
Ryan Sweet: Yep.
Mark Zandi: Because everything else feels like it's okay. You're creating jobs, unemployment's low and falling, industrial production, incomes are all rising. But you still got those two negative quarters of GDP. Technical recession.
Ryan Sweet: Correct.
Mark Zandi: Okay.
Ryan Sweet: And the NBER looks at more than just GDP. They look at employment, personal income, consumer spending, just a broad based number of indicators. And that's why usually we're in recession before they actually date it as a recession.
Mark Zandi: Yeah. That's an interesting thing. It takes a long time for the committee to feel comfortable and confident enough to say, "Oh, the recession began March of 2020. It ended April, 2020." It did actually pretty quickly in the pandemic because it was such a V-shaped kind of situation. The economy cratered and then came back when everything was reopened. But in most recessions, it takes a while. A long time.
Cris deRitis: Yeah.
Mark Zandi: For this committee to say... They're not about being fast, they're about being right.
Ryan Sweet: That's right. Yeah. That's right.
Mark Zandi: And that's why economists are constantly debating, bickering are we in recession? Are we not in recession? The recession could be over at that point, but we're still debating it.
Cris deRitis: Yeah. They're the historians, right? That's the purpose of that dating committee. It's not for day to day business use.
Mark Zandi: But overseas, do governments define recessions? Do you know? Again, I'm sure it's country by country.
Cris deRitis: I think in some countries they do. I thought in the UK was actually... Well, if they're using a technical definition, right? I guess it's the government who's producing the statistic and everyone knows that that's a technical recession. I know the IMF does some recession dating as well globally. I think they use a few more measures, right? So it's also this general or broad based decline in activity. But I think they consider a broader number of measures than what the NBER does. But generally the same concept.
Mark Zandi: Okay. So I know the business cycle dating committee has identified recessions back to 1854. You want to guess how many recessions have occurred since 1854? Do you guys-
Cris deRitis: In the US?
Mark Zandi: This is all US now. United States. Yeah. Okay. This will be my statistic. No, it's not a really good statistic, is it? Because there's-
Cris deRitis: That's a good one.
Mark Zandi: Is that a good statistic?
Cris deRitis: Yeah.
Mark Zandi: Okay. All right. And I'll ask you a follow up if you get closer on this one.
Ryan Sweet: I think there's been 14 since World War II.
Mark Zandi: No, I don't think so.
Cris deRitis: No, no.
Mark Zandi: No. 12.
Ryan Sweet: 12 recessions?
Mark Zandi: I'm pretty sure.
Ryan Sweet: Since 18-
Mark Zandi: No, no, no, no, no, no. Since World War II.
Ryan Sweet: Oh, okay. 12. Oh.
Mark Zandi: Yeah, yeah. 12 since World War II. And obviously there's been fewer recessions post World War II than pre-World War I because the economy's gotten more stable.
Ryan Sweet: Well, I bet there was a lot more recessions before World War I.
Mark Zandi: Yeah, for sure. Yeah.
Cris deRitis: 1800s were full of recessions.
Mark Zandi: Before the Feds-
Ryan Sweet: Because the economy was much more volatile. Yeah.
Cris deRitis: Yeah.
Mark Zandi: I mean, the Fed was put on the planet in 1913 with the goal of providing some stability to the business cycle. And they've been quite successful. If you go pre-1913, there was all kinds of recessions all the time, panics and financial panics and all kinds of things. So you want to take a crack at it just how many recessions since 1854?
Cris deRitis: 20.
Mark Zandi: 20. That's good. But that can't possibly be right if there was 12 since World War II.
Ryan Sweet: Right. I want to go-
Mark Zandi: I would label that as a bad guess.
Cris deRitis: Well, I'm assuming that they were long recessions, right?
Mark Zandi: Oh, okay.
Ryan Sweet: Depressions. I'm going to go 33.
Mark Zandi: Okay. Ryan, very good. 34.
Ryan Sweet: 34.
Mark Zandi: If I counted right. I could have counted wrong.
Ryan Sweet: It could be 33.
Mark Zandi: It could be 33, but I think it's 34. I actually think it's 34 going through the pandemic recession. Which is the shortest recession?
Ryan Sweet: Pandemic.
Cris deRitis: Yeah.
Mark Zandi: Two months. Two months. What do you think the longest recession was?
Ryan Sweet: Are you grouping the Depression into it?
Cris deRitis: Yeah. Great Depression.
Mark Zandi: Oh, that's another great question. After you answer my question, then I'm going to ask you the question, what's a depression versus a recession?
Ryan Sweet: So I'm going to say-
Mark Zandi: I'm taking some of my cherry drink here. Did you guys tried cherry drink ever before? Highly recommend it. I do it from medicinal purposes, but it's very good. I haven't tried it with alcohol though.
Cris deRitis: I was going to ask, is that a fermented cherry?
Mark Zandi: I've never heard of a cocktail with cherry drink. Have you?
Ryan Sweet: Yeah. Isn't it a Manhattan includes?
Mark Zandi: Oh, that includes cherry drink?
Ryan Sweet: I don't know if it includes cherry drink. It includes a cherry.
Mark Zandi: Okay. All right. Fair enough. I got it. Okay. Yeah. Now I forgot my question. Oh, this should be a slam dunk. Easy.
Ryan Sweet: The longest recession?
Mark Zandi: Yeah.
Ryan Sweet: It said Great Depression.
Mark Zandi: Great Depression. Right, right. That was 1929 to 1933. That was like, I don't know, three years or something. Something like that. 3 or 4 years. Right?
Ryan Sweet: Wasn't that basically two recessions just really close to one another?
Mark Zandi: I think the NBER actually, I actually have it in front of me. Look, I think the NBER actually labeled it as one recession. So here.
Ryan Sweet: Okay.
Mark Zandi: August of 1929. When was the stock market crash? When was that in 1929? Was that-
Ryan Sweet: October.
Mark Zandi: October. So it came a little after.
Ryan Sweet: Seems like really bad things happen in the stock market in Octobers.
Mark Zandi: Oh, yeah. I think so. Through March of 1933. So that's a pretty long time. 43 months. So a fair amount of time. Okay. So what's the difference between a recession and a depression? What qualifies as a depression? I mean, I've got my own homemade definition.
Ryan Sweet: Yeah. Well, everyone's got a homemade... There's no textbook definition of a depression.
Mark Zandi: Oh, the NBER doesn't say anywhere this is what a depression is?
Cris deRitis: No.
Ryan Sweet: I always think of depression as it has to have the three Ds. There's got to be deep, you have to have deflation and then it has to be duration. So it could be a long recession.
Mark Zandi: Or how about disinflation as opposed to deflation? Deflation is a high bar.
Ryan Sweet: Yeah.
Cris deRitis: Yeah.
Mark Zandi: Yeah. Actually, that's a great definition. I hadn't thought of that. The three Ds. I mean, my sort of rule of thumb was if the unemployment rate goes above 10% into double digits in a consistent way, that would be a depression. Particularly in the current context, the modern context. Because in the typical [inaudible 00:17:31] variety recession, unemployment goes to 6/7% somewhere in there. So if you're above 10, that's depression. If you stay there... In the pandemic we went to 15, I believe, right? For a month. Then we came right back in. So that doesn't qualify. But if you're double digits for 6, 9, 12 months, that's a depression in my view. Yeah. By that definition in the modern era, I don't think we've... Even in the '80 recession we got into double digits, but not long enough, I think, to qualify.
Right. Okay. Okay. Anything else on how to define a recession or a depression before we move on to the causes? I will say something I said earlier just to reiterate and we'll come back to it. Big difference in the length of business cycles, the duration of recessions, pre-Fed, post-Fed. If you go back and you take a look at that data from the NBER on recession data, back in late 1800s all the way up until the Great Depression, very clearly the economy was much more cyclical. Expansions were shorter. Recessions, longer. Business cycles were much quicker.
Since World War II, and given what the Fed has done since World War II, much, much longer business cycles, longer expansions, much shorter recessions. I think the recessions now typically last 6, 9, maybe 12 months. Somewhere in there. No more than that. Okay. All right. Let's talk about causes of recession. There's a whole range of kind of necessary and then maybe necessary and sufficient conditions for a recession. So let's go through each of those. So, Cris, what would you put at the top of the list for causes of recession?
Cris deRitis: Classically, it's kind of inventory boom bust cycle, right?
Mark Zandi: So you're saying balances. There's got to be balance [inaudible 00:19:37].
Cris deRitis: Correct. Yeah.
Mark Zandi: And you're saying inventory is historically when we are manufacturing based economy. That was a major imbalance.
Cris deRitis: Correct. Correct.
Mark Zandi: Okay. Less so now though, right?
Cris deRitis: Yes. Less so. Yeah, certainly.
Mark Zandi: Okay. What are the imbalances generally typically might be? And when I say imbalance, what I mean is there's something kind of off in terms of the economy's balance sheet, in terms of the leverage, high leverage. Or on the asset side, speculation, bubbles, something that's just very atypical. Or in the financial system, banking systems under-capitalized, or there's a lot of poor underwriting. Those are the kinds of things I think of as being imbalances. Is that how you think about it?
Cris deRitis: Yeah, I do. I do. So asset bubbles, certainly one cause of recession that's more modern if we go back to the housing boom bus period.
Mark Zandi: Yeah. I would make a distinction between leverage and asset values. It feels like to me leverage kills. I mean, if you've got a lot of debt, that is a much bigger macroeconomic problem than high asset prices. Even a bubble that bursts because that's equity, that's not debt. It doesn't drive companies out of business per se or cause households to default, go into closure, bankruptcy or that kind of thing.
Cris deRitis: True. Although if we're talking about recessions, the two usually go hand in hand, right? House prices went up and you have a lot of mortgage debt at the same time.
Mark Zandi: Well, that's the worst.
Cris deRitis: So that's the combo that brings you into recession or causes a deep recession, right?
Mark Zandi: Yeah. I guess there's two case studies with regard to asset bubbles. I mean, you go to Y2K, that was a whopper of... It felt like an equity market bubble that your internet was coming on, pets.com, that kind of thing. There was some leverage, but it was not a lot of leverage. There was some margin debt, but that really wasn't the issue, right? People started behaving based on the fact that they thought they were a lot wealthier given the run up in stock prices. And when stock prices went down, then they pulled back. The negative wealth effects. But that was a very minor, modest kind of economic downturn. And as we said earlier, may not even have become a recession if not for 9/11 hitting at that time.
But if you go to the financial crisis, the recession hit in '08 and first half of '09. We had an asset bubble in the housing market and that was leverage induced. I mean, a lot of mortgage borrowing, egregious mortgage lending, weird mortgage products that juiced up demand and helped to create this bubble in the housing market. So it feels like a different kind of problem. Does that resonate?
Cris deRitis: Yeah. Yeah. I'd agree with that.
Mark Zandi: Any other kinds of imbalances? So first condition for recession is these imbalances, kind of fault lines in the economy's balance sheet. What about overbuilt real estate markets? That's another, I would think, reasonable one, right?
Ryan Sweet: Yeah. That's another imbalance.
Mark Zandi: Yeah. How about what I would call spent up demand? So during the boom times and the expansion, people spend a lot of money. They can spend beyond what they would typically, their saving rate goes down. They buy a car a year before they would normally buy a car or they buy furniture before they would normally buy the furniture. And so you have this kind of situation where people have bought forward. What I call spent up demand as the opposite of pent up demand that develops during the recession and helps power and expansion. I would consider that. Would you consider that an imbalance as well?
Cris deRitis: Yeah, certainly. Yeah. And it could come from a variety... It could be inflation driven, right? If inflation's going through the roof.
Mark Zandi: I'd put that into a different-
Cris deRitis: My behavior might front load some of the spending.
Mark Zandi: Yeah, true. True. I would say though that the imbalances are kind of separate from the kind of the business cycle overheating dynamics, which I consider to be a second kind of condition for recession. But before we go there, think about the current environment and all the recession fears. You said the most important precondition for recession is an imbalance in the economy, right? And we identified a few of them. You mentioned inventory, leverage, asset bubbles, spent up demand. So what exists in the current environment that is an imbalance that would result in recession?
Cris deRitis: I wouldn't-
Mark Zandi: I'm going to Ryan because Ryan thinks there is going to be a recession. So what is it? What do you think that is?
Ryan Sweet: Well, you think that there's asset markets. You think the stock market was overvalued.
Mark Zandi: Yeah. But it wasn't speculative, right? It wasn't-
Ryan Sweet: If you look at leverage, low margin. Low margin debt.
Mark Zandi: How much is the margin debt? 3 or 400 billion, right?
Ryan Sweet: Yeah. I got to look at it as a [inaudible 00:25:14].
Mark Zandi: Yeah. Yeah.
Ryan Sweet: But you have a lot of spend up demand on goods. The only place that could save us is that there's pent-up demand for services.
Mark Zandi: Yeah.
Ryan Sweet: So that little bit of offset there.
Mark Zandi: Cris, you're also thinking recession. Not as high probability as Ryan.
Cris deRitis: Sure.
Mark Zandi: So where's the imbalance. What imbalance are you pointing to?
Cris deRitis: Well, a recession isn't just caused by imbalances, right?
Ryan Sweet: Right.
Mark Zandi: Okay. So you're saying it's not a necessary condition for a recession?
Ryan Sweet: No.
Cris deRitis: No.
Mark Zandi: It's a potential condition for recession?
Cris deRitis: Correct.
Ryan Sweet: I mean, look at the pandemic. That was a shock. That was an imbalance.
Mark Zandi: Yeah. That's kind of a case of its own though, right? I mean-
Ryan Sweet: Right.
Mark Zandi: Yeah. That doesn't feel like it fits into... It's not a case study for future recessions unless-
Ryan Sweet: What about the energy price shock of the-
Cris deRitis: Supply shocks certainly create recessions.
Mark Zandi: But again, I say that's a separate category. That's a separate set of factors. When you say, "Hey, what are the causes of recession?" First set of things are, and you brought it up first, is the imbalances that exist in the economy. And we can identify imbalances that exist in the economy prior to almost every recession. At least ex-post. Ex-ante, before the fact, that's harder to do. And that may be the case today. There may be problems out there that we're not appreciating, or at least Mark Zandi's not appreciating to the degree that we should. But that's one set of factors that's behind recession. Second set of factors is, you mentioned it, but in that case, you're hard pressed to come up with a smoking gun kind of imbalance. Is that fair to say?
Cris deRitis: Yeah.
Mark Zandi: Which doesn't mean there won't be a recession. I'm just saying... Yeah. And that can go to the severity of the recession. You can say, "Okay, I'm going to have a recession, but it's going to be less severe because there's not significant imbalances." But I'm probing you because I want to know, is there something out there, some imbalance in the economy that you think is potentially a real problem that people have not been focused on or identified?
Cris deRitis: I would say potentially a problem, but probably not going to be the cause of recession, would be some corporate lending, right? Some of the leverage lending, some of the zombie companies that we were worried about before the pandemic, they kind of got a lifeline with low rates. As rates go up, I am worried that we're going to see a lot more defaults, but I don't see that as being the real trigger of a recession. It might make it harder to come out of recession, right? Extend the recovery period.
Mark Zandi: Yeah. I mean, I think in every case, these imbalances by themselves don't cause recessions generally. You have some kind of shock, something goes off the rails, then the economy is stressed or it could be interest rates arising because of an overheating economy. Economy is stressed and you have these fault lines that exist in the balance sheet that get exposed by the stresses that are coming on the economy through the shock or through the higher interest rate environment. So right now we're focused on the fault lines in the economy and you're saying, okay-
Cris deRitis: Some corporate debt.
Mark Zandi: Yeah. Ryan mentioned equity prices. That feels like a stretch, but okay. You mentioned house prices. Do you think that's a fault line because they're very high as we've documented or overvalued? Do you view that as a fault line?
Cris deRitis: It's a risk, but as we've discussed, there's a lot of demographic, other factors out there that seem to offset it. But things can happen, right?
Mark Zandi: Yeah. Going to the point that the fault line could be deeper than we know, particularly if you get stress. But now you're saying, okay. Also the other place I would look is in the corporate leverage, corporate debt, corporate balance sheets that there's this group of companies that are out there that if you look at the corporate balance sheet altogether, it looks okay, right?
Cris deRitis: Yeah, sure.
Mark Zandi: But you're saying that the debt is kind of bar-belled. You got on one side of the distribution a bunch of companies that are in fine financial shape. Take Moody's or take Apple. Got a lot of cash, right? If they got any debt at all, it's because it's essentially, up until now, free money.
Cris deRitis: Opportunistic. Yeah.
Mark Zandi: Yeah. Probably when you do it. And then on the other side of the distribution, you got these companies that are all levered... Kind of PE firms have come in, levered them up looking for higher equity returns. They've kind of levered up right up to certain rating thresholds, which might affect if they get lowered. If their ratings are lowered, they might lose access to markets and their cost of capital would go up. And that's where you're saying we should be looking. That might be a stress line. Okay.
Cris deRitis: That's right. They're facing higher rates. So higher financing costs, on top of higher wages, on top of higher energy costs, right? There's a lot of negatives that if the demand side should fall as well, right? That could certainly lead to more defaults.
Mark Zandi: Okay. Okay. Yeah, I agree with you. I think that is a potential fault line that we need to focus on. Do you have any numbers on that or I'm press too hard? I mean-
Cris deRitis: In the past, I've looked at it... It certainly was much smaller than what we saw in the housing bust, right? Even if there is a problem there, I don't think it's to the magnitude of a Great Recession, but certainly could create some issues.
Mark Zandi: Some issues. Okay. All right. Okay. That's one set of causes that they're not imbalances in the economy, that we're calling imbalances, and they're not a necessary condition for a recession. You can have recession without imbalances.
Cris deRitis: Yes.
Mark Zandi: Okay. All right. Okay. Second set of causes or second bucket of causes, you alluded to it, was the potential of an economy that's overheating, right? Would you characterize it that way?
Cris deRitis: Yes.
Mark Zandi: You would? Okay. So do you want to describe that? What that risk is? Why is that a cause of recession?
Cris deRitis: I think you already did, right? In terms of the inventory site, you have an economy that is firing at all cylinders. It's going too far. There's a euphoria out there. People are spending, pulling ahead some of the spending they might otherwise do. And at some point, it runs out of gas, right? You've gone too far and therefore there's nothing left to buy. Or, I guess it will go to a bigger point, which I'll assert that all recessions at their heart are sociological phenomena in terms of when they actually begin and end. But that there's this general thinking or this belief that the economy is going down and that becomes a self-reinforcing cycle.
Mark Zandi: Right.
Ryan Sweet: Sort of sounds like today.
Mark Zandi: Okay. You think so?
Ryan Sweet: Yeah. I mean, you're seeing measures of consumer confidence dropping. We know it's gas prices, stock prices, stuff like that. But small business confidence, they're pretty pessimistic.
Mark Zandi: Yeah. It's not caving though.
Cris deRitis: But the spending hasn't really-
Mark Zandi: And the spending hasn't-
Cris deRitis: ... taken hit, right?
Mark Zandi: ... I mean, it's still strong.
Cris deRitis: People are worried, right? Their actions so far are not in panic mode.
Mark Zandi: The way I would think about this cause of an overheating economy, and this is kind of typical in business cycles, right? The economy expands for an extended period of time, unemployment declines. At some point, unemployment gets low enough that it's consistent with full employment. And at that point, the economy's growth rate has to slow so that you don't blow past full employment. That unemployment rates don't go so low that you don't get these broad based wage and price pressures that ultimately illicit interest rate increases and that tightening. And so almost by definition, every business cycle is going to get to that place. Sometimes in an expansion that's growing more slowly, that takes a while. That was the expansion that was after the financial crisis for various reasons. Or the economy grows so strongly very quickly, you get right up to that full employment line very, very quickly. And the business cycle's a lot shorter.
But the cause of the recession is that you're going past full employment, wage and price pressures intensify, inflation becomes more of an issue and interest rates rise. I mean, as those interest rates rise, they put pressure on the economy. They bring down asset prices like housing values and stock prices. They raise the cost of capital for businesses. They raise debt service for anyone who's borrowed money up to that point. It puts pressure on the financial system and their [inaudible 00:34:10] banks to extend credit. So it's the increase in interest rates. And the faster that increase and the higher the interest rates go in a short period of time, the more damage that does, the more difficult it is for the rest of the economy to adjust to that, the more likely you go into recession.
Ryan Sweet: After hearing that, I feel even more confident in my probability of recession.
Mark Zandi: Yeah. I mean, in my view-
Ryan Sweet: It describes us today.
Mark Zandi: ... Yeah. In my view, that is a... Well, let me say it this way. I think that is also not a nec... It's almost a necessary condition for a recession. Almost necessary. It doesn't absolutely have to be the case. But an overheating economy is a feature of the end of most business cycles, if not all of them, except for the pandemic. Even then to some degree, right? I mean, is there recessions you can remember where an overheating economy wasn't a feature of the end of the expansion going into recession? I think most of them ended in some way or another with an overheating economy.
Ryan Sweet: [inaudible 00:35:19].
Mark Zandi: Oh, go ahead. Go ahead.
Ryan Sweet: I was just going to say the double-dip in the 1980s, the second recession wasn't an overheating economy.
Mark Zandi: Oh, you don't think so? I mean, that was when Volcker was on the war pad to get inflation down. That's the prototypical kind of overheating.
Ryan Sweet: Yeah. But was that... Was the labor market overheating in the early 1980s?
Mark Zandi: Yeah. Yeah. Yeah. I mean, kind of the full employment unemployment was a lot higher, so it didn't get that low. But yeah, I think that was clearly an economy that was overheated. Maybe it wasn't overheating, but it was definitely overheated. Keep trying to get inflation down. Okay. So-
Cris deRitis: But the economy can grow for a long time without overheating, right? Look at Australia or Japan post-war. You can go for decades.
Mark Zandi: Well, we never have.
Cris deRitis: Okay. Well, 10 years is a long time. Yeah.
Mark Zandi: 10 years is a long time. The longest expansion in history, I believe, was the one after financial crisis that ended with the pandemic, right?
Cris deRitis: Right. So it would've presumably without the pandemic could have [inaudible 00:36:26].
Mark Zandi: That's because that expansion was so slow. So painfully slow that unemployment didn't come in for a long time. We never really got to full employment. I mean, we were debating at the end, maybe we're at full employment, but we just got to 3.5% unemployment, right?
Cris deRitis: Well, that's because of the catalyst of the recession.
Mark Zandi: Yeah, absolutely. I agree with you.
Cris deRitis: Yeah.
Mark Zandi: But at the end of the day, that also we were at the end of that lengthy expansion. We were arguing, at least I was arguing, the expansion was coming much closer to its end than its beginning, right? Because of the fact that we had gotten very close to full employment. Okay.
Cris deRitis: But does the economy need to overheat is my point, right?
Mark Zandi: Oh, I see. Again, maybe it's not a necessary condition. But it's a feature of most recessions. I would say.
Cris deRitis: Yeah.
Mark Zandi: Okay. Here's the third set of reasons for recession. So the first is imbalances. Second is overheating. Third is, and you alluded to this as well, is a shock. A shock in the sense that hard to predict. You can't predict a pandemic, can't predict Russian invasion of Ukraine, right?
Cris deRitis: Correct.
Mark Zandi: And most other recessions, I think there's some event that is that catalyst that undermines sentiment and confidence, the sociological reasons for recession as you called it, Cris. It drives people into the bunker. Does that make sense?
Cris deRitis: Yeah. That's right. So supply shock, it could be a natural disaster, pandemic, as you mentioned. So something like that. It could be a trade shock, right? Some partner all of a sudden decides they don't want trade with you anymore.
Mark Zandi: Or a policy mistake, right? That's kind of a shock, right? Like the Great Depression was in part, at least kind of the thinking is, debate about it, was an error around trade policy, right? Protection is trade policies. The economy is obviously already struggling, but that pushed it under.
Cris deRitis: Right.
Mark Zandi: I would also argue that the financial crisis, the Great Recession, and this may be a policy error, maybe the difference between a kind of a typical recession and a really bad one or a depression. If you go back to the financial crisis, I think I would argue that it went from being what would've been kind of a tough recession, not maybe worse than typical, but not catastrophic to something that was catastrophic because of a policy error. And the policy error is that the lawmakers at the time at the Fed, at the Treasury and the Bush administration were dealing with financial institutions that were teetering. And they resolved each of those teetering financial institutions differently. They treated the creditors in those institutions differently, the debtors and the equity holders.
First was Bear Stearns, and then Fannie Mae and Freddie Mac, and then Lehman Brothers. And then there was a million other failures at the time each treated differently. And as creditors in these institutions realized that there was no cookbook for actually how to resolve these institutions and they didn't know who was going to suffer and in what order they were going to suffer, the debtors or the equity holders, they bailed. They bailed. And that's when the financial system cratered. So it was a mistake by policy makers. And again, I don't blame anybody because this was crisis mode, right? And you're trying to resolve a problem while you're in the middle of a crisis. And very difficult to do. But there was no cookbook for resolving it. That was a policy error that led to the financial crisis; the very severe downturn that we suffered.
Cris deRitis: Yeah. That brings up the whole question, the ongoing debate of what policymaker should do, if anything, during recession. Should we just allow the cycle to heal itself? Or should we intervene? How much should we... Right? That's where the fun comes in, right? [inaudible 00:41:03].
Ryan Sweet: Cris is turning into an Austrian economist on us.
Cris deRitis: Not at all. I'm just bringing up the points of debate, right? I think they're fair points on both sides, right?
Ryan Sweet: Yeah. I remember during the Great Recession there was a lot of concern about moral hazard because of the way that Fed was treating each bank. And then AIG. Remember when the news came out about AIG?
Mark Zandi: That's the other one.
Ryan Sweet: That's when things really went south.
Cris deRitis: But is it the inconsistency of the policy versus-
Ryan Sweet: Or maybe they just didn't-
Cris deRitis: If they had chosen not to bail them out at all, right? Send a clear signal you guys are on your own.
Mark Zandi: If they did that with Bear Stearns right away or with Lehman right away-
Cris deRitis: Would we have been better off than the mixed? Who knows?
Mark Zandi: It's a good question. You're right. I don't know. And of course, if you're in that position, if you're Secretary Paulson or Fed Chair Ben Bernanke and you're left with that what do I do, it's pretty hard to say, "Okay, see you later, guys. We'll catch you on the other side." That's pretty tough to do. Of course, they did that with Lehman and set off a cavalcade of selling. Okay. So let's bring this back to the current context. So we've identified broadly speaking three reasons for recession. One, imbalance. Two, overheating. Three, shocks, right?
Cris deRitis: Yeah.
Mark Zandi: So in the current context, it feels like imbalance is maybe, but not really. Overheating, would you say-
Ryan Sweet: We're getting close.
Mark Zandi: Hard to argue that, right? Because 3.6% unemployment's not full employment. We've come to that conclusion. I mean, obviously inflation is high, but I would argue the reason for the current recession threat is shocks, right? Supply side shocks. The pandemic and the Russian invasion of Ukraine and the higher oil price, right? Okay. So that's why I think we can navigate through without recession.
Ryan Sweet: Assuming nothing else goes wrong though.
Mark Zandi: Well, yes. That's our assumption though. That's our baseline assumption. The baseline assumption is that the pandemic continues to fade, meaning with new waves, each wave is less disruptive than the previous one. And that the worst of the economic fallout from the Russian invasion is behind us. If you believe that and you just bought into the logic I articulate around the causes of why recession risks are high, that would argue for, well, we should make our way through. I mean, obviously a lot of risk around that, but we should make our way through. So how do you respond to that. Ryan?
Ryan Sweet: I think it's reasonable. I think I'm really concerned about oil prices and-
Mark Zandi: Okay, so you're saying you think oil prices are going higher is what you're saying?
Ryan Sweet: Mm-hmm.
Mark Zandi: Okay. So you're saying my underlying assumption around the Russian invasion is not in your baseline? That is not your baseline assumption?
Ryan Sweet: Nope.
Mark Zandi: Your baseline assumption is what's going to happen here?
Ryan Sweet: That oil price... I mean, they're not going to jump. They're going to steadily increase. Because I think Europe's going to put more sanctions on Russia. So if they go full oil ban on Russia, then we're going to get another jump in oil prices.
Mark Zandi: Okay. That's fair. I mean, reasonable. You just don't buy into the baseline assumption around oil?
Ryan Sweet: Yeah. Yeah. I mean, there's a lot of uncertainty. Forecasting oil is-
Mark Zandi: That's fine. That's fine.
Ryan Sweet: I mean, I'm also more pessimistic about the Fed pulling this off.
Mark Zandi: That the Fed misjudges here?
Ryan Sweet: Mm-hmm.
Mark Zandi: Policy error? [inaudible 00:44:54] back to the forms of shock. Okay.
Ryan Sweet: Yeah. So, I mean, it's just not one catalyst for recessions. It could be multiple catalysts. You can have a supply side shock, a policy error. It could be like the perfect storm.
Mark Zandi: By the way, here's a factoid for you. I think every recession since World War II has been preceded by a spike in oil prices. I'm very confident in that statement. Even the financial crisis. The all-time high oil prices was July of 2008.
Ryan Sweet: Yep.
Mark Zandi: Right?
Ryan Sweet: Mm-hmm.
Mark Zandi: Every single one.
Cris deRitis: Pandemic?
Mark Zandi: Actually, I should put that on my list of leading indicators. Yeah. Okay. Okay. Very good. Oh, Chris, how do you respond to the way I articulated things and your view that we are likely going to experience a recession?
Cris deRitis: Yeah. I think we're vulnerable to shock, right? So whether it's oil shock... I am still concerned about a supply shock or supply chain shocks, right? Especially with what's going on in China. So I don't think we're out of the woods by any means. And we're in a position now where even if we have a relatively minor shock, we don't have a whole lot of ammunition to fight it, right? Whereas if we were in a normal growing economy, you have a little supply shock. Okay, you can brush it off. At this point, might not be so easy, right? The Fed has got bigger fish to fry when it comes to inflation.
Mark Zandi: Okay. So you're arguing that economy's obviously vulnerable. We're dealing with some pretty massive supply side shocks.
Cris deRitis: Yeah.
Mark Zandi: Inflation's an issue. Interest rates are now on the rise. So here we are belly up and flailing. And if anything else comes along, you don't know exactly what that is, but odds are that something will come along and push us underwater. That's kind of what you're-
Cris deRitis: Yeah. That's what I'm arguing. Pandemic. All right. Cases are back up, right?
Mark Zandi: Yeah. Interesting. And you're saying the probability of getting something else hitting us that's of sufficient magnitude to push us under is better than even odds?
Cris deRitis: Yes.
Mark Zandi: Okay.
Cris deRitis: A policy error would be at the top of my list. I think that's fairly likely given a task.
Ryan Sweet: And financial markets are becoming more vulnerable. So just look at the rise interest rates in Europe. There's news of another sovereign debt issue. Then that's... It's game over.
Mark Zandi: For Europe?
Ryan Sweet: For us, because that will feed back through into US financial market conditions. So it doesn't have to be something that shocks us. It could be a shock somewhere else that feeds back into our financial markets.
Mark Zandi: Okay. There's a lot to just unpack here, but I want to keep moving forward and talk about the leading indicators of recession. But before I go there, I just want to stop, turn it back to you and say I kind of led the discussion around the framing, right? Here are the causes of recession. Broadly, imbalances, overheating and shocks. And I kind of push things into those buckets. Are you okay with that? Did I miss another bucket of things that you think are important in terms of causing economic recessions that I missed that we should include? I can't think of it. I'm just asking. Am I missing something?
Ryan Sweet: Should we have a bucket for just policy because there's fiscal policy as well?
Mark Zandi: I put that into the shock category, but okay. That's fair. You could do that. Cris?
Cris deRitis: Yeah. I think those are the right broad categories of the underlying fundamentals, but I would stress the sociological or psychological, right? The specific timing. Why we go into recession in this month versus the month before or the month after. That's a sociological phenomenon, right? So people lose confidence collectively and that tips us over.
Mark Zandi: Yeah. I agree with that. I mean, I think the way I see it, a recession is a loss of faith. Faith by consumers that they're going to hold onto their job, faith by employers that they're going to have someone that's going to buy what it is that they produce. If we collectively lose our faith and we run for that proverbial bunker, consumers stop spending, businesses stop hiring and start lying off. You get into that self-reinforcing negative cycle. That's a recession. It's ultimately a loss of faith.
Ryan Sweet: That's right. That's right.
Cris deRitis: And so conversely, you can have some of these shocks without recession, right?
Mark Zandi: Yeah.
Cris deRitis: Right? If people don't lose faith, we can actually work through them without actually going... That's what makes the whole practice of forecasting difficult, right? You have different responses depending on how people are feeling to a large degree.
Mark Zandi: Yeah. Okay. Let's move on to the leading indicators of a recession. What should people be looking out for to gauge whether we're going to go into a recession or not? So there's a long potential list. So, Cris, I'll turn to you first. What is your most favorite leading recession indicator?
Cris deRitis: Oh, it's obvious, right? It's everyone's favorite. It's the yield curve. You have to watch the-
Mark Zandi: [inaudible 00:50:15].
Ryan Sweet: I hate that thing.
Mark Zandi: See, I told you. Okay. So let's explain it. So what is the yield curve? How do you measure it? Why is it a good leading indicator? What is it saying now?
Cris deRitis: So it's the difference between the interest rates on long dated treasury securities and short dated treasury securities, right? Typically it's upward sloping, right? Typically if you're going to loan the government some money for a longer period of time, you're going to demand a higher interest rate, right? So that's a well-functioning economy. But in a time of stress or concerns about recession, right? That relationship can invert, right? I'm willing to lend the money to the government for a longer period of time at a lower rate just to preserve my capital because I'm concerned that the economy is going to go down and other assets and their classes are going to be impacted. So what I like about the yield curve is that it is an investor driven, market driven measure of the implied probability of recession.
Mark Zandi: Right. And what's it saying now?
Cris deRitis: Right now, it's positively sloping.
Mark Zandi: I missed it. What's your measure of the yield curve? Is it the-
Cris deRitis: 10 year versus the 2 year.
Mark Zandi: 2 year. Okay. And then why 10 versus 2?
Cris deRitis: Just historically empirically, it's been a very prescient predictor of recessions in the past.
Mark Zandi: In the 2 years, a very good reflection of what investors think the Fed's going to be doing.
Cris deRitis: Correct. That's right.
Mark Zandi: So if they're going to be stepping on the breaks really hard, that pushes up the 2 year yield. And a 10 year yield reflects what investors think is going to happen in the long run. So if they think the Fed's going to be successful in slowing growth, then the 10 year yield is going to be lower. And if you get inversion 2 year above 10 year, historically that's led to recession. Led to implies causality. You're not suggesting that you're saying-
Cris deRitis: It's been correlated with.
Mark Zandi: Correlated to because investors are forward looking and the 2 year represents their collective wisdom around what's going to happen.
Cris deRitis: Correct.
Mark Zandi: Yeah. Okay. So, Ryan, that seems so compelling to me. It seems so compelling to me. And theoretically and empirically, it's worked. Why don't you like it?
Ryan Sweet: I'm not saying historically it's been bad. I'm saying the last two cycles or the last cycle, since the Great Recession, I think the yield curve is misleading because the 10 year treasury yield is no longer a true risk free rate. Because the Federal Reserve, it can control both ends of the yield curve. Short term interest rates through the Fed funds rate and long term interest rates through quantitative easing or quantitative tightening. So it's just not the same yield curve as it was pre-financial crisis.
Mark Zandi: Okay. I have two questions for you. One, I thought the Fed was buying securities all along the curve. So they weren't just playing out at the end. So if they've lowered the rate, the term structure of interest rates, but it seems like it's lowered it across the yield curve. So therefore it should not be affecting the difference between the 10 year and the 2 year.
Ryan Sweet: So it's a Shift... Is it a shift or a pivot I guess is-
Mark Zandi: Well, it's a shift down.
Cris deRitis: Shift lower.
Ryan Sweet: That's what I thought.
Mark Zandi: Yeah. It's not affecting the difference between the two.
Ryan Sweet: Yeah. The composition though, I think they were heavier or long term. I think they bought more long term securities than they did short term.
Mark Zandi: Okay.
Ryan Sweet: I'll have to double check.
Mark Zandi: Yeah. Well, here's the other thing. If you buy into that argument, and let's just say you're right that they were buying more on the long end than on the short end. So you're saying that right now, the curves looks more flat or inverted, but isn't that counter to what you're saying? Are you believe in recession? So you're saying there was not that bias because of the Fed's actions on QE, the curve would be even more positively sloped, right? I mean, signaling less likelihood of a recession.
Ryan Sweet: No, I don't think you need the yield curve to invert to have a recession.
Mark Zandi: Okay. But that's never happened, right? Except for the pandemic there.
Ryan Sweet: There's been false signals from the yield curve, particularly the 10-2.
Mark Zandi: Not for 50 years. Not on a monthly basis. This I know because over the weekend I spent a fair amount of time on this question. Now on a monthly basis now, curve can convert for a couple three days. I don't think that's a strong enough signal. In fact, it did that earlier this... I think in April. It did that early April. And I don't think that means much. But if it's monthly, I think that's consistent; investors are saying something consistently. And prior to the pandemic, the 10-2 year got very close to inverting on a monthly basis, but never did. But we did experience a recession, right? But that was the pandemic recession, which is inherently unpredictable. So I don't view that as a blemish on the forecast accuracy. But every other recession since World War, excuse me, in the last 50 years, admittedly, there's not a lot of them, I think there was six. Each one of them we've seen an inversion. Still, I haven't convinced you?
Ryan Sweet: No, you haven't convinced me.
Mark Zandi: Okay. Fair enough. Okay. All right. What's your favorite recession indicator, leading indicator?
Ryan Sweet: I like lending standards on C&I loans because that's an indication that when banks start to tighten the screws on lending, the availability of credit is going to start to slow down. And I think that feeds that... Lending standards feeds into our probability of recession models. And it does a pretty good job of explaining, foreshadowing recessions.
Mark Zandi: Does that lead recessions?
Ryan Sweet: Mm-hmm.
Mark Zandi: Oh, I should take a look. I've never looked at that.
Ryan Sweet: The [inaudible 00:56:20] loan offers a survey. It has the net percent of banks that are tightening on C&I loans.
Mark Zandi: And that shows a significant tightening and underwriting on commercial and industrial loans prior to recessions beginning?
Ryan Sweet: Correct.
Mark Zandi: Oh, I didn't know that.
Ryan Sweet: And then you can also look at the weekly H.8 data. I believe it's the-
Mark Zandi: C&I loans?
Ryan Sweet: Yeah. The C&I of lending.
Mark Zandi: Yeah. The interesting thing about that is when you're coming into recession, it surges, right?
Ryan Sweet: Yes.
Mark Zandi: It surges because businesses have lines of credit that they draw it down when recessions are hitting, because they want the liquidity or fearful of not having enough liquidity. So you initially see this pop in C&I loans outstanding. That ultimately comes back in. So you're saying that the indicator is a pop in C&I loans outstanding?
Ryan Sweet: Mm-hmm.
Mark Zandi: Yeah. That doesn't lead though. I think that kind of lacks... It's kind of like a contemporaneous or a bit of a lack... I think it's one of those things that it's good to know because once that happens, you know for sure you're in recession, like obviously you're debating it.
Okay, I got mine, you're ready? And this goes to Cris' sociological reasons for recession. A more than 20 point decline in the Conference Board's Survey of Consumer Confidence over a three month period. So it's not the level of sentiment that matters. And by the way, the Conference Board Survey, which is more based on labor market conditions, that's pretty high. It's higher than its average over history. It's on the kind of on the high side. But it's down from where it was, but it's on the high side. But anyway, it's about the change in. And when you see these big, consistent move downs and sentiment, consumer confidence is measured with the Conference Board Survey over a three month period, that's the loss of faith. That's people running for the bunker and ending their spending. And that happens 2, 3, 4 months before recession. Doesn't give you a long lead, but-
Ryan Sweet: Did you compare a Conference Board to University of Michigan?
Mark Zandi: I did. Yeah.
Ryan Sweet: Conference Board does better.
Mark Zandi: Much better. Much better than the University of Michigan. And right now the University of Michigan is very weak, right?
Ryan Sweet: It's down 40 points from its recent peak.
Mark Zandi: Yeah. And by the way, it's in a three month period, right? Because it's got to be a sharp, quick decline. That's people... That means they're panic mode and they're stopping their spending. Okay. All right. Very good. I've got-
Cris deRitis: Speaking of the Conference Board, what do you think of the Leading Economic Indicators? That has a pretty good track record as well, doesn't it? It tends to turn negative.
Mark Zandi: Has it really been helpful in pegging recessions? I don't think so. Has it?
Cris deRitis: I haven't done a deep dive, but it's always been my-
Ryan Sweet: I think I tried it in our probability recession models, but it didn't [inaudible 00:59:16] added much.
Mark Zandi: Although having said that, I haven't looked at it recently because I kind of gave up on it as a good... I mean, it's a good leading indicator of future growth, but not of recessions. Not of turning points in the economy, as I recall, but we should take a look at that.
Ryan Sweet: Because it includes some pretty lagging indicators. I think it includes housing permits and things like that.
Mark Zandi: Yeah. Well, of course the other really good indicator, which is not much of a leading indicator, it's a very good coincident indicator. Which is still pretty valuable because when you're in recession, we're often still debating it, is the change in the unemployment rate. So if the unemployment rate increases by more than four tenths of a percentage point in a three month period, you are already in recession. And I think the kind of the chronology is consumers pack it in 2, 3, 4 months before the recession. It takes a few months before businesses say, "Oh, my gosh, I'm not selling what I thought I was going to sell." And pivot from hiring people to actually laying off people.
And once they start laying off, then we're in recession. Then we're done because that layoffs means higher unemployment. And once unemployment starts to move higher, that's when you get into that kind of self-reinforcing negative cycle, because unemployment starts to rise and then consumers say, "Oh, my gosh, now I'm losing my job. My wages are getting cut. I'm getting no bonus." They pull back further. Businesses see that, they fire more people and you're off into the abyss. And that's a recession. Yeah. Okay.
Ryan Sweet: What could be interesting in this cycle is that the unemployment rate could be rising but for the right reason that more people are being pulled into the labor force.
Mark Zandi: That's a good point.
Ryan Sweet: But, I mean, I still think there's that psychological because people are going to watch the news and see the unemployment go up and start panicking, but it could be rising for a good reason.
Mark Zandi: Yeah. Right. So it may not be as useful this go around is what you're saying.
Ryan Sweet: It still would be useful because I still think the average person will panic when they see the news, CNBC, Bloomberg talking about higher unemployment rate.
Mark Zandi: You guys mention [inaudible 01:01:24].
Oh, sorry, Cris. Go ahead.
Cris deRitis: If jobs are still plentiful, you don't think that that's the stronger factor here. Yeah, unemployment rate's going up, but I still see plenty of opportunity.
Ryan Sweet: That could be, I mean, we have 11 million open job positions.
Cris deRitis: Yeah.
Mark Zandi: And by the way, that's another reason why I'm more sanguine about making it through without recession. Just feels like the job market is so [inaudible 01:01:52], there's so many open unfilled positions, quit rates are so high, going to be pretty hard to kind of have that thing kind of come to a standstill and go in reverse it feels like to me. But anyway. You guys didn't mention the stock market. You don't think that's a good leading indicator?
Cris deRitis: Half the time it is.
Ryan Sweet: Yeah. It's probably better than the yield curve.
Mark Zandi: Yeah. It's the old Sam, Paul Samuelson quip, the Nobel Laureate who said the stock market has predicted nine of the last five recessions. So you can go definitely go down with no recession. Although I think every recession has featured a big decline in stock prices. I'm not sure if it's much of a lead, but we've seen big declines in stock prices. Okay.
Cris deRitis: On that note, what about credit spreads?
Mark Zandi: Yeah, I was going to ask Ryan. I haven't looked at credit... Credit spreads being the difference between rates on corporate bonds and treasury yields, risk free rate. That spread would reflect the concern investors have over the potential that those companies are going to default on their debt. So it should be a good indicator. Ryan, is that a reasonably good leading indicator or not?
Ryan Sweet: It's okay. I mean, I think you have to include all these things together. You can't just hang your hat on one of them. I mean, I did try using corporate credit spreads in our probability recession model and the yield curve was, it pains me to say it, but the yield curve worked better than corporate bond spreads.
Mark Zandi: Oh, really?
Ryan Sweet: In predicting recessions. Yep.
Mark Zandi: Say that again.
Ryan Sweet: In predicting recessions.
Mark Zandi: No.
Ryan Sweet: I know, I know you're trying to beat me at this.
Cris deRitis: The connection's breaking up, could you repeat?
Mark Zandi: Or it's the storm. Oh, by the way, I'm looking outside and it's perfect sunshine out there.
Ryan Sweet: I know.
Mark Zandi: Yeah. They send the kids home from school. Geez, Louise. We never got to the game. Let's do the game real fast and then talk about recession probabilities in the current context and then we'll call it a podcast. I've kind of given you my statistics. I can give you another one. But, Ryan, what's your statistic?
Ryan Sweet: All right. I got two of them. They're related. All right. So it's -3.7% and -2.1%.
Mark Zandi: Is that the average decline in GDP and jobs peak to trough in recessions since World War II?
Ryan Sweet: No, you got it. It's the average decline peak to trough in GDP for the last five recessions. That's -3.7%. But if you take the pandemic out, the average decline is 2.1%.
Mark Zandi: Okay. You got to be impressed with-
Ryan Sweet: I'm really impressed. Yeah.
Mark Zandi: Laser like response.
Ryan Sweet: Yeah.
Mark Zandi: All right. Very good.
Ryan Sweet: That was impressive.
Mark Zandi: And I bet you, if you go look at the decline in jobs-
Ryan Sweet: It's probably [inaudible 01:04:42].
Mark Zandi: Yeah. Just say it. Just say it. All right. And you probably picked five recessions because you didn't have enough time to do all [inaudible 01:04:51].
Ryan Sweet: And I didn't have done all of them.
Mark Zandi: Very good. That's very rough... So you're saying the peak average, typical peak to trough decline in the past five recessions in GDP is 3.7% including the pandemic?
Ryan Sweet: And the Great Recession. Yes.
Mark Zandi: And the Great Recession.
Ryan Sweet: So if you take out the pandemic, it's 2.1%.
Mark Zandi: Because then the pandemic was down 10.
Ryan Sweet: 10.
Mark Zandi: Yeah. 10-
Ryan Sweet: It's massive.
Mark Zandi: And I think the Great Recession was 4 peak to trough.
Ryan Sweet: It was.
Mark Zandi: It was. Yeah. Okay. All right. Very good. Cris, what's your statistic?
Cris deRitis: I can give you a fun one or a mind blowing one.
Mark Zandi: Let's do both. Fun one first.
Cris deRitis: Okay. The fun one. How many global recessions has Ryan experienced in his lifetime?
Mark Zandi: Oh, I love this.
Ryan Sweet: Oh, this is a good one.
Mark Zandi: Yeah. So Ryan is about 18.
Ryan Sweet: Yep.
Mark Zandi: No. Ryan, you must be 40. Are you 40 years old?
Ryan Sweet: Yeah. 42. So I was born in 1980.
Mark Zandi: And you look like you're 32 by the way.
Ryan Sweet: Oh, I appreciate that.
Mark Zandi: 42. You can say [inaudible 01:05:57]. So 42 would put us back to what? 1980, right?
Ryan Sweet: 1980.
Mark Zandi: And the US has experienced... I think we've experienced five recessions since then. Something like that. And you're saying global? Is this every country on the planet developed, undeveloped?
Cris deRitis: Global recession, right? So IMF goes through and says [inaudible 01:06:26].
Mark Zandi: Oh, not how many... Oh, you see what I was doing? I was going to tell you-
Cris deRitis: Yeah, yeah, yeah.
Mark Zandi: Yeah. No. Okay. So how many-
Cris deRitis: How many times has the world economy gone into recessions?
Mark Zandi: I'd say five times.
Cris deRitis: Five times. No. That's actually how many times... Well, I don't know.
Mark Zandi: That's how many times the US has gone in.
Ryan Sweet: Three?
Cris deRitis: I think that's how many times you've experienced a global recession in your lifetime.
Mark Zandi: Well, no. 1980, 1982, 1990, 2001-
Cris deRitis: 1980? Global recession.
Ryan Sweet: Yeah. Global. That wasn't global.
Mark Zandi: 1980 was not a global recession?
Cris deRitis: Nope. You want that? There was 4. '82, '91, 2009, 2020.
Mark Zandi: Well, hold it. Didn't I say five?
Ryan Sweet: Yeah, you're off.
Cris deRitis: Yeah. Yeah.
Mark Zandi: I'm off five by 1. Oh, guys.
Ryan Sweet: Precision, Mark.
Cris deRitis: How many are there?
Mark Zandi: Okay. All right. Okay.
Cris deRitis: You and I experienced '75 too.
Mark Zandi: That's true. Was there a global recession in '82?
Cris deRitis: Yes.
Mark Zandi: Okay. That was really one recession. It wasn't two. US did two. The rest of the world said, "No, we're not following your lead. We're going to call this one."
Cris deRitis: All right. You're going to have to go back to the committee.
Mark Zandi: I'm just saying.
Cris deRitis: File an appeal.
Mark Zandi: Okay. All right. We've had a long conversation here and I should have had us articulate what we think the probabilities of recession were before we even had the conversation. But we run a survey off of Twitter and @MarkZandi. By the way, what's yours, Ryan?
Ryan Sweet: @realtime_econ.
Mark Zandi: Yeah. There you go. Off Twitter and LinkedIn. And I think we've got, I'm looking right now, we had 155 responses. And the question was, who do you think is closer, Mark, Ryan or Cris to the probability of recession between now and the end of 2023? Let's say 18 months from now. So over the next 18 months. I said 40% probability. Cris said-
Cris deRitis: 55.
Mark Zandi: 55. Yeah. And, Ryan, you said 75?
Ryan Sweet: Correct.
Mark Zandi: Okay. So the survey responses are Mark, me, 45% of folks buy into what I'm saying. It's a 40% probability of recession through the end of 2023. 38% buy into Ryan's dark pessimism, 75% probability through the end of 2023. And 17% buy into Cris's down the middle of the road. So it's kind of a barbell distribution. Either you're really pessimistic or you're reasonably saying you're not in the middle, you're not in the middle. It's interesting. Okay. Let's end it this way. I'm at 40% probability before we had this conversation. Chris, you were at 55. Ryan, you were at 75. What is your probability of recession now after this conversation?
Ryan Sweet: Go ahead, Cris,
Mark Zandi: Yeah. Cris goes first.
Ryan Sweet: Because he's in the middle.
Cris deRitis: I haven't changed. Maybe I've bumped it up actually. Closer to 60.
Mark Zandi: Really?
Ryan Sweet: Coming into the dark side.
Mark Zandi: That's still pretty good odds. But that's not enough to change the baseline forecast.
Cris deRitis: That's correct.
Mark Zandi: Oh, that's so smart. For folks listening, we have this rule that if you want to make a big change in the forecast or underlying assumptions, you have to be very confident. Meaning, subjectively there has to be a two thirds probability that that's going to happen before you make the change. And you're not quite there yet, but you're getting close. You're getting close. Okay. Ryan, you're at 75. He's stubborn of course. He's not going to change.
Ryan Sweet: No, I was going to bump it down to probably 65 now.
Mark Zandi: Oh, really? [inaudible 01:10:32] That is huge. Okay. So what changed your mind?
Ryan Sweet: Going back to the imbalances and everything. I think the economy can... It's got to be a pretty big shock, I think.
Mark Zandi: Yeah.
Ryan Sweet: I'm not confident the Fed's going to do it, pull it off, but we'll see.
Mark Zandi: Yeah. Okay. Well, I'm still at 40. But I'll have to tell you, I sat down this weekend and wrote a piece, and it's up on EV, on recession indicators and really kind of went through things. I actually felt better after doing that about the economy's prospects. I still think it's uncomfortably high at 40, but I'd say the risks to that are to a lower probability.
Ryan Sweet: How many cherry sodas did you drink when you were writing that piece?
Mark Zandi: Well, again, no alcohol.
Ryan Sweet: Okay. Just checking.
Mark Zandi: No alcohol. No alcohol. Anyway, okay. That was a great conversation. I know there's so much more we could have talked about. Policy and monitoring fiscal policy and severity of recessions, but maybe we'll come back to that at a future podcast. But I think we should call this one a podcast. What do you guys think? Anything else you want to say or cover at this point?
Ryan Sweet: What was your mind blowing number?
Mark Zandi: Oh, he didn't tell us his mind blowing number.
Cris deRitis: Oh, you want the mind blowing number very quickly? Here's the question to you. What fraction of the time was the US economy in recession from 1857 to 1900?
Ryan Sweet: Oh, my.
Mark Zandi: [inaudible 01:12:02] Wait a second. Wait a second. You can see I'm looking out here so I'm not looking at anything. The typical recession on average was 17 months. The average length of the business cycle was about 60 months. So what is it? 17 divided by 60? That's the number. Is that right?
Ryan Sweet: He's hesitant.
Cris deRitis: 1857 to 1900. So just-
Mark Zandi: Oh, 1900. I was thinking [inaudible 01:12:38] 1854 to 20-
Cris deRitis: Let me give you some context. Since
Mark Zandi: Okay. No. Okay. Oh, wait, wait, wait.
Cris deRitis: Oh, okay.
Mark Zandi: 40% of the time we were in recession before 1900. And since World War II, it's down to 15%.
Cris deRitis: Oh, so close... 50%.
Mark Zandi: It was 50 before 1900?
Cris deRitis: From 1857 to 1900. And then 14% from 1955.
Mark Zandi: People listening to this now understand why I'm chief economist, right?
Cris deRitis: That's pretty impre... What about since 2000?
Mark Zandi: Since 2000?
Cris deRitis: Yeah. How long have we been?
Mark Zandi: I could probably do that. I mean, I could actually calculate that. So in 2000, that recession was probably, I don't know, maybe no more than nine months. The 2008, that was 18 months. The pandemic was two months. So 2 11, 18, 29. I'd say kind of 29 months out of a hundred and... So it's three decades, 2000, 2010. No, 2000. I mean, it will be 240. 10% of the time?
Cris deRitis: Oh, 11. Very good.
Mark Zandi: There you go. See how I did that? All right, baby. Oh, yeah. So fun to be an economist. I don't understand these jokes. Accountants economists, weathermen economist. I love my job. You guys love your job?
Ryan Sweet: Oh, yeah.
Cris deRitis: Absolutely.
Mark Zandi: Unbelievable. What a job. All righty. Okay. We're going to call this a podcast because I think we have another one after this. So we should go. I'm going to get more cherry drink and we'll reconvene. All righty, guys. Thank you.
Cris deRitis: Thanks.
Mark Zandi: Take care.
