'Recession' Might as Well Be a Reason to Rejoice

Dec. 3 (Bloomberg) — The market isn't supposed to swoon when you tell it what it knew already. Nonetheless it seemed to do precisely that on Monday. After the National Bureau of Economic Research issued a routine report on our recent troubles, the Dow Jones Industrial Average dropped 7.7 percent.

The folks at the NBER must be blinking hard. All they did was say we were in a recession, and date the start of it to December 2007. Since everyone knew something was wrong with the economy, that shouldn't have come as such a shocker. Besides, American recessions aren't that long — a year or so on average.

The Boston scholars who monitor the business cycle for the country may even have told themselves they were supplying evidence of good prospects. After all, as NBER chief James Poterba points out, by its very nature the NBER recession proclamation is a lagging indicator. "We're looking in the rearview mirror here," Poterba said yesterday. The NBER doesn't forecast.

The funny part is that the NBER was created to reduce ruction by introducing a little science into the jumpy world of markets. In other words, to limit unnecessary bear runs, not trigger them.

Back in the first part of the 20th century, the economy was deemed to be in one of two modes: normal or panic. In the panics, the market crashed, businesses closed, banks failed. Then as now, markets made wild moves on the basis of imperfect information.

In one case, as Richard Sylla of New York University's Stern School of Business has pointed out, international markets overreacted to something that shouldn't have meant much to them: a new commercial bank for immigrants in New York was failing. The panic was engendered because of a name: The bank was called Bank of United States and it sounded like a central bank.

New Words

Scholar Wesley C. Mitchell and others founded NBER to try to give a more nuanced picture of what would come to be called the business cycle. Maybe there was something between "panic" and "OK," and that state warranted description. Economists began using words that started with "d" and "r" to try to capture a slowdown in the economy. "Depression," "recession," "slump" and above all, "contraction," were favored because they were perceived to be gentle and descriptive, rather than hysterical.

The new verbiage didn't work in the long run, as we all know. The market came to dislike even the softer words. In November 2001, for example, the Dow fell to 9,873 from 9,982 after the NBER said that the recession had begun earlier in the year. Still, that was a 1 percent fall, not an 8 percent nosedive.

What Cycle?

So why the current edginess? One reason may be our own success. Since World War II the business cycle has showed signs of softening in what scholars at places like the NBER call "the great moderation."

Many adults came of age in the 1990s, when up seemed the only way to go. The gist of it is that markets don't want to hear where we stand in the business cycle. They want to hear that there is no business cycle at all.

Today a greater share of the population works in parts of the economy that are buffered against recession — government, schools or health care. These people may not have even noticed the "R" of 2001.

Today's recession, though, is definitely bad enough for them to feel. The drop in home prices has been an unsettling eye-opener to baby boomers and the generations after. "Only during the Great Depression and now did housing prices fall," says Victor Zarnowitz, a longtime NBER guru. It was in October 1954, a great month for strong housing market reports, that the Dow finally returned to its 1929 pre-Depression high.

Market Doubt

This season's jumpiness isn't auspicious. The NBER may have triggered such a move because the market doubts itself.

John Prestbo manages the Dow Jones Industrial Average for Dow Jones. He notes that back in December 2007 — when the NBER now tells us the recession began — the Dow was only 5 percent below its high reached two months earlier. And this was after all kinds of bad news about subprime loans, problems at Countrywide Financial Corp., various denials by Citigroup Inc. and big trouble for bond insurers. "The market is normally supposed to focus six to nine months ahead," Prestbo says. "In this case, it didn't."

What an odd trap: We're reacting more strongly because we didn't overreact to bad news before. There are plenty of serious signs that recession will persist, or even deepen. But a backward looking meter isn't one of them.

(Amity Shlaes, a senior fellow in economic history at the Council on Foreign Relations is a Bloomberg News columnist. The opinions expressed are her own.)

© Copyright 2008 Bloomberg

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