The New Boom-Bust Cycle

The financial media are desperate to find good news in the troubled finance and housing sectors, the very industries that got us into this mess. This quest for green shoots is frequently comical. Today, the Wall Street Journalfeatured a piece about new jobs in the financial services industry. Why, JPMorgan hired 950 new loan counselors, and a former Morgan Stanley guy found a job with an asset-management company! But given that financial services firms have shed 600,000 jobs since December 2006, that hardly seems like a triumph.

On Tuesday, Bloomberg noted that housing starts were "soaring," in May, up 17.2 percent from April. That's up three straight months, the Journalchimed in. But housing is an extremely seasonal business. The CEO of a large bank once told me that his bank's mortgage business all but disappeared in the fall because men in the Northeast wouldn't look at houses on Sundays during the football season. So noting that housing starts or sales rose sequentially in the spring months is a little like saying traffic at the train station next to Yankee Stadium was up hugely in April, when 20 games were played, from March, when no games were played. What really matters is the comparison with the previous year. And the news is horrid on that front. "Year over year, housing starts were 45.2 percent lower than the pace of construction in May 2008," the Journal noted.

If you're waiting on housing and finance to get us out of the mess they caused, then you better pull up a comfortable chair and a bag of popcorn, because it's going to be a long wait. Just as regulators always fight the last battle—regulating accounting after the dot-com meltdown, promising to regulate derivatives now—analysts always look to the last boom to cause the next one. The new reality is that the sector that dragged the economy down is never the one to lead the recovery.

In the past, when recessions were relatively frequent and the economy was comparatively static, a down industry could bounce back and ignite the whole economy. The same manufacturers that furloughed workers as the recession began would start hiring again once inventories had been drawn down. In the 1950s, when General Motors or RCA recalled workers to their jobs at the plant, it was a good indicator the recession was ending.

But, more recently, recessions have frequently coincided with—or precipitated—significant shifts in the economy, which left large firms fundamentally altered. In the early 1990s, large manufacturing and service companies underwent wholesale restructurings, shedding units and tens of thousands of jobs. During the recession of 1991-92, there was a lot of talk about industrial policy, which could help get troubled manufacturers back in the game. But those industrial jobs were gone for good. Instead, it turned out that services, trade-sensitive firms such as Wal-Mart, and technology drove growth in the 1990s. Lately, I've been dining out on a line I heard not long ago from a senior Obama administration economic official: In all the briefing papers prepared for the famous Clinton Little Rock summit in late 1992, the word Internet never appeared.

The last two recessions were precipitated by collapsing bubbles—technology/dot-com in 2001 and housing/finance in 2007. And in both instances, there was an expectation and hope that the sectors that had started the party would revive it.

Back in 2000 and 2001, stock analysts and executives continually warned that the second half of the year would see a huge comeback for Cisco, or for WorldCom, or for Webvan. Instead, the economy revived because of heavy borrowing, cheap credit, and a housing boom. Things never imagined in 1999—zero percent financing and negative-amortization loans, mortgage-equity withdrawal—helped propel the economy into its next growth stage. Between November 2001 and the spring of 2005, housing-related industries accounted for more than 40 percent of private sector job growth.

Today, we see that same misplaced hope in finance and housing. During bubbles, leading sectors get so irrationally big that they can drive a $14 trillion economy. After they pop, they shrink rapidly and lose their capacity for leadership. When it comes, a recovery in housing and credit will be good for the stock of homebuilders and banks, but it will be a modest revival. It won't bring back the freewheeling, easy-money days of 2006.

There's something else working against the old leaders resuming their positions: the rapidly changing global economy. These days, industries, sectors, and companies rise and fall around the world with astonishing speed. Business models that were genius in 2003 and 2004 don't make a lot of sense now. In some sectors, business models that made sense in January are inviable today. There will be another economic boom one of these days, but it will arrive suddenly and from an unexpected place.