A recession, especially one that is global in nature, is a time of great social stress. Unemployment rises, incomes fall, export earnings collapse, savings are lost, companies face big losses or even bankruptcy. That places a huge amount of pressure on politicians and government officials: some will be blamed for the trouble, all will be expected to do something to cure it. The big unknown, however, is how severe is the blame, and how will the political leaders react.
...In many recessions, confidence returns in a natural way once people see that disaster has not happened, and once some begin to think that business opportunities are so cheap that they have the chance to make a lot of money during a recovery. So investment revives and recovery does happen. But this is where the second issue, fraud, comes in.
The affair of Bernie Madoff, the seemingly respectable New York money manager who has defrauded his investors of up to $50 billion, is extremely damaging to confidence. If savers, whether individuals or big institutions such as banks and pension funds, come to think that every money manager might be another Madoff, then they will keep their money in cash and government bonds for much longer. That is what happened in Japan after its 1990s financial crash: private investors felt they had been robbed, and so stayed away from equities even when interest rates were zero. If more frauds are exposed, then savers will take longer to regain confidence, and it will take a lot longer before companies get the capital they need to make the world economy recover.
Arun Natarajan is the Founder & CEO of Venture Intelligence, the leading provider of information and networking services to the private equity and venture capital ecosystem in India. View free samples of Venture Intelligence newsletters and reports. Email the author at email@example.com