The term “green shoots” to describe signs of economic recovery has spread through the journalistic world as fast as mold in a dank cellar. To counter this euphoria, “Dr. Doom,” otherwise known as Prof. Nouriel Roubini of New York University, has coined the term, “Yellow Weeds,” to warn against false expectations.

What’s a body gonna believe? To understand what is going on one has to go back to the basics of the “Great Financial Meltdown of 2008″ and the “Great Recession of 2009″ (my terms). The crisis began when analists began to drastically devalue securitized debt assets, also known as “derivatives” and “toxic assets” and other more colorful terms. This brought down the whole debt structure built on these investment instruments.

To get some idea of the structure that was undermined one has to first look at its size. I just heard that the “notional” worldwide value of derivatives is $450 trillion. To say this is an astronomical number is to put it mildly. The total economic output of the US economy in 2008 was just over $14 trillion and for the whole world $61 trillion. We are talking about an asset class that is 7.5 times the size of the entire panet’s economic output.

And this was devalued because analists were convinced that a slump in the values of homes would lead everyone to default on his mortgage. Furthermore, there was no equity left in your home so you were unable to borrow on it to consume more than your current income would allow. Now both of these predictions had merit. But they were overblown. What should have been a minor adjustment to the value of this “debt beast,” was elevated to major surgery, that left the world’s economy almost dead.

Fortunately those in charge were a bit better at understanding the situation than were the analists devaluing the “securitized debt assets.” They put in place some guarantees and other devices to offset the damage done by the erroneous devaluations. And these devices worked.

Don’t believe me, then tell me why several banks, who were on the “verge of extinction”, have, in a few short months, managed to pay back the funds they got from the TARP program?

So back to “green shoots” and “yellow weeds.” The financial sector of the economy has recovered, thus the “green shoots.” However, the rest of the economy has not yet seen the light, thus the “yellow weeds.” However, since this mess started in the financial sector, its recovery should lead the rest of the economy out of the wilderness.

Leo Cecchini
June 2009