How To Find Gold In a Recession Economy

The recession has hammered New York, yet the mood is upbeat in a midtown Manhattan classroom where struggling business owners have gathered to sip wine and swap business cards. "I'm going to bring my business to a whole new level," vows Valerie Bennis, whose company, Essence of Vali, sells natural health and beauty products. Orders from spas and hotels have dried up, but that's forced Bennis to seek lucrative new customers, like drug companies looking to expand their product lines. Matthew Frank, laid off from Goldman Sachs last year, is starting a consulting firm targeting local utilities—with hopes to land a couple clients by summer. Lauren Levy works at a big Wall Street firm that announces layoffs every week, so in her spare time she's helping a college pal start an infant-wear business. "The only way to go in a recession like this is up," she grins.

Millions of American may feel like they're going in the opposite direction, yet for all the distress, recessions can also be a time of fantastic opportunity. Without a doubt, the Great Recession has triggered widespread pain, as companies from Wall Street to Detroit shrink (or die), jobs disappear, incomes decline and anxiety spreads. But in American history, virtually every period of economic upheaval has sundered bloated conglomerates, carved openings for hungry new competitors, rewarded aggressive innovation, and produced Adversity Millionaires. "There's always been a yin and yang," says Professor William Sahlman of Harvard Business School. "One person's crisis is another's opportunity."

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Famed economist Joesph Schumpeter first articulated the concept of "creative destruction" in the aftermath of the Great Depression. It's a pleasing theory that justifies the death of obsolete companies and industries, since in capitalism they're replaced by newer, better ones.

The trick is making sure you're part of the creation, which is usually scarce at the beginning of an economic purge, and not the destruction, which tends to be everywhere. During the depression, for instance, thousands of businesses failed, and most that survived slashed spending and payrolls. Yet even amid the carnage of the 1930s, some determined entrepreneurs found the resources to start or build companies that later became powerhouses. Hewlett-Packard, Polaroid and Revlon were founded during the depression. IBM and RCA, formed earlier, expanded in ways that made them dominant in their industries.

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Chemical company DuPont faced a conundrum in 1930, when its scientists invented neoprene, a form of artificial rubber. The material's real-world potential was promising. But DuPont's revenues were falling, and with banks going bust or hoarding their cash and the future looking scary, it was tempting to simply put off investments. Yet DuPont increased R&D spending, and by the late 1930s brought neoprene and its cousin, nylon, to market. Within a couple of years the two materials were used in every car and airplane made in America, and DuPont was one of the most successful companies in the world. While competitors were hunkering down, says economic historian Tom Nicholas of Harvard, DuPont was hiring scientists and thinking ahead: "When the uptick came, they were ready to take advantage of it."

One common attribute of those who succeed during difficult times is a shrewd grasp of the changes going on around them. And that requires unconventional wisdom. Today's headlines, for example, herald every arcane indicator suggesting the economy may be on the verge of a rebound. The prevailing cliché involves "green shoots" bursting forth from a fallow economic landscape. Many Americans, worn out from job insecurity and plunging household wealth, are eager to believe things will get back to normal before too long.

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That probably won't happen, even though the recession has already lasted a year and a half, which is much longer than usual. A recent Wall Street Journal survey of economists found that most believe the recession, technically speaking, will end later this year. But they also expect another 2 million jobs to disappear over the next 12 months, and they predict it will take years—not months—for the economy to fully recover.

You don't need to be an economist to understand some of the fundamental changes transforming the U.S. economy. It starts with consumers like you and me, whose spending in recent years accounted for as much as 70 percent of all economic activity in the United States. That percentage is going down, and not because we're all suddenly as thrifty as Ozzie and Harriet. When the housing bubble was inflating, people "saved" by investing in real estate and everything associated with it: Appliances, furniture, and home improvements, along with cars, boats and vacations financed with home equity loans. That wasn't entirely foolish. If you could earn 10 percent on your money by investing in your home, why accept 2 percent on a bank CD? As a bonus, we also got cool stuff while "investing" in our homes, and that spending kept the economy humming.

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Obviously real estate turned out to be a lot riskier than a bank account, and now consumers are saving for real. Economist Gary Shilling predicts that the savings rate, which bottomed out close to 0, will rise by 1 percentage point a year for the next 10 years or so. With more money going into banks and less into stores, economic growth will be stunted. "We'll have slow growth for the foreseeable future," Shilling says, "and housing will be dead for years."

That should worry anybody counting on a return to the status quo. But it could be good news for people poised to benefit from a shakeup. Glenn Grossman, for example, seems to be cultivating an inverse relationship to the state of the overall economy. Grossman left a job with bond-trading firm Cantor Fitzgerald in 1999, shortly before the Internet bubble burst. With the stock markets deflating, no decent jobs surfaced, so Grossman started his own investment banking firm, the Dinosaur Group, in 2001. His goal was to create a modest, 1950s-style brokerage firm that took few risks and catered to small and mid-sized firms looking to raise cash.

The boom years nearly killed his 50-person firm, which he runs with his brother and son. "The go-go years were terrible for us," says Grossman. Potential clients all wanted to trade in collateralized debt obligations and other flashy derivatives, which Grossman's firm shunned. Then the housing bust triggered a financial chain reaction, as trillions of dollars worth of CDOs and their ilk blew up, nearly bringing down the global financial system. In the aftermath, Dinosaur has been hiring talented bankers fleeing bigger Wall Street firms, and gaining clients who never would have bothered to return the firm's calls a few years ago. "If I can survive this crisis, it will be the best thing that ever happened to my firm," says Grossman. Other boutique firms are beginning to sprout from the rubble on Wall Street, perhaps one of the true green shoots to emerge from the financial meltdown.

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Small enterprises and individuals can benefit too, if they focus on where the economy is headed and not where it's been. Matthew Frank, the former Goldman Sachs employee, is targeting his startup, Aqueous Advisors, at water utilities because he figures there will be a lot of business there. "The pipes underneath the cities are rotting," he says. "There are $300 billion in needed fixes." Plus, the Obama stimulus spending could trickle down to such projects. Tearing up roads to fix old pipes may not be the most popular way to spend taxpayer money, which is where Frank hopes to help—his firm will help devise strategies for generating community support. And if the idea doesn't fly, Frank learned an important lesson in that Manhattan classroom, through a four-week seminar sponsored by New York City and the Kauffman Foundation, which promotes entrepreneurship: "If you're going to fail, fail quickly."

If he does, there are plenty of other fields likely to welcome industrious workers with new ideas—recession or not. Sahlman of Harvard ticks off several. "There are enormous opportunities related to energy," he says, including solar heating, insulation, biofuels, and improving the electrical grid—all Obama priorities. Sahlman is optimistic about the prospect for science and technology to help solve problems like poverty and global warming. In retail industries, luxuries and extravagances are obviously out, but time-tested business strategies still hold. "The opportunity to compete on price with an acceptable level of quality will make you very competitive," Sahlman insists.

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Trying something new might even feel liberating. Lawrence Scheer, another participant in the Kaufmann program, was a Wall Street lawyer who hated his job, but loved the pay. Then the work dried up and he decided to start Magnificent Baby with his college friend Lauren Levy. Their merchandise, a line of innovative clothing meant to ease the contrivances of changing a baby, won't be ready until 2010. But forming a startup has given Scheer a new sense of purpose. "It's awesome," he says. "I feel useful."

Scheer is realistic about his firm's prospects, acknowledging that even if it succeeds, it could take three years before there's enough revenue to pay two employees a decent salary. Meanwhile, he's living on his savings and thinking about teaching standardized-test prep courses to bring in some extra income. And his partner, Levy, is holding on to her day job as long as she can. That highlights another enduring lesson for people who want to thrive in good times and bad: Have a backup plan. Or two.