Provisional
Truth | Essays | May 23, 2007
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Economic Tsunami Warning
More than anecdotal evidence now points to an economic
tsunami forming from the sub-prime mortgage meltdown
“ripples” which began to register on financial seismometers
18 months ago.
It's an instructive image, how a seemingly small,
inconsequential thing can later, unexpectedly manifest
itself in a big, deadly, destructive way.
As
with a real tsunami, when produced by an underwater
earthquake, it travels virtually unnoticed in open water,
appearing as mere ripples or swells moving across the sea.
Only when the wave energy and momentum approach the
shallowing continental shelf, and, ultimately, the
shoreline, does the destructive magnitude of a tsunami
become evident.
In
the U.S., recent years of low interest rates, massive
government deficit spending, tax cuts for the wealthy and
off-balance-sheet financing for military adventures and
hurricane relief have the nation's business machine humming,
but we eventually may point to what seemed at the time a
small, “off-shore” economic earthquake as the cause of
future misery.
In
recent months observers, analysts, traders, economists,
Federal Reserve governors and government officials almost
unanimously have been pronouncing the current
sub-prime mortgage
meltdown as harmless “ripples” in the ocean of the
American economy, much the way sailors in open ocean would
hardly recognize a fast-moving tsunami.
And for the last two years, since the peak of residential
real estate markets around the country (about mid-2005 in
hindsight), as the term “sub-prime” gained verbal traction
in the mainstream media, this army of
prognosticators, pundits and whistlers-past-graveyards has
continued to wishfully pronounce any potential economic
fallout from the meltdown as “contained,” and “unlikely to
spill over” to the general economy.
The consensus among these hopefuls is the growing number of
price-inflated homes in default, soon not-to-be-owned by
several million unfortunate, over-leveraged working
Americans,
financed with teaser-rate terms and, in some cases, approved
with fraudulent documentation, will be insufficient to
rattle the rest of the American economy.
Often, however, as economic history has taught, the
consensus is wrong, misjudging evidence and clinging to a
status quo – linear thinking – as so aptly demonstrated by
the “new paradigm” of the high tech era of the late 1990s
which promptly succumbed by March 2000 to the gravity of
finance and common sense.
Fed Chief Ben Bernanke isn't worried (is
he ever worried?):
“Credit
market innovations have expanded opportunities for many
households. Markets can overshoot, but, ultimately, market
forces also work to rein in excesses.
For some, the self-correcting pullback
may seem too late and too severe.
But I believe that, in the long run, markets are better than
regulators at allocating credit,”
as he noted in an address in mid-May (emphasis added).
But as Doug Nolan, whose
Credit Bubble
Bulletin appears at
The Prudent Bear, notes, “An
argument can be made today that market forces are finally
reining in subprime excesses. Yet I view this development in
anything but positive light. Unfortunately, rather than
correcting or self-regulating (in response to an
'overshoot'), it is much more a case of highly-adaptable
Wall Street 'structured finance' simply abandoning subprime
for greener pastures. Today, the insatiable appetite for
yield is more readily satisfied by ('subprime') loans to
support private-equity, leveraged buyouts and the global
merger and acquisition mania.”
Nonetheless, inflation will not remain at
bay given the amounts of liquidity sloshing through the
world's financial system. And, as we know, inflation
arises when an increased amount of money is available, or
made available, to
purchase a finite, or limited, amount of goods and services.
Although higher inflation only has begun to register in
government reports, it is a harbinger of an ominous future,
as open ocean “ripples” begin to approach land. The problems
become magnified when inflation crashes head-on into
recession, and both economic conditions survive.
The result:
stagflation, a term coined to described a previously
contradictory environment of a declining economy combined
with high liquidity, a relic from that 70s economic show
when a nasty business recession a rapidly expanding money
supply as baby boomers and stay-at-home mothers began
joining the American workforce en masse.
Anyone who waited in a gasoline line in 1979 or bought a
home with a 14 percent fixed-rate mortgage or received a 15
percent raise at work or watched the Dow Jones Industrial
Average waver around 1000 for a number of years remembers
stagflation.
Like a movie that's wildly successful at the box office
usually guarantees its sequel, or two sequels, as is evident
in 2007 with all the “3” movies playing, so stagflation
likely will see a comeback as well as similar economic
conditions arise.
A
perfect storm of wave-amplifying factors in the form of
doubled energy prices, higher food and health-care costs,
and rising property taxes (more than doubled in some areas)
combined with factory closings and layoffs, government
deficit spending and consumer deficit spending resulting in
record debt levels, may become the shallowing coastline that
forms an economic tsunami in which the sub-prime mortgage
meltdown does, in fact, spill over and seize the engine of
U.S. capitalism.
One wouldn't know it judging from the performance of U.S.
and global stock markets, with many indexes roaring to new
records over the last six months, or from strong corporate
earnings, or from huge increases in creation of debt-money
around the world fueling everything from massive private
equity buy-outs (Cerberus to raise $57 billion for its
purchase of Chrysler) to record-price-setting sales of
artwork (Andy Warhol's “Green Burning Car I” sold for nearly
$72 million at Christie's this week).
It is worth noting, as did Doug Nolan in his
May 18th Credit Bubble Bulletin, that in just the
past two years China’s Shanghai Composite index has surged
265%, India’s Sensex 122%, Russia’s RTS 187%, Mexico’s Bolsa
142%, and Brazil’s Bovespa 108%.
All of which points to massive amounts of liquidity – money
– being created around the world, which, as economic history
instructs, always results in inflation (again, the economic
scenario in which too much money chases a finite amount of,
or too few, goods and services.)
But here in the U.S., potential
recessionary evidence to the contrary is mounting,
notwithstanding stock market records.
Mortgages in foreclosure across the
country rose 62 percent to 147,708 in April from a year
earlier, according to a May 15th estimate by a
California-based research firm and as many as 2.2 million
Americans are at risk of losing their homes, the Center for
Responsible Lending in Durham, North Carolina, said in a
December study as reported by
Bloomberg. (LINK)
The foreclosures have “the
possibility of making economic conditions worse, because
they will shrink consumer spending,'' said Weihong Song,
professor of finance at the University of Cincinnati, in
that Bloomberg report.
Housing accounts for about 23
percent of the U.S. economy, when taking into account
purchases of furniture, appliances and items for new homes,
according to the Joint Center for Housing Studies at
Harvard, including housing-related jobs represented by
national homebuilders, small home building companies,
skilled laborers, contractors and subcontractors, real
estate agents, title companies, retailers and manufacturers
of home goods.
Factory closings are increasing
as jobs disappear or are exported overseas. Not only in
traditional smokestack industries like the planned
shuttering of a number of U.S. auto plants, but also in
high-tech industries, like the recent closing announcement
by Intel of a thousand-employee flash memory chip plant in
Albuquerque.
As
high-paying, skilled jobs vanish, the effects are magnified
throughout the economy, combining with higher food, energy
and insurance costs and higher property taxes, shrinking
available spending in other parts of our consumer nation.
The residential real-estate boom has resulted in another,
unintended consequence: huge increases in property taxes,
the brunt of which have occurred in high-demand retirement
regions of the nation.
Angered citizens, whose tax bills have doubled, or more, in
the last five years now are leading tax revolts,
especially
in Florida whose many retired residents living on fixed
incomes also have seen huge jumps in property insurance
rates since 2005 after that year's vicious hurricane season.
Who knows, we may see former New Yorkers returning home from
Florida because the property tax rates in the Empire State
now are lower.
In
the banking sector, many financial institutions are
beefing
up loan-loss reserves in preparation for the tsunami. Some
already have recorded significant charge-offs, beginning at
the end of 2006, to cover sub-prime losses.
Other banks may have to begin reserving for potential losses
in the home equity loan arena. Where property values have
begun to fall precipitously, some of those home equity
loans, when combined with first mortgage balances, now may
exceed the market values of those homes, and banks which
aggressively have sold home equity loans may start getting
nervous.
Many “regular” (not-sub-prime) borrowers who had built
significant equity in their homes but in recent years have
leveraged the
“ATM” cash-generating capability of their
property with home equity lines of credit, may find those
lines of credit reduced or terminated, along with demands
for payment or requirements to convert the lines to
higher-rate term loans with big monthly payments.
The sub-prime mortgage meltdown also is gaining traction
politically, as elected national and state officials look
for likely targets to blame, starting on Wall Street, and,
as they hope, to extract reparations for consumers in
exchange for the huge profits made in the last five years.
The U.S. House Financial
Services Committee is working on legislation to assist
sub-prime borrowers if mortgage lenders don't, said Chairman
Carolyn Maloney, (D) NY. And U.S.
Senator Hillary Clinton,
(D) NY, a candidate for president, has called for sub-prime
borrowers to be given new loans at lower fixed rates.
Ohio Attorney General Marc Dann said in mid-May
he wants to
sue Wall Street firms because their bond sales enabled
consumers to get mortgages they couldn't afford. Ohio has
already won the right through a lawsuit to review
foreclosures by New Century Financial Corp., the bankrupt
California-based lender. Dann may add investment banks and
credit-rating firms to the case or bring new suits, perhaps
using Ohio's civil version of the federal Racketeer
Influenced and Corrupt Organizations Act.
Ohio home sales fell 5.8 percent
in the first quarter and the average price declined 1.5
percent to $143,383 from a year earlier, according to the
Ohio Association of Realtors. Ohio had 11,431 default
notices, auction sale notifications and repossessions by
banks in April, 39 percent more than in March and 135
percent more than a year ago, according to data. Only
California and Florida had more.
Even former Fed Chairman
Greenspan offers odds of one in three for recession by
year-end, noting as he did in late February the duration of
the present expansion is reaching the point typically where
it begins holding signs saying “The End is Near!”
Greenspan's comments, taken
seriously to the tune of a half-trillion of evaporated stock
market wealth within a couple of days of his speech,
evidently now are not considered reliable – more Greenspan
jawboning like 1996's “irrational exuberance” – given the
recovery, and new subsequent new highs, of global markets.
Yet in September 2005 remarks
while still Fed chief,
Greenspan warned, “History cautions
that extended periods of low concern about credit risk have
invariably been followed by reversal, with an attendant fall
in the prices of risky assets.”
While we may fervently wish we are living in a global
“goldilocks” economy, not too hot, not to cold – just right,
we may be one terrorist
incident or Katrina-like hurricane away from a nasty
recession in this country and extending worldwide, the like
of which has not been experienced in America
since
1973-1974.
That recession, by the way,
was long before the births of a good chunk of our
population, and, as such, is as far removed from experience as the Great
Depression was from baby boomers in the 70s.
In the 1970s, President Ford and
his chief economic adviser Alan Greenspan, engineered a
recovery based on tax cuts and government spending to
stimulate the economy.
Those tools, while theoretically available to the Fed and
the government, this time likely would exacerbate
conditions, especially inflation and a weakening U.S.
dollar, in an environment in which America's national debt
is approaching $9 trillion, the government still is running
budget deficits to pay for previous tax cuts and
off-balance-sheet military spending in the Middle East and
consumer borrowing already may be nearly maxed-out.
Stay tuned. The economic ripples observed today may turn out
to be, in fact, a
destructive tsunami of stagflation, which, in hindsight, we
will realize was caused by a small,
“off-shore” earthquake of sub-prime mortgage defaults
beginning in 2005.
-- What do I know?
Send me an email.
--Keith Hazelton
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