Issue: 93
Sent: 18-12-2007 14:00:03
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Interesting 2008 - Lester Wills
I have been writing about the potential fallout from the sub prime mess in the US. As I said , I think this saga has a long way to run as it is not just about people gaining large mortgages that they could never afford to pay. George W. has come up with a plan to help many of those people.
Part of the problem is that a huge number of people were using their homes as ATMs. Between 2004 & 2006, Americans pulled in excess of US $800 billion a year out of residential real estate according to data presented by James Kennedy and Alan Greenspan.
But in the first half of 2007 equity withdrawals were down 15 percent nationally compared with the average for the last three years, and consumption supported by such funds plunged nearly 25%.
During the northern summer, the size of withdrawals fell sharply according to the chief economist at Moody's. He stated that only a year ago, money taken out of houses was almost 10% of the disposable income in the US, by September 2007 it had dropped to about 5 percent, a difference of about $350 billion a year.
As consumer spending accounts for about 70% of all economic activity in the United States, even a slight dip in home borrowing takes huge amounts of money out of the flow. Consequently, the prospect of a slowdown, combined with the squeeze on households from higher oil costs, is not good news for retailers.
According to Christian Menegatti, lead analyst for RGE Monitor, a consulting firm in New York, "a fall of 2 percent in consumption would be big enough to trigger a recession".
However, this is only part of the problem. A recent article in the New York Times suggested that prices in both the stock and bond markets indicate many believe the snowballing housing crisis and worsening credit crunch will soon tip the U.S. economy into a recession.
This is because some experts are suggesting that the total loses facing the financial sector could amount to almost US$500 billion as many banks have hidden loses that have been concealed in off balance sheet investments (e.g. SVO's).
In fact there is even a suggestion that some of the most exposed Wall Street banks and investment houses could find their profits and much of their capital base totally wiped out. If that scenario is correct, some of these institutions will be forced to sell off assets and lay off workers just to remain solvent.
As the financial sector represents a major proportion of the US economy (US banks made up 30% of the profits of all US companies last year), the effects will most certainly spread across the rest of the economy and of course the stock market.
Other indications that concern is growing include:
The Federal Reserve Bank of New York has said it would make at least US$8 billion available so banks do not find themselves short of cash through early January.
Former Treasury secretary Lawrence Summers said he now believes the odds now favour a recession, a view he has only recently formed.
Analysts at Merrill Lynch recently published a research note stating that they believed 2008 would be the year when a recession hits the US.
The chief economist at Standard & Poor's was quoted as saying "It looked like the problems in the credit markets were going away or at least calming down a few weeks ago, now the signs are that they're not."
Dick Syron, the head of Freddie Mac, the government sponsored agency that also trades mortgage backed securities has indicated that he has never seen circumstances so bad. The company then announced huge losses from home loans that may 'never be repaid'. This was then followed by a US$6 billion fund raising, with the company stating the money was needed "in light of actual and anticipated losses". Freddie Mac by the way is the second largest buyer and guarantor of home loans in the US.
As the New York Times pointed out recently, credit flowing to US companies is drying up at a pace not seen in decades. It should be noted that such a rapid constriction of credit has never been witnessed before. What's even more worrying is that smaller declines preceded three recessions.
Some will point to the fact that markets have been down and have recovered again very quickly. However, no one can deny that the swings have been pretty dramatic. Sadly volatility normally increases ahead of a slump, with corrections as much as 10% occurring. Mind you, the stock market is not always the best guide, given that it has predicted 9 of the last 5 recessions.
Since I wrote this a number of major banks around the world have indicated that losses tied to bad debt (and the sub prime mess) are likely to be worse than expected, the latest indication that the credit markets are not returning to normal.
Not only that market euphoria over trans-Atlantic action by central banks to fix the global credit crisis wore off pretty quickly, with investors saying they expect the injection of more capital to do little to solve long-term problems.
The only thing I can add is that 2008 could prove to be very 'interesting'.
Brings to mind that old Chinese curse, 'may you live in interesting times'.
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