Wednesday, January 7, 2009

Are We There Yet?

In a word, no.

There is no point in repeating what qualified and proven analysts such as Meredith Whitney and Nouriel Roubini have said and is obvious from the news, some of which is linked below. Roubini, known for his accurate predictions, thinks the contraction will be global and will last two years or longer. See Warning: More Doom Ahead

The Obama administration will be counting on consumer spending to again elevate us from a recession. Consumers’ $10 trillion in annual spending currently represents 70% of the GDP. Government deficit spending will be added to the $3 trillion in current government spending, which represents 20% of GDP. While the government might follow through on its promises to increase spending by $1-3 trillion, from the economy’s greater dependence on consumer spending it is apparent that the key to any recovery will turn on consumer confidence and whether consumers will spend the new-found money they will enjoy from a promised 3 million new jobs and a revived economy. But it will take quite some time from the passage of a new stimulus package and federal programs to “create” those jobs and for any money from them to filter into the economy. We have learned that putting cash directly into consumer pockets might provide some immediate but little long term effect on the economy.

Consumer confidence is not high at the moment and it is hard to see it improving significantly until the economic fundamentals improve generally – certainly not while unemployment is rising at an unexpectedly greater pace.

Additionally, the solutions offered by the Federal Reserve are based on the assumptions that if everyone borrowed more, they would spend more. That is not happening. And it may never happen. The economy will have to adapt to a paradigm shift. See Op-Ed: Social Mood Changes Forever

The credit crisis among the large financial institutions continues to serve as the core drag on the economy. The huge volume of over-the-counter credit default swaps outstanding represent contingent liabilities that are, as a group, three to four times the GDP and ten times the size of their underlying credit obligations. And many remain undisclosed on the books of banks, investment houses, hedge funds, insurance companies and others who sold or bought that form of insurance, which was backed by nothing but promises and the financial wherewithal of the counterparties. The downgrading of financial instruments and institutions will continue to grow the counter-party risk in the financial system.

A counterparty default would mean that an obligation, such as paying interest and principal on a bond, would no longer be insured – so that if a municipality or homeowner, for example, defaulted on bond or mortgage payments, the municipal bonds or mortgage-backed securities, and other financial instruments derived from them, would lose significant market value. That could cascade into downgrades of corporate or bank assets that would affect the creditworthiness of the institutions and their ability to raise capital. To date the solution has been for the Fed to take some of the assets at risk onto its own balance sheet and to conceal and minimize the extent of the problem in the hope that no one will see that the emperor has no clothes and the counterparties will come through when called-upon. The Fed has not explained adequately why they think that this will work – they apparently have no hard data on how many credit default swaps are backed by counterparties who have the financial wherewithal to deliver on their promises. That has contributed to a credibility problem among the banks themselves. No one knows who is really solvent.

The only permanent solution to this impasse is a level of forthrightness and transparency that would inspire confidence in the soundness of the financial institutions. But the largest banks are not sound and many suspect that public knowledge of the full extent of their exposure would crash the entire financial system. See Reggie Middleton’s analysis at The banks are going to need more investment capital, period. And few are willing to invest in them. See

There is not a way to reverse the damage to banks’ balance sheets caused by the bursting of the housing bubble except to run the movie backwards – undoing defaults and foreclosures, reflating the value of each house mortgaged, fulfilling the unrealistic expectations of defrauded consumers, assuring that housing values will keep going up forever, and fixing it so that no one will ever need to call upon a counterparty in a credit default swap. It just ain’t gonna happen, folks. Moreover, the potential remains for still more mortgage defaults and foreclosures. See
And home sales are not likely to rise until the employment picture improves – not any time soon.{7FDA1504-8F8D-4795-B8F0-B4EA17FDDFF4}

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