Centerfield

There is another complication (or perhaps just an enhancement of the FEAR issue). When anyone goes to create a new risk model, they not only have to make a new model. They have to figure out, especially for home mortgages, how they will defend that model against charges of redlining.

Part of the attraction of sub-prime mortgages was that they could be written in areas where other risk models would say "Based on historical experience, homes in this area are simply too big a risk." With sub-prime mortgages, and CDOs based on them, it became possible to comply with anti-redlining legislation. Any new models of risk have to not only avoid redlining, they have to prove that they did not do so. (While, most likely, still factoring in the perfectly valid geographic components of risk.)

Add: Do not confuse risk with uncertainty. They're different if related things. Both are elements in "fear."

Corporate cash holdings (cash/debt/equity ratios)are at all-time highs. Most of American industry is MUCH less exposed today to debt-market fluctuations and flat growth than they were a decade ago, and in great position for capital investment without relying on the debt markets. The "bubble" is pretty well confined to the financial industry, and to specific areas of that. Home prices in some areas still have some more falling to do but most of the damage has already been priced into the market.

The Euro remains overvalued "despite" record high inflation in the Euro zone.

Tully, You keep talking about American industry when this is not a business driven downturn. This is a consumer debt problem at its core. The reason issues started to fail is because consumers can no longer afford their debt.

I know most of us here are likely better at managing their money compared to the average person. It is also still heavily regionalized for the worst effects. However the regions they are affecting are large.

I will use Florida as an example since it is the one I know best. This entire bubble burst is going far beyond just the subprimes. While the foreclosure rates beyond subprimes is not a major problem, there is becoming a combination issue of consumer debt cap and many starting to get stuck in negative equity. These people are not going to be getting significant relief anytime soon. Conservative estimates are for at two more down years in this state.

I know Florida is likely the worst-case or one of the worst. However, it is going to be difficult for many of these people to qualify for loans in the near future. The credit crunch is also taking a massive hit on muni-bonds.

The question I have is, how leveraged are the consumers outside of the hardest hit areas? Are they also going to find themselves in a credit trap. If they are, it will take quite a while for this to correct itself.

So things may look fine on Wall Street; but this slowdown/recession/whatever you want to call it is going to be much harsher on the consumer than the last few.

That wasn't my clearest post ever, by a long shot.

What I was trying to talk about was how likely lenders think their potential loan recipients are to be able to pay a potential loan back.

Many lenders' perception of that risk has skyrocketed beyond reason, and bond insurance has become hard to get, and apparently expected in many contexts.

Plus, there are special cases in which nobody really knows, like subprimes, and that creates uncertainty even when the fraction of uncertain debt is small relative to business size.

There are many consequences. EVERY kind of loan is unreasonably expensive or hard to get. Mortgage loans haven't fallen to follow the Fed drop. Road and sewer projects all over the nation are on hold, and having their bond-issuers' ratings pummeled unreasonably.

It's VERY fortunate that savings are high, because they'll be needed. But there are always some cash-low businesses, like Borders,

And cash-low companies and companies in capital-intensive industries will have to put expansion plans on hold.

Kuch higher shrinkage from failing companies and shrunken growth add to a likely economic shrinkage, as I see it. Does it make more sense that way?

Jim, consumer debt isn't exactly a bubble. Or new. I've watched Paul Krugman confidently predict nine out of the last two recessions. Pardon me if I don't hold an armor plate over my head and fret overly much about the sky falling. Fundamentals remain sound despite market panic and popular hysteria.

If you wish to panic, by all means, go right ahead. But unless you were silly enough to take out an adjustable rate mortgage (almost always DUMB) or borrrow more than you should have, I don't see why you should. Even if you're in a negative equity situation from buying in to a bubble, your mortgage payment isn't going to change on a fixed-rate. And from the market POV, most of the damage has already been priced in.

Yep, there are still some people out there who will have to cut back hard, who will not be able to expand their credit, and who may eventually get hosed anyway if they borrowed too much in the first place, especially on adjustables. There always are. But even in subprime over 90% of the loans are current. And rates are pretty darn low.

But such "shrinkage" also makes the markets more efficient, Jon. And it goes on constantly.

Some lenders are in temporary lockdown mode, sure. But they'll be out of business in short order if they don't issue new loans, you know. Sharks gotta swim to survive. These things are temporary, and don't have the long-term impact y'all seem to think they do.

And you do know that road and sewer projects are paid for out of TAX dollars? Um, gee, what's the effect of not raising taxes? Hint: It's usually not a negative impact on the economy, local or otherwise.

(PS: If you want to see some scary consumer debt/income levels, look to Europe. Seriously.)

As Tully alludes to, failing companies and individuals with more debt than they can handle go on all the time. But as I think Jon was saying in the beginning, what is different this time is that nobody seems to have a good handle on just who is holding what risk. Or how big those risks actually are.

If everybody was clear who was actually holding subprime mortgages, for example, those individual companies might still be in trouble. But there would be a lot fewer of them than are currently agonizing over the situation. So the critical variable for how long the economy is feeling shaky is actually how long it takes to resolve that uncertainty.

My guess (based on absolutely no information, I admit) is that it will be the end of the year at the earliest. Which means, it will impact the election . . . somehow. But if things get sorted out by early next year, the next administration will have a much brighter economic environment to work in.

Tully, I guess that is where we differ. As I see it, current fundamentals are weak at the consumer level. Now, if the commodities market corrections continue, that will probably be a bigger help to the economy than any tax cut or interest rate drop.

I also think your discount of the effects on the bond market is short sighted considering that public-private partnerships in funding development projects has become much more prevalent in the last couple of decades.

I am not saying the sky is falling. What I am saying is that the recovery will not occur as quickly as it has in the past. My point is that the a lot of the economic growth of the last five years has been built through increasing debt, mainly the explosion of credit devices against home equity. That bank is likely closed or people will be less likely to dip into that. I simply think that it is too rosy an outlook to say that the markets POV has correctly taken everything into account. I fully expect the impact of the stimulus package to be almost non-existent.

I suspect it will be 2010 until we get economic growth back to a rate above 5% for the year. I just see too many factors that retard a quicker recovery and there is probably more danger to the recovery in the way of future government attempts to fix it.

I only focus on the consumer as the key in this recovery because I think they are going to suffer some shell shock. Yes some of it is fear. However, It has been a couple of generations since housing values have really plunged on a wide scale. A lot of big ticket purchases, home improvements for example, had been driven through home equity financing. If the consumer no longer feels safe that equity is stable, they are going to be less likely to tap into this resource even if it becomes available. Hence, unless this bubble has completely bottomed out or bottoms out by this summer for the consumer, something that I am currently thinking is unlikely, I think there will be a shift in consumer thinking towards credit in the short term of the next three to five years that will cause more of a push to saving first to buy or just saving a higher percentage before getting the loan. This increase in time before the consumer is able to act is then a natural braking process on the economy. Hence my feeling the recovery will be slower.

Yes, you are right that the banks will make the credit available. What I question is if the consumer will be willing to use it for a while. I do think there is a good chance that the dynamic may have or is changing.

The following is something that will rquire investment. HERE

Most of the solutions to energy, security, education and environment will require investment. Confidence helped Reagan. Confidence is required to meet the problems and the "sky is falling" rhetoric or serious risk aversion is counter productive. Yes, there are problems, but reasonable solutions require reasonable investment. Perhaps the Democrats must recalibrate their wish list and start with those investments that are most important. It would also be prudent not to add to the present slow down with knee jerk moves, nor fail to provide for the required repair of our military readiness and programs designed to meet growing needs.

Er, Jim? The economic growth rate hasn't been consistently above 5% for quite a while. Consistent 5%+ real GDP growth would scare me more than the current scenario, as it would indicate an unsustainable economy-wide bubble. I suspect your being in one of the most affected regions from the regional housing bubble collapse is overly coloring your perceptions of the magnitude of it. As I said, most of the damage from the mortgage markets has already been done, and priced back into the system. And in a lot of places housing prices and loans haven't been affected at all. Only bad loan practices that should have been curtailed long ago, like 125% equity seconds.

It has been a couple of generations since housing values have really plunged on a wide scale

Um, dude, I was around and in the market in the Carter years. In Denver. Try ONE generation, maximum. Fifteen percent mortgage interest rates combined with an oil bust in an oil town and a REAL recession. There was likewise a national housing peak-and-bust running from a 1989 peak through to a '98 recovery to the '89 peak level. Our current run-up began from the '93-'94 trough.

wj, a lot of us think that we've probably already hit bottom in the business cycle. Of course we won't KNOW until a few months down the road. And if you're in one of the areas hardest hit, as Jim is, it will look grim for a year or two or more. The more profound the drunk, the longer the hangover.

But I've been making the rounds of muni underwriters on behalf of a project I'm on now, and while they've tightened up some, it's not nearly as bad as some are trying to paint it. The biggest worry for them is the re-insurance markets where they lay off their risk--they're waiting to see which companies are going to take hits from the shake-out. But they're not afraid to underwrite solid general obligation munis at all. The biggest drag on munis right now is sheer political uncertainty related to revenue bond munis issued on for-profit-participation projects, but that has little to do with the housing bubble. Bond brokers are unclear about when and if and how the AMT will be reformed. A good reform that pushes the ceiling back up and they can sell hand over fist. More quibbling and incremental fixes, and their sales market is increasingly constricted. AMT doesn't exempt income on revenue munis issued on for-profit-participation projects, only on strictly governmental GO bonds. And AMT is biting harder and harder.

Ys, Jim, I do discount the whining of developers that suck off the public teat to get rich. That type of "public/private partnership" played a major role in causing the current bubble. I analyze and review such proposals regularly, and barely one in ten passes muster for ANY net public benefit. Mostly they just make developers richer with the help of politicians, and the flowback to the public is less than the money the taxpayer gets tapped for, even without counting the time-cost-of-money. The taxpayer always get something back, but what they don't get is a monetary profit on their "public investment" of taxpayer dollars. It's like paying $1.10 each to buy dollar bills, and then celebrating getting a buck back on your $1.10 "investment." That's how the Good Ol' Boy network functions just about everywhere.

ANY time a developer comes up with an "economic impact study" that claims to deliver more back to the public than the public pays, it should be put under a microscope by some real cynics. I've yet to see an honest one, and that includes the very few that do show a net public benefit. If you see an economic impact study that does not include the negative economic impact (complete to multiplier) of the additional taxation involved, you're being kept in ignorance as to the total real impact. The public might actually want those projects for other (non-monetary) reasons, but be aware you're paying a taxpayer cut to get them, not making a public profit as the developers and their political supporters claim.

Tully, fair enough and accurate assessment. I was really thinking more about folks being upside in equity vs mortgage values and that was my fault for mixing up the stats. You are absolutely right on real GDP too. I certainly am mixing stats in my head.

I guess my concern is that the last recovery and growth period was financed by the growth of debt versus real capital. Oh it is real capital, just not from this nation. Maybe I just see this as a problem because I think the post-fordist model of intellectual property and services is not a model for long term sustainable growth of the nation. If this model is to work, we need to make many structural changes to education, health and family structure that I am not sure are possible with out current leaders nor any likely leader for the near future. This is not PC; but not everyone can be a scientist, MBA or computer programmer.

I'm going to stop my self there because I have gone way too far OT and I have no clue how to address the issue I brought up anyways, so in some ways I am not sure why I brought it up.

I just really wonder how we, as a country, are going to reinvent the economy this time around. I easily saw the last couple of recovery and bubbles developing during or prior to the recovery phases of the prior recessions. I am not seeing the process that will jump start the economy this time. The last thing I want is for government to start stepping in. That is a sure way to ruin it. The housing bubble was a time of growth that a vast amount of people participated. I suspect the next big growth will be on a much smaller scale. Not to mention, Social Security and Medicare hanging as Damocles Sword over everything.

I guess I just want to see some kind of positive indicator of the way instead of just seeing that it can't go much lower. I'm not doom, just gloom.

Bleah. Just shoot me. I think lack of sleep is catching up with me. That should be post-industrial and not post-fordist. Thank goodness I have a vacation coming up.

Tully, being in one of the hardest hit (read, worst offending on silly loan practices) areas probably does color my view. On the other hand, perhaps having my own house paid off helps maintain my persepctive.

I wouldn't be surprised if we have hit bottom in the real economy. But until there is some clarity on who is holding what risks, the financial sector nationwide is likely to be real nervous. That was what I was thinking of when I said that I thought it would be year-end before things got sorted out. And that sentiment in the financial sector will have secondary negative effects in the rest of the economy. Not as serious as in the financial sector, but enough to keep the recovery from really getting off the ground for a while.

Getting the AMT reformed could be a big help to the economy. But somehow I doubt that anything will get done on that before next year either. I'd really like to believe that a lot of politicians in Congress would figure out that they could look good to the voters by doing something. But I can't quite make myself believe it. The bond brokers you are talking to seem to have the same lack of faith.

Here are three tests we need to see passing before I'm ready to see things recovering. Mortgages have to be reasonably easy to get and get closer to the Fed's rate. We have to see a month go by without well-run companies having trouble getting funding, And we have to stop seeing articles about sewer projects not getting funding.

Where's the economy going next? I've been telling people looking for where to go next, Plastics^h^h^h^h^h medicine. (1) Baby boomers needing more and more care at the same time as (2) a biotech revolution. Any questions? ;-)

And, one big question I missed:
Some lenders are in temporary lockdown mode, sure. But they'll be out of business in short order if they don't issue new loans, you know. Sharks gotta swim to survive.

Yep. Like Bear, Sterns, eh?

Jon, there is no trouble at all getting mortgages if you have decent credit. What's not getting issued are subrpimes and over-equity loans based on expectations of home equity rising faster than GDP. Mortgages are not going to get down to Fed short-term rates--go look up something called the yield curve, and adjust your expectations to it. Thirty-year rates are not at all the same thing as overnight rates between banks!

What about Bear Stearns? They got hosed, and got a 28-day loan with Fed subsidy from JP Morgan Chase. They then got bought out by JP Morgan Chase at roughly three cents on the dollar. The fed gets its money back, and JPMC gets a lot of assets. BS investors and principals got whacked in the wallet, which is exactly how it's supposed to work. BS was a classic case of a panic run on a solvent financial institution--their actual liquidity was adequate before the run. But Chicken Little can kill any bank.

I have no idea which sewer projects you're talking about, but I suspect that as I noted actual public net benefit may be a wee bit lacking there, and my sympathies for developers are darn near zip. Well-run companies not gettng funding? Such as? How do YOU know they're well-run? Because an inability to get debt issued kind of argues against that, and the equity markets are always there. Sounds more like a complaint that easy money is not avalable for speculative expansion. Well, why should it be?

Jon, there is no trouble at all getting mortgages if you have decent credit.

There USED to be trouble, but I think mortgages are now into healthy recovery.

BS was a classic case of a panic run on a solvent financial institution--their actual liquidity was adequate before the run.

The Economist says BS was almost 30x overleveraged when they fell, and refusing to become more solvent (see today's post). Is that your idea of adequate liquidity?

Sounds more like a complaint that easy money is not avalable for speculative expansion.

No doubt. And those unemployed back in 1929 were just a buncha lazy bums, too.:-)

I'm combining a local and a Florida sewer project, both done by gummints that didn't have money problems before the, er, CRISIS.