Imagining Recession

The world’s housing, oil, and stock markets have been plunged into turmoil in recent months. Yet consumer confidence, capital expenditure, and hiring have yet to take a sharp hit. Why?

Ultimately, consumer and business confidence are mostly irrational. The psychology of the markets is dominated by the public images that we have in mind from day to day, and that form the basis of our imaginations and of the stories we tell each other.

Popular images of past disasters are part of our folklore, often buried in the dim reaches of our memory, but re-emerging to trouble us from time to time. Like traditional myths, such graphic, shared images embody fears that are deeply entrenched in our psyche. The images that have accompanied past episodes of market turmoil are largely absent today.

Consider the oil crisis that began in November 1973, resulting in a world stock market crash and a sharp world recession. Vivid images have stuck in people’s minds from that episode: long lines of cars at gas stations, people riding bicycles to work, gasless Sundays and other rationing schemes.

Today, the real price of oil is nearly twice as high as it was at the peak of that crisis, but we have seen nothing like the images from 1973-5. Mostly we are not even reminded of them. So our confidence is not shaken, yet.

Just before the October 19, 1987, stock market crash, the biggest one-day drop in history, the image on people’s minds was the crash of 1929. Indeed, the Wall Street Journal ran a story about it on the morning of the 1987 crash. I know that those images contributed to the severity of the 1987 crash by encouraging people to sell, because I ran a survey of individual and institutional investors the following week.

Images of 1929 – of financiers leaping from buildings, unemployed men sleeping on park benches, long lines at soup kitchens, and impoverished boys selling apples on the street – are not on our minds now. The 1929 crash just does not seem relevant to most people today, probably because we survived the 1987 and 2000 crashes with few ill effects, while 1929 seems not only the distant past, but another world.

But images of the 1987 crash, driven by computers in tall modern steel-and-glass office buildings, do seem to be on people’s minds today. The stock market suffered one of its biggest one-day drops this year on the 20th anniversary of the 1987 crash, with the S&P 500 falling 2.56%. No previous anniversary of the 1987 crash showed any such drop.

The image of a bank run, of long lines of angry people lining up outside a failed bank, was briefly on our minds after the Northern Rock failure in Britain. But the Bank of England’s direct intervention prevented these images from gaining a foothold on our collective psychology.

The images that are uppermost in our minds are of a housing crisis. We imagine residential streets with one “for sale” sign after another. Worse, there are images of foreclosures, of families being evicted from their homes, their furniture and belongings on the street.

If home prices continue to decline in the United States and possibly elsewhere, there could be many more vivid images. You may yet be presented with the image of your child’s playmate moving away because his parents were thrown out in a foreclosure. You may see a house down the street trashed by an angry owner who was foreclosed. Such images become part of your sense of reality, and could disturb your sense of confidence and reduce your willingness to spend and support the economy.

Could such changes in psychology be big enough to tip us into a world recession? While it is far from clear that they will, it is a possibility. Psychology need only change enough to bring about a drop in consumption or investment growth of a percentage point or so of world GDP, and market repercussions can do the rest.

Source HERE

Robert J. Shiller is Professor of Economics at Yale University, Chief Economist at MacroMarkets LLC, which he co-founded (see macromarkets.com), and author of Irrational Exuberance and The New Financial Order: Risk in the 21st Century.

The Dollar Crisis, The Recession & the views of Presidential Canidate Ron Paul

Homebuilders' index scraping bottom

December reading of U.S. builders' sentiment comes in at record low for third straight month.

WASHINGTON (AP) -- A December reading of U.S. homebuilders' sentiment remained at a record low for the third straight month.

The National Association of Home Builders said Monday its housing market index, which gauges builders' perceptions of conditions and expectations for home sales over the next six months, came in at 19 in December. The number was at the lowest level since the index began in January 1985.

Index readings higher than 50 indicate positive sentiment. The seasonally adjusted index has been below 50 since May 2006, and declined for eight straight months this year, and has been unchanged since October.

Tighter lending standards, rising defaults among borrowers with weak credit and a sense of worry about the housing market's future have meant fewer buyers for hard-hit homebuilders such as D.R. Horton (DHI, Fortune 500), Pulte Homes (PHM, Fortune 500) and Centex (CTX, Fortune 500).

Many builders are "bracing themselves for the winter months when home buying traditionally slows, scaling down their inventories and repositioning themselves for the time when market conditions can support an upswing in building activity," David Seiders, the trade group's chief economist said in a statement.

That's likely to occur, he said, by the second half of next year.

Confidence dropped in the northeast, but inched up in the Midwest and South. It remained unchanged in western states.

Nationwide, new-home sales are projected to fall to 788,000 this year, down 25 percent from 1.05 million last year, the National Association of Realtors said last week. Sales are expected to drop further to 693,000 in 2008, according to the Realtors' group.

Source HERE

The Catastrophist View

What would it take to send the U.S. economy—and New York’s—into free fall? A doomsday primer.

By Duff McDonald

• Published Oct 28, 2007

Peter Schiff is laughing at me. I’ve just asked him to entertain the following notion: that we dodged a bullet during August’s financial-market turmoil and, with the stock market bouncing right back from every dip, things might be okay. So why worry?

He stops laughing. “Why worry?” he asks. “Because we dodged a bullet but are about to step on a hand grenade.”

Sitting in a corner office of a nondescript building just off I-95 in Darien, Connecticut, Schiff, the president of brokerage Euro Pacific Capital, and author of Crash Proof: How to Profit From the Coming Economic Collapse, will spend the next hour spelling out a singularly pessimistic view of the American economy. And he will do so while exhibiting a curious juxtaposition unique to the bearish prognosticator: He speaks of disaster with a smile on his face. No, he’s not happy about our impending doom. But he is happy that people are finally taking him seriously.

Some people, anyway. The recessionary fears that were sparked by the global liquidity crisis in August have eased, largely because of a resilient stock market and a belief that the Federal Reserve’s interest-rate cut in September curtailed deeper losses. When Goldman Sachs invested in its own imploding Global Equity Opportunities hedge fund in August, calling it an “opportunity” and not a “rescue,” people laughed. Guess who laughed last? Goldman, which had reportedly enjoyed a $370 million gain on its $2 billion rescue by October. The optimists stay focused on stories like Steve Jobs’s next stroke of genius.

But Schiff, whom CNBC calls “Dr. Doom,” has not, as bears do when winter approaches, gone off to hide in a cave. Why not? Because every single one of the underlying economic factors that he has identified as cause for concern has worsened. And his is no longer a lone voice in the woods. If you don’t care to listen to a man nicknamed Dr. Doom, you can listen to people like former Federal Reserve chairman Alan Greenspan, esteemed bond-fund manager Bill Gross, or famed money manager Jeremy Grantham. They’re part of a growing chorus of voices that are saying many of the same things as Schiff.

Their bearish arguments come in many shapes and sizes, but here’s the basic one: The past five or six years have been deceptively fortunate ones for the U.S. economy. That’s because any troublesome developments—the surge in oil prices from $28 per barrel in 2003 to about $87 today, for example—have been papered over by rising home prices. Home equity has been used to buy flat-screen TVs, SUVs, and more homes. Wall Street bought up all this debt from lenders, thereby allowing them to lend more.

The softening of real-estate prices in most parts of the United States put a crimp in this system, but it hasn’t stopped it. The question is, what, if anything, will? What will bring on the apocalypse that Schiff and others believe is inevitable? They see it like this:

THREAT NO. 1
The Bottom Continues to Fall Out of the Housing Market
Manhattan’s gravity-defying real estate aside, it’s quite clear the nation is experiencing a genuine housing crisis. In August, pending home sales dropped 6.5 percent, and they currently sit at their lowest level since 2001. The National Association of Realtors conducted a recent survey that showed more than 10 percent of sales contracts fell through at the last moment in August, primarily owing to disappearing loan commitments from banks. The crisis will only deepen, when more borrowers see their adjustable-rate mortgages adjusted upward. There was a foreclosure filing for one of every 510 households in the country in August, the highest figure ever issued, and by one estimate, more than 1.7 million foreclosures will occur in the country by the end of 2008. That’s not just subprime borrowers: According to the Federal Housing Finance Board, while nearly 35 percent of conventional mortgages in 2004 used ARMs, some 70.7 percent of jumbo loans—those above $333,700 (the jumbo threshold in 2004; it’s now higher)—did too.

Historically, bond-market investors have been the boring counterparts to their equity-market brethren. But in his October Investment Outlook, famed bond investor Bill Gross was anything but. The managing director of money management firm pimco pointed out that the Federal Reserve is caught in a bind: It must continue to lower interest rates to ameliorate this burgeoning housing crisis, but in doing so, it “risks reigniting speculative equity market behavior, and … a run on the dollar.” (More on the dollar later.) Gross doesn’t have the answers but observes that the Fed is “in a pickle, and a sour one at that.” Worse yet, concerns that a rate cut might be inflationary actually caused bond yields to rise in the wake of the rate cut, something that doesn’t normally happen. The Fed’s influence, always overstated, might turn out to be nonexistent in a credit market that remains on edge.

Hedge-fund veteran Rick Bookstaber, the author of A Demon of Our Own Design, spells out a potentially disastrous scenario that could unfold regardless of what the Fed does: Continued foreclosures result in a further drop in housing prices, which results in further foreclosures, which result in a further drop in housing prices. Even for those of us not selling, reduced home values result in a reduced sense of security, which results in reduced consumption, which results in a slowing economy, which … you get the point.

THREAT NO. 2
The Derivatives-Related Meltdown, Part II
Anybody who glances occasionally at the financial pages these days knows that mortgages issued to home buyers are packaged together (in a process called securitization) into a collateralized-debt obligation, or CDO. That’s what’s known as a derivative, a security whose value depends on the value of other securities. The price of the CDO, you see, is “derived” from the prices of the underlying mortgages. (It works with credit cards, too, or bank loans—any kind of debt will do.)

In principle, the idea of a CDO makes perfect sense. In buying $5 million worth of a CDO, an investor has essentially lent money to an entire portfolio of homeowners, instead of placing all his eggs in one basket, say, by funding a single $5 million mortgage. In the real-estate-crazy environment of the past decade, the CDO market took off like a rocket. But the buyers of these derivatives made a critical error—they confused the spreading of risk with the elimination of risk. A booming economy made this confusion not just possible but irresistible. With relatively few defaults in the first half of the decade, investment firms, including many hedge funds, came to see CDO returns as a sure thing and loaded up on them, often borrowing money to do so, taking on debt to buy debt and thereby setting up a potentially deadly chain reaction. The readiness of the secondary market to buy all these mortgages encouraged the lenders to run wild and lend to anyone who walked through the door, leading—inevitably, in retrospect—to a decline in loan quality. Analyst Christopher Wood of Asia-Pacific investment house CLSA succinctly defines the problem in his highly readable newsletter Greed & Fear: “[Securitization] has one fatal flaw, which will ultimately prove to be its undoing … it removes the incentive of those making the loan to worry about whether the loan is a good credit.”

Still, it all held together until mortgage defaults began to cut into the yields of these CDOs and holders looked to sell them, only to realize their value had slipped. Forced liquidations as a result of that “price discovery” were a primary factor in Bear Stearns’ hedge-fund calamity in August. And it’s not over yet: The aftershocks of the mortgage meltdown are still being felt, as banks such as Citigroup and Deutsche Bank announce multibillion-dollar write-downs.

Each time one of these write-downs has been announced, the market has had a curiously positive response, taking the news as a sign that the worst was over and the banks were cleaning up their books. But because these derivatives are linked to other debt, there’s no reason to be certain that trouble won’t bleed into other markets. Among other things, the liquidity crisis froze the market in structured investment vehicles (SIVs), a nifty bit of financial engineering that banks use to profit from the spread between short-term debt and long-term debt. No one yet knows how nasty these losses could turn out to be because SIVs are stashed, Enron style, off the books.

THREAT NO. 3
Consumers Run Out of Steam (and Take the Economy Down With Them)
The U.S. economy, for all its worldly sophistication, is driven by mall shoppers and late-night Amazon addicts—70 percent of the gross domestic product is accounted for by consumer spending, which is buttressed by debt. According to the Federal Reserve, total U.S. household debt was, as of August, $2.5 trillion—a 24 percent increase in the past five years. Total credit-card debt, including gas cards and the like, was $915 billion.

The willingness of consumers to keep spending and piling on debt in the midst of a slowing real-estate market is hailed on Wall Street as an act of patriotism, which Schiff considers perverse. Imagine, he suggests, that you ran into a good friend and asked him how he was doing. His reply: “I took out a third mortgage, maxed out my credit cards, and emptied out my kids’ college savings account so I could buy a bigger TV and a new car, and we’re going to Greece on vacation over the holidays. Things are great!” Schiff lets the idea sink in and then finishes the thought: “And we’re celebrating the fact that we’re doing this as a nation?”

The Catastrophist View

In a recent interview, John Santer, a district director of NeighborWorks America, a community-based nonprofit, pointed out that 43 percent of American households spend more than they earn each year, and fewer than six in ten have enough savings to last them three months if they were suddenly out of a job. So where’s the money coming from? From 1991 to 2005, Americans borrowed $530 billion against the value of their homes each year.

James Glassman, a senior economist at JPMorgan Chase, told a Tulsa, Oklahoma, luncheon crowd in early October that before 1985, consumer spending grew in line with income, but since that time, it’s grown half a percent faster on an annual basis. As a result, household savings, which once reached 10 percent of income, is now literally negative. “My guess is that in five years we’ll look back and realize … that the consumer we knew for twenty years is coming to an end,” he said.

Roger Ehrenberg, an ex–Wall Streeter and author of the financial blog Information Arbitrage, forecasts extreme financial pain. “You’ve got a weaker dollar, declining economic fundamentals, and a debt-strapped consumer—I’d call that a bad fact set,” he says. “Lay on top of that the mortgage problem and declining home values, and you can paint a pretty ugly picture.”

THREAT NO. 4
That the Rest of the World Decides They Don’t Need Us and the Dollar Tumbles Hard
The dollar is falling, possibly collapsing, depending on whom you talk to. The greenback has sunk close to its lowest point in the post-1973 floating-exchange-rate era, so low that it’s been overtaken by the Canadian dollar—affectionately known as the loonie—for the first time since 1976. How low will it go? When Alan Greenspan was asked by Lesley Stahl of 60 Minutes last month what currency he’d like to be paid in, his response was telling: “[The] key question … is, ‘In what currency do you wish to hold your assets?’ And what I’ve done is I diversify.” Translation: He isn’t betting on the dollar. And neither is the majority of Wall Street.

Here’s why catastrophists see that as a major problem: About 25 percent of our government debt is held by foreign governments, with the major holders being Japan ($610.9 billion), China ($407.8 billion), the U.K. ($210.1 billion), and our friends in the Middle East, the oil-exporting countries ($123.8 billion). When the current Fed chairman, Ben Bernanke, cuts rates to soften the housing blow for Americans, he also weakens the dollar by making dollar-based investments less attractive. And when the dollar weakens, so, too, does the value of these gigantic positions held by the foreign governments. At some point, they’re no longer going to tolerate the losses we inflict on them by lowering rates, and if that happens and they start dumping dollars, watch out for the peso.

The bulls will tell you that foreign governments understand the American economy is the key to global economic health, and that they’ll suck it up and take it when we devalue their debt. To which Schiff offers another analogy. Imagine if five people were washed up on a desert island: four Asians and an American. In splitting up their duties, one Asian says he’ll fish; another will hunt, another will look for firewood, and another will cook. The American assigns himself the job of eating.

“The modern economist looks at this situation and says the American is key to the whole thing,” says Schiff. “Because without him to eat, the four Asians would be unemployed.” The alternative: Without the American, the Asians might eat a little more themselves and even spend some time building a boat. This is happening as we speak: With the rise of the Chinese consumer class, the local citizenry is now spending, and the country is no longer totally dependent on exports. Which means they’re no longer totally dependent on us.

Readers of the financial press are surely familiar with the buzzword of the moment, decoupling. It’s used to describe how U.S.-Europe and U.S.-Asian trade relationships are becoming less dependent at the same time as European-Asian ties are growing. Most Asian nations, including China, are seeing more rapid growth in exports to Europe than to the U.S. And the U.S. now accounts for a declining share of European exports. The bearish interpretation: that the longtime global embrace of the dollar is loosening.

THREAT NO. 5
That We Don’t See It Happening Because It’s a Slow-Motion Train Wreck
Last but not least, we can circle back to the Dow Jones Industrial Average making new highs in October—14,087.55 on October 1—offering hope that our equity portfolios will carry us through to the other side of whatever it is we’re on the wrong side of. Before addressing the fact that the equity market might just be clueless, there’s one last dollar-related point to make. The true value of a stock portfolio isn’t really its quoted worth in dollars—it’s what you could buy with that portfolio if you were to sell it.

Given that we as Americans don’t manufacture that much anymore (we’re a service economy!), we are largely talking about foreign-made goods, such as flat-screens from Korea or cars from Germany. Over time, if the dollar continues to slump, foreign manufacturers will raise prices to compensate for what they’re losing in the exchange rate. In that light, a Dow at 14,000 with the euro at $1.42 is really no different from a Dow at 13,000 with the euro at $1.33. (One reason the price of oil has risen so high is that it is quoted in dollars, and the sellers thereof have had to continually jack up the per-barrel price to maintain their own purchasing power at home and elsewhere.)

Still, a rising Dow is better than a falling Dow, and the bulls are piling into every rally. Which still doesn’t impress Jeremy Grantham, chairman of Boston-based money manager GMO, in the least. “The equity market is always slow to pick up on someone else’s crisis,” he says, referring to the turmoil in both the housing and fixed-income markets. “And so you’ve got a slow-motion train wreck that has to work itself through the system.”

How will it work itself through? Grantham points to the recent strength in profit margins, fueled by—you guessed it!—our plummeting savings rate, and says there’s nowhere to go but down. “If you start with an overpriced market and bring profit margins down, that’s more than enough to bring stock prices down,” he says. “It is the most certain mean-reversion in all of finance.” Grantham calculates that the U.S. stock market will have to fall by a full third before it gets to its “fair value.” At which point we will likely be in full-blown recession. And when that happens, Schiff says, we will see a country in downsizing mode, “selling the consumer goods we’ve been buying back to the Chinese. It will be one big, giant repossession.”

So assuming all this is true, that Schiff and his fellow doomsayers are right about the rotten core of the U.S. economy, how will this affect New York City? We’ve grown accustomed to the idea of our local economy, particularly the real-estate market, being inherently stronger than the nation’s and possibly immune to whatever woes strike the rest of America. Wall Street, after all, makes money on downs as well as ups, and the stampede of foreigners and foreign cash could, if anything, be aided by the weak dollar.

Last week, though, the argument against New York invincibility was implicitly made when Merrill Lynch announced a larger-than-expected write-down of $7.9 billion dollars in its third quarter alone, primarily due to losses in the credit markets. Numbers as large as that can paradoxically seem trivial due to the abstract nature of accounting—a “write-down” involves no movement of real-life cash, just a readjustment of some theoretical values—but here’s something nontrivial to consider: Merrill Lynch is one of the largest employers in New York City. While so far only a few Merrill bigwigs have been shown the door, it’s almost certain that a chunk of the company’s rank and file will soon follow. All told, New York–based financial companies had already announced more than 42,000 layoffs as of October, according to one study, and the pace could pick up through the end of the year. That’s people who won’t be bidding up new apartments, who won’t be going out to dinner five times a week, who won’t be testing the outer limits of their credit cards at Barneys. The downstream effects of this could be even more severe, as every Wall Street job is estimated to account for another 1.3 to 2 jobs, meaning that additional job losses could push 100,000.

Meanwhile, the public sector is feeling it, too. A recent report by Nicole Gelinas, published by the Manhattan Institute, forecast a budget deficit for New York City next year and predicted that Mayor Bloomberg, who enjoyed a string of budget surpluses until this year, will likely be forced to leave his successor with a double whammy: a deficit and a projected 50 percent increase in outstanding debt. Of course, the catastrophists could be dead wrong, as they have been for going on a decade now—but to them, it sure smells like the seventies all over again.

Source HERE

Bears are becoming harder to ignore

Tom Petruno:
Market Beat

Bears are becoming harder to ignore
November 24 2007

Peter Schiff and David Tice don't do what they do for the love it gets them.

They are two of the most bearish investment professionals in America. Their outlook for the U.S. economy and stock market is beyond grim.

Schiff, who heads brokerage Euro Pacific Capital in Darien, Conn., sees the dollar and stock market collapsing and the value of American per-capita economic output falling below that of Greece.

Tice, who manages the Prudent Bear mutual fund in Dallas, likewise predicts that U.S. markets will crumble and says the economy could face something akin to the Great Depression.

Of course, forecasts like these aren't the way to make a lot of friends in this country, let alone on Wall Street. Some would call being bearish on America unpatriotic, even treasonous.

And that means many investors long have automatically tuned out the likes of Schiff and Tice. Besides, the doomsayers have been wrong forever, haven't they?

Yet this year, with the debacle in housing and its toxic fallout in markets and in the financial system, the bears' warnings about the future may no longer seem quite so far-fetched. The risks to U.S. prosperity have risen markedly -- even many stock market bulls will admit that much today.

Schiff, 44, and Tice, 53, have no connection except for their outspoken pessimism about where the U.S. is headed.

They share the same basic thesis: America is facing its comeuppance for 25 years of borrowing and spending, saving little and relying increasingly on foreign capital to support its standard of living.

Now, the bursting of the housing market bubble, the surge in mortgage defaults and the plunge in the dollar have exposed what Schiff and Tice believe are serious structural weaknesses in the U.S. economy.

"Our economy is going to be a mess at the end of this," Schiff says. "Our assets are going to get very cheap."

His tactic for preserving his clients' wealth, he says, is to send it all abroad. He hunts for dividend-paying stocks of large foreign companies that are focused on their home markets -- names such as Swiss telecom giant Swisscom and the parent firm of Hong Kong utility China Light & Power Co.

In theory, Schiff's strategy will protect the purchasing power of the money if the dollar follows his script and continues to melt down.

A former Shearson Lehman broker, Schiff went into the business for himself in the mid-1990s in Southern California and moved East in 2004.

He concedes he was too early with his overseas-only stock strategy in the late 1990s.

With the dollar's slide since 2002, however, foreign stocks have been spectacular performers for U.S. investors. Schiff says his firm's client base has grown to more than 8,000 individuals with a total of $1 billion in assets. He and his brokers make money off the commission income from the trades they make, he says.

The idea of global portfolio diversification is one that many people have taken to heart in the last few years. Month after month, the lion's share of Americans' net new investment in stock mutual funds goes to foreign portfolios, not domestic.

Even so, most U.S. investors aren't abandoning their domestic holdings. That's where Schiff's acerbic views diverge from the mainstream.

The common perception is that the rest of the world needs the U.S. economy as a growth engine. Schiff says that is outdated thinking, given the rise of emerging-market economies such as China, India, Russia and Brazil. Because of America's heavy borrowing needs, "We're a burden on the rest of the world," he asserts.

"China is not export-dependent," he says. "They're exporting because Americans are consuming." Ultimately, Schiff says, "the Chinese are going to buy more of their own products." As their consumption rises and their savings rate falls, "they're not going to lend to us anymore."

If foreigners stopped exporting so much of their capital to the U.S., Schiff says, "they'd have more to spend themselves. And there are a lot more of them than there are of us."

One potential flaw in his strategy, however, is that a U.S. market and economic crash could drag the entire planet into recession or depression. Schiff thinks the rest of the world can overcome an American economic decline, though he says that, initially, foreign stock markets probably would fall along with Wall Street.

Tice's survival scheme for the U.S. economic and stock market downturn he foresees is to go "short": borrowing stock and selling it, betting the price will fall. If a short bet is correct, the seller eventually can repurchase the stock for less than the sale price and pocket the difference.

Tice has been a well-known short seller since the mid-1990s via his Prudent Bear fund. He earned hefty returns in the bear market of 2000 to 2002. But the bull market since 2002 has made life tough for short sellers: They can lose big if the stocks they're targeting rise instead of fall.

This year, Tice's $800-million fund is raking it in again. The portfolio is up about 15% year to date, compared with a 4.2% rise for the average U.S. stock fund. Tice has shorted stocks such as Starbucks Corp. and Harley-Davidson Inc. as well as many banking issues, he says.

He believes the American consumer is tapped out. "Real estate is just imploding," Tice says. Hundreds of billions of dollars in home equity have been pulled out in recent years to support Americans' spending, he notes. That binge now is over.

"The consumer looks like he's dying a slow death," Tice says. He expects that to lead the economy into a morass that will feed on itself.

"This is the big one," he says.

Wishful thinking on the part of someone who stands to lose a lot if the stock market zooms anew? Maybe. If money exits his mutual fund, Tice's management-fee income will dive.

Tice has two daughters, ages 18 and 21. He admits they don't share his dismal view of the future. "They say, 'It can't be that bad,' " he says. "They think we'll muddle through."

The majority of Americans probably share that sentiment. The U.S. economy is, after all, very dynamic. We may well look back on this period in a few years and marvel at how well it all worked out.

And even if the bears' darkest predictions come true, the performance of your investment portfolio may be the least of your worries. The more important question may be whether you have stored enough canned food and ammo.

Source HERE

Voodoo debt and the coming recession

This article by Bill Fleckenstein's touches on many of the concepts in Mr. Roubini interview (posted yesterday). This article helps to supports and explain some of the concepts and preditions that Mr. Roubini has been sharing with the financial world for almost two years.

Harry

With debt piled high in a variety of voodoo mortgages, the declining economy will soon turn into a bobsled ride to tears.

By Bill Fleckenstein

The eyes tend to glaze over at the mention of "collateralized debt obligations" (CDOs) and "credit default swaps" (CDSs).

It's understandable. These financial instruments -- the glue that has held together the speculation in housing finance and the housing ATM -- have proved somewhat incomprehensible, even to the professionals. That's why I referred to them as "financial dark matter" in my column two weeks ago. (Special thanks to my friend Jim Grant for having gotten me up to speed on this subject in his past two issues of Grant's Interest Rate Observer.)

Shedding light on dark matter

But while CDOs and CDSs are hard to fathom, a disruption in these risk-filled markets would become all too comprehensible to average folks -- as the aftermath would bring serious turmoil in real estate and the economy. In the spirit of "forewarned is forearmed," I will now attempt to explain a bit of this mortgage exotica, and then show what risky behavior it has financed in neighborhoods across America.

In the marketplace, there are indices known as ABX.HE. They are a synthetic version of assets backed by U.S. home loans. They are subdivided into "tranches," or sections, that are grouped by their relative risk. Two weeks ago, a friend alerted me to the rather large trade that went through in a particular tranche of one of these indices. (It happened to be the BBB- tranche, which is the riskiest.) When the trade took place, it knocked the bid price a bit lower. It has continued to drift and now is off about 1.5%.

One tranche now bears a stench

What makes that interesting? In the nine months since the ABX.HE began trading, every time one of these indices has sold off, some CDO manager (with a natural appetite for asset-backed home-equity-loan securities) has stepped into the market and driven these slightly fallen angels right back up. But now those buyers seem to have disappeared.

I believe that the CDO and CDS markets (the lower-grade tranches in particular) will be ground zero in any financial dislocation. As my friend says: "A slowdown in the housing market is a growth event. Something going wrong in subprime is a volatility event" (i.e., a market dislocation). Granted, it's too isolated thus far to draw any big conclusions from, but then again, all trends must begin somewhere.

Source HERE

The Subprime Bailout: Too little Too Late

The consensus is moving from the soft vs. hard landing debate towards how severe the hard landing will be

Nouriel Roubini Dec 11, 2007

While a few months ago analysts were still heatedly debating whether the US would experience a soft landing or a hard landing (a recession) the center of the macro debate has now clearly shifted away from soft landing versus hard landing discussion to a recognition that a hard landing is the most likely scenario; thus, increasingly now the debate is on how deep and severe the forthcoming hard landing will be.

David Rosenberg of Merrill Lynch is now clearly predicting a recession for the US economy in 2008; Jan Hatzius at Goldman Sachs is not formally speaking of a certain recession in 2008 but most of his analysis is consistent with a high likelihood of a recession in 2008; Mark Zandi of Moody’s Economy.com is also very close to a hard landing view.

More interesting now even the thoughtful Richard Berner – who used to be strongly in the soft landing camp while his counterpart Steve Roach was in the hard landing camp – is now predicting a recession in the US in 2008, even if he expects such a recession to be mild. And even the soft-landing optimists at JPMorgan are now recognizing that the likelihood of a US recession is now at its highest level in years. When mainstream analysts such as Berner start to talk about a recession beng likely you know that the debate has clearly shifted towards a discussion of not whether a recession but rather how deep of a recession.

And in the academic camp some of the most senior economists in the profession – Bob Shiller, Marty Feldstein, Larry Summers, Paul Krugman – are all in various degrees in the hard landing camp or very concerned about a hard landing.

So it is time to move away from the soft landing vs. hard landing discussion and start considering seriously how deep the coming recession will be; in the view of this authors the 2008 recession will be more deep, protracted and painful than the short recessions of 1990-1991 and 2001; this time around – unlike 2001 when only tech investment faltered - most components of aggregate demand are under threat: falling residential investment, falling capex spending by the corporate sector and now evidence of a sharp slowdown and near stall of private consumption that accounts for 70% of GDP. When the US saving-less and debt burdened US consumer is now under threat the risk of a more protracted and severe recession than the mild one of 2001 are significant.

And don’t be misled by better than expected reported same store chain store sales for November this week; those data – as known to all analysts – are distorted by the longer sales calendar in November compared to 2006; whatever gains will be obtained in November will be undone by a payback in December. As Goldman Sachs put it today in a note to clients:

Same-store sales data for major retailers improved substantially in November. Our Goldman Sachs Retail Index jumped to 4.5% on a year-over-year basis, from 1.2% in October. From this vantage point, it looks like the indefatigable American consumer is spending freely as the holiday season gets underway. However, the improvement in monthly data contrasts with relatively tepid weekly reports and declining consumer confidence, and is mostly explained by reporting differences. Some retailers compared a four-week November that ended with the Thanksgiving week in 2006, but included the week after in 2007. The extra holiday shopping days in 2007 boosted sales at these retailers, but will involve a payback in the next release, which will now have fewer holiday shopping days than last year. We estimate this distortion accounted for roughly 2½ percentage points of the improvement in the GSRI… The corollary of better November data is a headwind for December retail sales reports. If the effect of over two percentage points is symmetric, then December same-store sales stand a good chance of coming in at or below zero.

Indeed, according to the UBS/ICSC data that looks at a broader range of retailers than the major ones same store chain store sales fell in 3 out of the 4 weeks of November with the figure in the reporting week ending on December 1st being a negative 2%.

So the US consumer is indeed at a tipping point and the overall holiday sales will end up showing the weakness in the sector that represents over 70% of GDP. If the saving-less US consumer falters – as it soon will being hit by falling home prices, falling HEW, rising debt servicing ratios, high debt burdens, high oil prices, sharply falling confidence, a slackening labor market – a recession becomes inevitable.

Indeed, as reported by the WSJ, the consensus among professional economists is now shifting towards the hard landing scenario as they put the chances of a recession at 38%, the highest in more than three years:

Economists Say Recession Risk Is Climbing By PHIL IZZO December 11, 2007; Page A3 The risk of a U.S. recession is rising, and the Federal Reserve should do something about it, according to economists in the latest WSJ.com survey.Fed officials have "to move to show their willingness to both avert risk of recession and stabilize the financial crisis," said Diane Swonk of Mesirow Financial. She said Fed Chairman Ben Bernanke's emphasis on consensus has proved to be the central bank's "weak spot in crisis mode. Now they need to show conviction instead of consensus."

Fifty of the 52 economists surveyed expect the Federal Open Market Committee to trim its target today for the federal-funds rate, the rate charged on overnight loans between banks. Only two see the Fed holding the rate steady at 4.5%.Some 61% say a quarter-percentage-point cut would be right; 27% say the Fed should cut rates by a half-point. Only 12% say the Fed should stand pat.

The economists, on average, now put the chances of a recession at 38%, the highest in more than three years, and up from 33.5% in November. They also reduced forecasts for U.S. economic growth across the board. They expect the nation's gross domestic product to grow at an annualized rate of 0.9% this quarter, down from 1.6% in the previous survey, with six economists expecting either a negative or a flat reading. Three economists project an economic contraction in the first quarter, with the average growth forecast at 1.5%, down from 1.9% in November.

Source Here

Mr. Roubini predicts the housing crisis almost two years ago

Fannie CEO: housing trouble until 2009

One more prominate real estate industry figure states for the record that the US housing crisis will last until 2009, "at the earliest." Just yesterday former Fed chairman, Alan Greenspan, said that the odds the U.S. falling into a recession are "clearly rising" The drum beats louder. Can you hear it?

Harry

Fannie CEO: housing trouble until 2009

By MARCY GORDON, AP Business Writer 2 hours, 24 minutes ago

WASHINGTON - Fannie Mae's CEO (Mudd) told shareholders Friday he does not expect a housing market recovery until late 2009, "at the earliest," and that the mortgage-finance company is strong enough to ride out the downturn...

Mudd said Fannie Mae was "in a stronger position" because of the extensive changes to its management and operations over the past three years made in the wake of its $6.3 billion accounting scandal and with the recent steps taken to curb losses and buttress its finances.

He called them "extraordinary steps, but steps we believe are prudent."

The Fannie chief reaffirmed his gloomy forecast for the housing market, saying "This is the worst housing and mortgage market in recent memory, and we are still working our way to the bottom, in our view."

Source here.

Inflation hottest in two years

There should be little doubt that with commodity prices at near record highs, the ever weaker greenback, repeated cuts in interest rates and the flooding of the market with dollars that inflation would soon show its unwelcome head.

Now, with inflation clearly on the rise, the chances of further interest rates cuts drops. Therefore, the odds of a recession increase. The Federal Reserve is a jam. Reducing rates, printing money will lead to even higher inflation and if they decide to sit on their hands...recession.

It's time to look at your financial situation and protect yourself from either scenario. I will be posting financial strategies to consider in times such a these.

Harry

Inflation hottest in two years

By Mark Felsenthal 15 minutes ago

WASHINGTON (Reuters) - Consumer prices rose the most in more than two years in November as energy costs surged and a host of other prices marched higher, damping prospects of further interest-rate cuts from the Federal Reserve.

The Labor Department said on Friday that the consumer price index jumped 0.8 percent in November, the biggest gain since September 2005, as energy costs leaped 5.7 percent.

Even stripping out fast-rising food and energy prices, the so-called core CPI rose a relatively steep 0.3 percent, the largest increase since January and ahead of the 0.2 percent rise expected on Wall Street.

"It puts the Fed in a little bit of a bind and people have to question how aggressive the Fed can be in cutting rates if inflation is rearing its ugly head," said Firas Askari, head currency trader at BMO Capital Markets in Toronto.

U.S. stock and government bond prices fell and the value of the dollar hit a seven-week high as traders saw the data suggesting slimmer chances of further rate cuts from the Fed, which has lowered borrowing costs by a percentage point over the past three months. At mid-day, the Dow Jones industrial average (.DJI) was off about 80 points.

"All of these dovish, weak-money individuals out there screaming for rate cuts really need a bucket of cold water in the face because if the Fed goes down that path we may have a bubble in the CPI," said Michael Darda, chief economist at MKM Partners in Greenwich, Connecticut.

GASOLINE ON THE FIRE

Gasoline prices rose 9.3 percent last month, the steepest climb in half a year. Over the past 12 months, gasoline costs are up 37.1 percent, the biggest one-year gain since September 2005.

However, the increase in consumer prices was broadly based.

Apparel costs rose 0.8 percent, medical care prices increased 0.4 percent and owners' equivalent rent -- a gauge of the cost of home ownership that accounts for nearly one-quarter of the overall CPI -- gained 0.3 percent.

The report on consumer prices followed producer price data on Thursday that showed an unexpectedly steep 3.2 percent climb, the biggest increase in 34 years.

Inflation in the 13-nation euro zone was also on the rise last month, with prices up 3.1 percent year-on-year, the steepest gain in six and a half years and a reminder that the Fed is not the only central bank struggling to tamp down inflation at a time growth is threatening to falter.

At the same time, policy-makers expressed concern that high energy and commodity prices could fuel broader inflation.

Read full article here.

Citigroup Rescues SIVs With $58 Billion Debt Bailout (Update1)

Is this $58 BILLION Debt Bailout in the best interest of the Citigroup's shareholders? Are Citigroup action's actually preventing a meltdown in the capital markets or delaying the inevitable, which down the road could be a far bigger problem. I'm afraid that no matter how massive the bailout funds amount to...the bigger the bailout warchest, the consequences and side effects could result in a equal or even more powerful effect in the opposit direction.

Harry


Citigroup Rescues SIVs With $58 Billion Debt Bailout (Update1)

$58 billion of debt to avoid forced asset sales that would further erode confidence in capital markets. Moody's Investors Service lowered the bank's credit ratings.

The biggest U.S. bank by assets will rescue the so-called structured investment vehicles, or SIVs, taking responsibility for their $49 billion of assets, the New York-based company said in a statement late yesterday.

Citigroup follows HSBC Holdings Plc, Societe Generale SA and WestLB AG in bailing out SIVs to avert fire sales of assets. The funds, which sell short-term debt and invest the proceeds in higher-yielding securities, have cut their holdings by more than 25 percent since August to $298 billion, according to Moody's. The decline may reduce the urgency for a bailout sponsored by the U.S. Treasury, Citigroup, Bank of America Corp. and JPMorgan Chase & Co.

Ratings Cut

Moody's lowered Citigroup's credit rating to Aa3, the fourth-highest level, from Aa2 late yesterday. The bank will probably ``take sizable writedowns'' for securities backed by home mortgages and collateralized debt obligations, Moody's Senior Vice President Sean Jones said in a statement.

``Citigroup's weak earnings should prohibit the bank from rapidly restoring weak capital ratios,'' which may lead to further downgrades, Jones said.

SIVs emerged in August as one of the biggest threats to capital markets that were rocked by record high defaults on subprime mortgages. Financial institutions have since reported more than $70 billion of losses and writedowns. Citigroup invented SIVs in 1998 and was the biggest manager of the funds.

The average net asset values of SIVs tumbled to 55 percent from 71 percent a month ago and 102 percent in June, according to Moody's. The net asset value is the amount that would be left for investors if a fund had to sell holdings and repay debt. Moody's said Nov. 30 that it may cut the credit ratings on $105 billion of SIV debt.

Source Here.

Greenspan: Odds rising for a recession

In an interview with NPR News, Mr. Greenspan says that the odds of a recession are “clearly rising” because of the slowdown in economic growth. “We are getting close to stall speed … and we are far more vulnerable at levels where growth is so slow than we would be otherwise,” the former Federal Reserve chairman says. “Indeed it’s like someone who has an immune system that’s not working very well is subject to all sorts of diseases and the economy at this lever of growth is subject to all sorts of shocks.”

Many say that it was Greenspan and his policies that led up the and were some of the root causes of the housing bubble and subsequent collapse. But, Greenspan says he’s not to blame for the housing bubble and credit crisis that have spread like a virus throughout the nation’s economy.“We’ve had housing bubbles in two dozen or more countries around the world all of which look almost identical to ours and the reason why we’ve had these bubbles everywhere is everybody’s long term rates have gone down, and that in turn I trace back to the extraordinary events that occurred when central planning became an obviously inefficient way to operate an economy,” he tells the host of Morning Edition.

Out of office, but his words still hold weight and influence. He's part of a seemingly ever growing chorus of powerful economic, business and political voices enlightening but also adding momentum as our economy spirals down into a full blown recession.

Harry

Greenspan: Odds rising for a recession

By JEANNINE AVERSA, AP Economics Writer Thu Dec 13, 6:56 PM ET

WASHINGTON - Former Federal Reserve Chairman Alan Greenspan says the odds the U.S. will fall into a recession are "clearly rising" and he believes economic growth is "getting close to stall speed."

Greenspan, who ran the central bank for 18 1/2 years, until early 2006, offered his views on the economy in an interview on NPR News' Morning Edition that will air on Friday. Excerpts of the interview were released on Thursday.

A severe slump in the housing market, a stubborn credit crisis and turbulence on Wall Street are endangering the country's economic health. Growth in the current October through December period is expected to have slowed to a feeble pace of just 1.5 percent, or less.

Economists, including Greenspan, have warned that the chances of a recession are growing.

Asked whether the economy will tip into a recession — something that has not happened since 2001 — Greenspan said, "It's too soon to say, but the odds are clearly rising."

He said he felt this way because of the slowing pace of growth. "We are getting close to stall speed," he said. "We are far more vulnerable at levels where growth is so slow than we would be otherwise," he added. "Indeed, it's like someone who has an immune system that's not working very well is subject to all sorts of diseases and the economy at this lever of growth is subject to all sorts of shocks."

Greenspan's remarks come just days after the Federal Reserve, under Chairman Ben Bernanke, sliced a key interest rate for a third time this year to prevent the housing and credit troubles from sinking the economy.

The situation poses the biggest challenge yet to Bernanke since succeeding Greenspan in February 2006.

Some analysts have questioned whether Bernanke waited too long to cut the Fed's key rate and whether he has acted aggressively enough to soothe the economy's woes. The Fed initially dropped its key rate in September, the first reduction in four years. That was followed up by additional rate cuts in late October and then again on Tuesday.

Greenspan again rejected criticism that his policy actions helped to feed a housing boom that eventually went bust. Critics say Greenspan held interest rates too low for too long after the 2001 recession.

To have prevented such euphoria in housing that fed a bubble in prices, Greenspan said the Fed would have had to jack up interest rates so high that it would have damaged the economy. "That would have broken the back of the economy, and brought the housing boom down," Greenspan said.

Source Here.

Why the Fed bailout might not work

There are so many reasons why the bailout won't work. Here are some specifics about the flaws in the current bailout plan.

Harry

Why the Fed bailout might not work

The announced plan to make credit markets more liquid could end up having the opposite effect.
By Peter Eavis, senior writer

NEW YORK (Fortune) -- The Federal Reserve's latest move to make credit markets more liquid could deepen problems in the banking system and actually cause the markets to be even more illiquid.

Wednesday, the Fed, along with other central banks, announced a plan that is designed to enable banks to borrow money directly from the Fed at below-market rates. This will allow a wider range of banks to access Fed credit, and simultaneously allow them to submit a broader range of collateral to the Fed when taking out those loans.

Why do this now? The Fed explained in a release Wednesday: "This facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress." In layman's terms this means that rates on loans between banks - measured by something called the London Interbank Offered Rate, or Libor - are too high for the Fed's tastes, so it is now prepared to itself lend to banks at much lower rates.

Before this move, banks could borrow directly from the Fed through the so-called discount window, at 4.75 percent. The key Federal funds rate is lower, at 4.25%, but that is open to a narrower range of financial institutions and accepts a narrower range of collateral than the discount window. The new program - called the Term Auction Facility (TAF) - will auction funds to banks at rates very close to the lower Fed funds rate. The first TAF auction, for $20 billion, is scheduled to begin on Dec. 17.

The potentially dangerous aspect of the TAF is that it will allow banks with problems to borrow their way out of trouble, rather than by taking measures like issuing large amounts of stock to bolster their balance sheets. Struggling banks are struggling chiefly because they were mismanaged and wrote too many risky loans when credit was cheap. The TAF potentially gives mismanaged banks even more cheap credit, which will delay a much-needed restructuring of the banking sector. Nervousness about banks could then deepen, leading to even fewer loans being made.

Source Here.

The Fed's tightrope act

It's a long way down with no net. It may just take one more gust of wind and it's down down down.

Harry

The Fed's tightrope act

The banking industry is in a quagmire but the economy really isn't in that dire shape. And inflation is still an issue. What's Ben Bernanke and company to do?

See all CNNMoney.com

By Paul R. La Monica, CNNMoney.com editor at large

December 13 2007: 1:02 PM EST

NEW YORK (CNNMoney.com) -- The financial services industry is reeling due to exposure to bad subprime mortgage loans. But some market observers suggest that the rest of the economy is still in relatively decent shape, which could mean that the Federal Reserve may not cut interest rates that much further in 2008.

On Thursday, the government reported that the Producer Price Index, which measures wholesale prices, rose 3.2 percent, the biggest jump in 34 years. To be sure, much of this increase was due to soaring oil prices.

But the so-called core PPI number, which excludes volatile energy and food prices, rose 0.4 percent, above Wall Street's expectations of just a 0.2 percent increase. This could be a sign that inflation is still a concern.

What's more, despite all the doom and gloom about the housing market, the Commerce Department reported Thursday that retail sales surged 1.2 percent in November. And even if you exclude sales at gas stations, which were obviously juiced by rising prices at the pump, sales were still up a healthy 0.6 percent.

Largest jump in 34 years for wholesale prices

Add this up and the Fed's two big announcements this week suddenly seem to make a lot more sense.

"It's clear that the economy's moderation in recent months has been relatively gentle. There has been no outright collapse," said David Resler, chief economist with Nomura Securities International. "The economy may be on the soft side, but that doesn't mean we're going into a recession."

The Federal Reserve cut two key interest rates by only a quarter of a percentage point Tuesday, a move that caused Wall Street to panic. The Dow plunged nearly 300 points.

Many investors were hoping for a half-point cut, or at the very least, a half-point cut to the discount rate, which is what it costs banks to borrow directly from the Fed. But Wednesday, Ben Bernanke & Co. saved face somewhat by announcing a plan to inject billions of dollars into the banking system.

In conjunction with several other central banks in Canada and Europe, the Fed said it would conduct four auctions in the next month that will allow banks to bid for loans. Sources said it will probably cost banks less than the 4.75 percent discount rate to borrow money this way.

The combination of a mild rate cut and the new auction system seems to indicate that the Fed is looking for a creative way to solve the credit crunch on Wall Street rather than by simply slashing interest rates.

Source here.

Wholesale inflation surges to largest amount in 34 years

The past two days the Fed has taken further steps to prevent a deepening downturn in the economy (see here). These actions have push the dollar lower and therefore help to raise oil prices (and as we learn today other prices are sure to rise even more).

It is the Fed's mandate to be vigilant in the fight of inflation. Stable prices are a must in an orderly economy. The Fed has maintained that core inflation is in check and therefore they've continue to lower interest rates (now to a the lowest point in 2 years) and in addition pump money (see here) into the market to both prevent a recession (or worst) and to jump start the economy.

Now with the signs of inflation so blaring, the Fed will have to tread much more carefully in their next actions. Further cutting of interest rates or injecting billions of dollars of liquidity into the system my be the trigger to spark a vicious spiral of inflation. With housing down in the dumps, a recession PLUS inflation would be a nightmare economic scenario.

Harry



By MARTIN CRUTSINGER, AP Economics Writer 2 hours, 54 minutes ago
WASHINGTON - A record jump in gasoline prices pushed wholesale inflation up by the largest amount in 34 years. Still, shoppers stormed the malls in November, giving retail sales their biggest gain in six months.

The Labor Department said Thursday that wholesale prices soared by 3.2 percent last month, propelled by a record 34.8 percent rise in gasoline costs.

Even outside energy, inflation pressures emerged. Core inflation, which excludes energy and food, posted a 0.4 percent rise in November, double what had been expected.

Meanwhile, the Commerce Department reported that retail sales jumped by 1.2 percent last month, double the gain economists had expected. It was the biggest increase in six months and followed a much weaker 0.2 percent rise in retail sales in October.

The big rise in inflation demonstrated the pressures facing the Federal Reserve, which is trying to combat a sharp slowdown in economic growth while at the same time making sure that inflation does not get out of hand.

Source Here.

Fed and Friends: Games People Play

Just a few months ago the Fed Chairman, Bernanke, said this would only be a $50 Billion problem. Then it was maybe $100 Billion...then $150 Billion...now $170 Billion+?!?! We are in the 1st inning of a long 13 inning game.

Those Fed rate cuts along with the Fed and other central bankers worldwide are causing the highest inflation in nearly 20 years. Did it help or hurt? Clearly it is not helping the foreclosures or the value of the money (what you may have left!) in your bank account.

Greenspan said yesterday it won’t be over until homes sell. Prices need to plunge to 50% less or we all need to get 50% raises. What!?!? Obliviously, there will need to be a further 'correction" in home prices, BUT stating for the record that 'prices need to plunge to 50% less...' is defeating all the measures that are suppose to circumvent or at least minimize the potential economic carnage from the housing and sub-prime disaster. If I were a potential home buyer and I hear this coming from our leader at the Fed...well, I think I'd wait a while before jumping in the market. And surely that is exactly what is happening.

Harry

Fed and Friends: Games People Play

9:36:48 AM December 12th, 2007

Now that I’ve got your attention. This isn’t a game. (Or is it?) But the Fed’s joint action with friends from around the world shows several things.

First, it shows why the Fed was so comfortable not cutting rates more than a quarter of point, which as I pointed out yesterday gave the initial impression that it wasn’t kowtowing to Wall Street. Well, it wasn’t kowtowing because it didn’t have to: It knew this was coming — a Wall Street pleaser, for sure — which makes you wonder whether there would’ve been a half-point cut, after all, if this bag-o-tricks wasn’t already in its hip pocket. (Otherwise, why not announce this yesterday, or the day before, or the day before that?)

But let’s take this a step further, to point two: If the Fed needed a little help from its friends, of vice-versa, wouldn’t that suggest that the situation we’re seeing is far worse than even we know? From what I can tell, this kind of action isn’t done willy-nilly. This credit crunch is a world-wide event. Lots-o-mortgage-and-other-loan junk stuffed in lots-o-smart-guy-portfolios here, there and everywhere.

The beat goes on…

Source Here.

America's vulnerable economy

America's vulnerable economy

Nov 15th 2007
From The Economist print edition

Recession in America looks increasingly likely. Can booming emerging markets save the world economy?

IN 1929, days after the stockmarket crash, the Harvard Economic Society reassured its subscribers: “A severe depression is outside the range of probability”. In a survey in March 2001, 95% of American economists said there would not be a recession, even though one had already started. Today, most economists do not forecast a recession in America, but the profession's pitiful forecasting record offers little comfort. Our latest assessment (see article) suggests that the United States may well be heading for recession.

Granted, GDP grew by a robust 3.9%, at an annual rate, in the third quarter. Granted also, revisions may well push this figure up. But that was the past. More timely signs suggest that the economy could stall in this quarter. By early next year, output and jobs could be shrinking. The main cause is the imploding housing market. Experts said that house prices could never fall nationwide. But fall they have, by 5% in the past 12 months. Residential investment has collapsed, but a glut of unsold homes means that prices have much further to drop. Americans' spending is likely to be dented much more by a fall in house prices than it was in 2001 by the stockmarket's collapse. With house prices lower and credit conditions tighter as a result of the subprime crisis, households can no longer borrow against capital gains to support their spending.

Dearer oil is set to squeeze households further (this week's drop in crude prices notwithstanding). Consumer confidence has already fallen sharply. It cannot be long before consumer spending stumbles, which in turn would hurt companies' profits and investment. The weak dollar will boost exports, but at only 12% of GDP, exports are too small to make up for a weakening of consumer spending, which accounts for 70%.

I want to break free

Will an American recession drag the rest of the world down with it? The economies of Europe and Japan rebounded strongly in the third quarter, but look likely to slow down. Although both should be able to keep chugging along, neither is likely to set any great pace. Strengthening currencies will hurt exporters in both places. Europe's own housing hotspots are cooling, and some of its banks have been sideswiped by America's subprime ills.

The best hope that global growth can stay strong lies instead with emerging economies. A decade ago, the thought that so much depended on these crisis-prone places would have been terrifying. Yet thanks largely to economic reforms, their annual growth rate has surged to around 7%. This year they will contribute half of the globe's GDP growth, measured at market exchange rates, over three times as much as America. In the past, emerging economies have often needed bailing out by the rich world. This time they could be the rescuers.

Of course, a recession in America would reduce emerging economies' exports, but they are less vulnerable than they used to be. America's importance as an engine of global growth has been exaggerated. Since 2000 its share of world imports has dropped from 19% to 14%. Its vast current-account deficit has started to shrink, meaning that America is no longer pulling along the rest of the world. Yet growth in emerging economies has quickened, partly thanks to demand at home. In the first half of this year the increase in consumer spending (in actual dollar terms) in China and India added more to global GDP growth than that in America.

Most emerging economies are in healthier shape than ever (see article). They are no longer financially dependent on the rest of the world, but have large foreign-exchange reserves—no less than three-quarters of the global total. Though there are some notable exceptions, most of them have small budget deficits (another change from the past), so they can boost spending to offset weaker exports if need be.

This does not mean emerging economies will grow fast enough to make up for the whole of a fall in America's output. Most of them will slow a bit next year: for instance, China's growth rate may dip to “only” 10%. So global growth will ease—which, after five years at an average of almost 5%, close to its fastest pace ever, it needs to do. But thanks to the vigour of the new titans, it will stay above its 30-year average of 3.5%.

A tale of two prices

The rising importance of the world's new giants will not only boost growth. It will also shift relative prices, notably those of oil and the dollar. And the consequences of this will be less comfortable for developed countries, especially America.

The oil price has risen mainly because of strong demand in emerging economies, which have accounted for as much as four-fifths of the total increase in oil consumption in the past five years. In past American recessions the oil price usually fell. This time it is likely to hold up. That will not only hurt the finances of Western consumers, but may also make the jobs of their central bankers harder, by combining inflationary pressure with economic slowdown.

The enfeebled dollar—lately in sight of $1.50 to the euro—would be weaker still without enormous purchases by central banks in emerging economies. This support is now waning. China and others are putting a smaller share of increases in reserves into the American currency. And Asian and Middle Eastern countries with currencies linked to the dollar are facing rising inflation, but falling American interest rates make it harder to tighten their own monetary policy. They may have to let their currencies rise against the sickly greenback, meaning they will need to buy fewer dollars. More important, as international investors wake up to the relative weakening of America's economic power, they will surely question why they hold the bulk of their wealth in dollars. The dollar's decline already amounts to the biggest default in history, having wiped far more off the value of foreigners' assets than any emerging market has ever done.

The vigour of emerging economies is good news for the world economy: for its growth, it has much less need of a strong America. The bad news for America is that this, in turn, may mean that the world also has less need of the dollar.