Aware Brain

A few months ago, I wrote about the concept that we are in an “Etch-A-Sketch” economy. Instead of a recession where the economic conditions decline, level out, and then recover, the present crisis will be taking the shape of that first design most of us draw on an Etch-A-Sketch, the descending stairs. At each horizontal stair tread, there is the temptation to proclaim the recession over, and that there are signs of recovery, or even some green shoots!

Nobody will really know when the actual “floor” is reached until the level begins to consistently and significantly rise.

In the meantime, there are many examples of skepticism about the infamous “Green Shoots” metaphor used by Ben Bernanke on 60 Minutes. As we all know, in that interview he expressed optimism that the economy was showing signs of a comeback: “And I think as those green shoots begin to appear in different markets and as some confidence begins to come back that will begin the positive dynamic that brings our economy back.” Bernake said. “Do you see green shoots?” Pelley asked.  “I do. I do see green shoots. And not everywhere, but certainly in some of the markets that we’ve been functioning in. And we’ve seen some improvement in the banks, as well,” Bernanke replied.

In addition to many economists who disputed the notion of the beginning of a recovery, a high-level British Finance Minister had to backtrack from taking the green shoots position.

So now let’s fast forward almost 3 months to the present day, and see where some experts and data point towards. First, legendary investor Jim Rogers sees the markets as being ready to plunge again. The stock market may hit new lows this year or the next as the current rally has been largely caused by the money printed by central banks and fundamental problems remain unsolved, he said.

At the same time, Barrons Magazine sees the US Housing market not as being in recovery, but simply having been in the “eye of the hurricane”, again refering the green shoots theory: “We’re out of the eye of the hurricane, but here comes the back half of the storm. A lot of people think that we’ve seen the worst of the housing crisis. They’re talking about green shoots and glimmers of hope, when they should be back in the storm shelter, preparing for a flood of inventory that will overwhelm the markets and produce another round of falling prices”. Law firms for banks are once again lining up to file foreclosures and to process evictions. Asset managers have warned to expect a flood of properties, beginning in early June. This will hit as the number of potential buyers continues to dwindle. Builders, traditional sellers and investors who entered too early are already loaded with REO properties. If true, this sounds like it could be the next stair in the Etch-A-Sketch.

Adding to the pressure about to be felt by consumers is the impending interest rate spike. On Wednesday, A selling spree in Treasurys pushed rates higher, as spreads between the 2-year and 10-year widened by over a dozen basis points in a single day. CNBC reported that this spike in rates will derail a fragile economic recovery and snuff the market’s rally. The turmoil of that day was not unexpected, “It was just the follow through that was a problem,” said Brian Edmonds, head of interest rate trading at Cantor Fitzgerald.

The scramble for distressed homeowners to modify their mortgages may be in vain, as well. Workout arrangements and federal programs to help struggling borrowers have the intention of keeping homeonwers out of financial trouble. However, these will have little long-term effect on the real estate market. First, about 80% of homeowners do not qualify to begin with. What about the 20% who do obtain some sort of loan workout or modification? Over half of those will end up delinquent even with the modification.  In the study released Tuesday, Fitch projected that 55% to 65% of these loans that are being reworked to avoid foreclosures may end up at least 60 days delinquent anyway within 12 months.  “Loan modifications hold clear value for many homeowners provided the modified payments are sustainable, but more often than not, reducing the home payments to an affordable level may not be enough to rescue borrowers who are overextended on other credit and expenses,” said Diane Pendley, a managing director at Fitch.  Fitch based its projection partly on “shrinking disposable income, escalating job losses and possibly some deceptive practices on the part of the borrowers themselves,” the New York company said.

Assuming that Americans get through the next downward legs of the decline, there is another potential financial obstacle on the horizon: a national sales tax. With budget deficits soaring and President Obama pushing a trillion-dollar-plus expansion of health coverage, some Washington policymakers are taking a fresh look at a money-making idea long considered politically taboo: a national sales tax. Such a tax has not been seriously considered in the United States, but advocates say few other options can generate the kind of money the nation will need to avert fiscal calamity. At a White House conference earlier this year on the government’s budget problems, a roomful of tax experts pleaded with Treasury Secretary Timothy F. Geithner to consider implementing the tax. “Everybody who understands our long-term budget problems understands we’re going to need a new source of revenue, and a VAT is an obvious candidate,” said Leonard Burman, co-director of the Tax Policy Center.

The federal budget deficit is projected to approach $1.3 trillion next year, the highest ever except for this year, when the deficit is forecast to exceed $1.8 trillion. The Treasury is borrowing 46 cents of every dollar it spends, largely from China and other foreign creditors, who are growing increasingly uneasy about the security of their investments. Unless Congress comes up with some serious cash, expanding the nation’s health-care system will only add to the problem. Some have called for replacing the Federal Income Tax with a national sales tax, but these “Fair Tax” proponents may not have predicted that the government may like that national sales tax as an addition to the income tax, instead of a replacement of it. The President wants to raise income taxes for individuals and impose new taxes on business, but by itself those increases would not generate enough cash to cover the cost of health care, much less balance the budget. Jim Rogers makes note of the governments appetite for spending in his predictions as well. “Governments have not solved the essential problems that caused the crisis but instead they “flooded the world with money,” according to Rogers. Trying to solve the problem of too much consumption and too much debt with more consumption “defies belief” and will not work, he said.

Sounds like it is time to go back to the drawing board. Or Etch-A-Sketch.

~ by Dave on May 29, 2009.

Posted in Uncategorized