After the housing bubble bursts….

“Market conditions are the worst anyone in this industry can ever remember. I don’t think anyone has a recollection of a total disappearance in liquidity…There are billion of dollars worth of assets out there for which there is just no market.” Alain Grisay, chief executive officer of London-based F&C Asset Management Plc; Bloomberg News

The hurricane that began with subprime mortgages, has swept through the credit markets wreaking havoc on municipal bonds, hedge funds, complex structured investments, and agency debt (Fannie Mae). Now the first gusts from the Force-5 gale are touching down in the real economy where the damage is expected to be widespread. The Labor Department reported on Friday that US employers cut 63,000 jobs in February, the biggest monthly decline in five years. The cut in payrolls added to the 22,000 jobs that were lost in January. 52,000 jobs were cut in manufacturing, while 331,000 have been lost in construction since September 2006.

The news on commercial construction is equally bleak. The Wall Street Journal reports:

 “For the second month in a row, the Commerce Department reported a decline in spending on nonresidential construction — which includes everything from hospitals to office parks to shopping malls….Signs of trouble cropped up at the end of the year. As credit markets tightened, office space sold in the fourth quarter dropped 42 per cent from a year earlier, and sales of large retail properties declined 31 per cent, says Real Capital Analytics, a New York real-estate research group….If spending continues to slow, construction workers, who are reeling from the housing slowdown, face more layoffs.” (“Building Slowdown Goes Commercial”, Wall Street Journal)

Home sales are down 65 per cent from their peak in 2005. Inventory is stacked a mile-high. Vacant homes now number about 2 million; an increase of 800,000 since 2005. Demand is weak and prices are plummeting. It’s all bad. Meanwhile, the Federal Reserve and the Bush administration are scrambling to devise a plan that will keep homeowners from packing it in altogether and walking away from their mortgages. But what can they do? Will they really write-down the principle on the mortgages like Bernanke recommends and face years of litigation from bond holders who bought mortgage-backed securities under different terms? Or will they simply allow the market to clear and send 2 million homeowners into foreclosure in 2008 alone?

The deflating housing bubble is finally being felt in the broader economy. Home equity is vanishing which is putting downward pressure on consumer spending and shrinking GDP. Also, the dollar is at historic lows, and an intractable credit crunch has left the financial markets in disarray. Experts are now predicting that consumer spending won’t rebound until housing prices stop falling which could be late into 2009.

The housing bubble was entirely avoidable. It was the policies of the Federal Reserve which made it inevitable. By fixing interest rates below the rate of inflation for almost 3 years, Greenspan ignited speculation in housing and created a false perception of prosperity. In truth, it was nothing more than asset-inflation through the expansion of debt. The Fed’s actions were complimented by repeal of regulatory legislation which prevented the commercial banks from dabbling in securities trading. Once the laws were changed, the banks were free to peddle their mortgage-backed securities to investors around the world. (A-rated mortgage-backed bonds are currently fetching just 13 per cent of their face value!) Now, those sketchy bonds are blowing up everywhere leaving large parts of the financial system dysfunctional.

Now that the financial system is in terminal distress; many people are questioning the wisdom of handing over so much power to organizations (banks) that don’t operate in the publics interest. Thomas Jefferson anticipated this scenario and issued a warning about the perils of abdicating sovereignty to unelected, profit-oriented bankers. He said:

“If the American people ever allow private banks to control the issue of our currency, first by inflation, then by deflation, the banks and the corporations that will grow up will deprive the people of all property until their children wake up homeless on the continent their fathers conquered.”

Even though the nation is stumbling towards an economic hard-landing; the banks are still only interested in finding a way to save themselves. Earlier this year, the Bank of America to members of Congress asking the US government to guarantee $739 billion in mortgages that are at “moderate to high risk” of defaulting to save the banks from potential losses.

Morgan Stanley’s Asia chairman, Stephen Roach, states that the country is not in a cyclical downturn, but post-bubble recession. There is a big difference. The Fed’s interest rate cuts and Bush’s “Stimulus Plan” are unlikely to stop housing prices from continuing to fall nor will they miraculously fix the problems in the credit markets. The massive expansion of credit in the last 6 years has created a $45 trillion derivatives balloon that could implode or just partially unwind. No one really knows. And no one really knows how much damage it will cause to the global financial system. Stay tuned.

Roach notes that the recession of 2000 to 2001 was a collapse of business spending which only represented a 13 per cent of GDP. Compare that to the current recession which “has been set off by the simultaneous bursting of property and credit bubbles…. Those two economic sectors collectively peaked at 78 percent of gross domestic product, or fully six times the share of the sector that pushed the country into recession seven years ago.”

Not only will the impending recession be six times more severe; it will also be the fire-siren for America’s consumer-based society. Attitudes towards spending have already changed dramatically since prices on food and fuel have increased. That trend will only grow as hard times set in.  

Roach adds: “For asset-dependent, bubble-prone economies, a cyclical recovery – even when assisted by aggressive monetary and fiscal accommodation – isn’t a given….Washington policymakers may not be able to arrest this post-bubble downturn. Interest rate cuts are unlikely to halt the decline in nationwide home prices…Aggressive interest rate cuts have not done much to contain the lethal contagion spreading in credit and capital markets…A more effective strategy would be to try to tilt the economy away from consumption and toward exports and long-needed investments in infrastructure.”

The Federal Reserve and Washington policymakers are still stuck in the past trying to revive consumer spending by creating another equity bubble with low interest rates and their $600 per person “stimulus” giveaways. Wrong way. Invest in infrastructure and environmentally-friendly technologies, rebuild the economy from the ground up, reestablish fiscal sanity and minimize deficit spending, put America back to work making things that people use and that improve society, and (as Roach says) “help the innocent victims of the bubble’s aftermath – especially lower- and middle-income families”. And, most importantly, abolish the Federal Reserve and give the control of our money back to our elected representatives in Congress. That is the only way to put America’s economic future back in the hands of the people.

That’s a plan we can all get behind ; www.wealthfreedomfighters.com

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