The Sum of all Fears

In a nutshell, I'll try and explain the reasons why the US economy (and others as well) are in very real danger, though it must be said less danger than last September. For those of you who think this isn't a big deal or that recovery is just around the corner, you're going to be sadly mistaken. There will be no recovery in the USA until we as a nation pay down (and/or bankrupt) the enormous debt we've accumulated. Here's my thesis on what went wrong:

Beginning in the Reagan years, the US began living WAY beyond it's means; for the five decades ending in 1980, the total amount of debt we as a nation were in (US Govt, mortgage, corporate, personal and GSE combined) was always around 150% of our GDP. Starting around 1980, banks abandoned all semblance of common sense and began lending to people who had no business getting loans. When I was a kid in the 1970s, my father complained endlessly about the 20% down requirement for getting a mortgage. Banks, which up to that point were leveraged at ten to one since the 1930's (ten dollars loaned out for every dollar in the vault) began leveraging themselves up and up; by the late 2000s, big banks found that they had leveraged themselves to thirty five and forty to one. (Remember.. if a bank is leveraged at ten to one, and one tenth of their loans go bad, the bank is toast. Forty to one.. only one fortieth). The politicians in Washington were (I believe) simply ignorant of these facts.. Alan Greedspan was telling them that all was well since the late 80s. I knew a gal who was not even employed (no doc loan) and got herself a $200K house with only 3% down !! We as a nation consumed SO MUCH that our economy became 70% consumption and 30% production.. utter madness. As banks become more and more leveraged, they loaned out to riskier and riskier clients.. it was insanity. Worse, nearly all levels of government were doing the same during these boom years.. the US Gov't slowly but surely borrowed $7 trillion+ after Reagan defeated Carter. All of it created the greatest prosperity any nation has ever known. But it was built on a mountain of debt.. our total debt-GDP ratio exploded to 375% of GDP.: http://market-ticker.org/uploads/debt-trend-breakdown_2.jpg The banks, now finding that these loans cannot be paid, are selling most of their assets for cash to cushion their leverage positions (deflation/deleveraging), sucking the cash out of the economy. This is why gas went from $4.29 to $1.99 last year.. less cash in the system as opposed to the goods available for that cash.

Worse, the big banks began writing huge insurance policies (called credit default swaps) on each other and a number of other things, thus making their situation far, far more perilous. Here's my article explaining these exceedingly dangerous devices:

http://themeanoldinvestor.blogspot.com/2009/11/investment-update-unemployment-credit.html

For most people, these big numbers don't mean much and, so far, have not affected them too much, although most do realize there's a tough recession going on. Most have the cavalier attitude that "nothing like that can happen here; this is America". But remember.. the 1920s were called the "Roaring 20's" and much of it was funded by overzealous bank loans to do leveraged stock purchases and consumer loans (sound familiar ?).. and it all ended with the stock market crash in Oct 1929. Remember this.. during the Depression, there was a nice stock market bounce throughout much of 1930 and 1931 (the crash was in October, 1929)... and then came a complete collapse in 1932/33. Here's an article Ambrose did earlier this year.. it's a fabulous read on where we are, and especially fabulous are the stories it tells of the Depression that most of us never knew about: http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4339501/Bad-news-were-back-to-1931.-Good-news-its-not-1933-yet.html

As for a recovery, it seems that the plan is to print and print more; most of this money is winding up in the stock markets and bank vaults, with little of it going back to the rest of us. I do believe this trend will continue for some time, with the result being that there will be no consumer driven recovery as available credit continues to constrict and unemployment (and under-employment) continues to worsen, never mind that most Americans are still neck deep in debt (or bankrupt). So far, inflation has'nt been a problem, and I doubt it will anytime soon given the low amounts of this money seeing its way back onto Main St. I also don't see much deflation since Bernanke will do whatever it takes to keep that at bay. Unemployment will go to at least 12% next year and hundreds more banks will fail http://www.calculatedriskblog.com/2009/11/unofficial-problem-bank-list-increases.html & the FDIC will need massive aid as the commercial real estate debacle begins and the Alt-A and Option-A mortgage refi mess begins (remember.. to do a refi, the home/commercial property has to be worth at least the amount you want to refinance; a lot are'nt). There will be a second stimulus in 2010, with a lot of this going to municipal governments to prevent a debacle in the muni bond markets. The Fed will also be forced to keep the MBS purchases (scheduled to end next Feb) to help the mortgage markets and perhaps will need to begin purchasing Bonds again. The deficit will again be in the $1.5 trillion range, though there is word that there will be a dandy tax hike on the rich in Pelosi's healthcare bill that will take effect in 2010. I think crude oil will go up, forcing up prices on nearly everything in the US, further weakening consumer spending and hiking credit card default rates. Gold will continue it's march to the stars, hitting at least $1,300 next year. I think equities will be forced lower on the weakness of consumer spending. In other words, there is no recovery at least thru next year, despite the efforts of the stimulus packages. In the US Bond markets, given the amount we are going to need to borrow (and the amount others will need to borrow as well) and that the Fed is no longer purchasing, there is a chance rates will rise, and along with this go the mortgage rates, with predictable results. While the US can weather a 2-3% hike in rates, Japan cannot (see article below). The muni bond market will likely be OK for the most part if there is a second stimulus, though rates for some will continue to spiral. Bernanke knows the danger spiking interest rates present and so will be very agressive in preventing such.

There are today some nations living the nightmare already; Spain's unemployment is 20%; Greece, Ireland, Latvia and Iceland are in Depressions as well. Next up on the plank will be England and Japan, who's economies are in worse shape than ours is.

Other nations, in particular Japan and European Union countries, also have very serious economic issues. EU banks, not to be outdone by Yankee banks, have leveraged themselves to heights far above ours.. worse, many of these loans are to third world and former East Bloc nations who's economies and currencies are a mess and have a high chance of defaulting (US banks mostly loaned to American consumers and companies). For example, Austrian banks loaned hundreds of billions to citizens of eastern europe to buy houses; the loans were written in Euros, not the local currencies; when the crisis came, the local currencies went to pot and so instead of a mortgage note of, say, 500 zlotys (the Polish currency) a month, it now cost 700 zlotys. Default rates soared. In the case of Japan, this outstanding article sums it up nicely: http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/6480289/It-is-Japan-we-should-be-worrying-about-not-America.html

The world's economy is highly integrated; what affects one nation will affect others, thanks in no small part to the invention of the credit default swap. With so many nations in such trouble, the world's economy is very delicate. One major problem could send us all off the plank, though it's strong enough to weather small problems (Iceland, Latvia etc). Here is an article from Hong Hong's governor on what the US printing will do to other nations (create bubbles): http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aU3AiTc_Q_vk

How bad can it get ?? Here's a video of Congressman Kanjorski of Ohio, who sits on the House Financial Services Committee and the Capital Markets Subcommittee, on what went down last September.. this is The Sum of all Fears: http://www.youtube.com/watch?v=HOhc2e6UfMM

This is all going to end very badly, and it will happen very quick when it does. I think there's a good chance the next crash will start in another nation, with Japan (their bond market) and Europe (their banks, sovereign debt) at the head of this. A war and/or serious terrorist attack could trigger this, especially if crude prices are above $125 for an extended period. I do not see us getting into 2012 before another crash occurs in one form or another. But with equal measures of resourcefulness, hard work and frugality, working together, this too shall pass. Lets up hope that after this baby goes down we as a nation will see fit not to burden our own children with trillions in debt and give too much power to Gov't, who is either incapable or willfully ignorant of the catastrophe they are allowing and participating in.