On March 23,
the Federal Deposit Insurance Corporation, which insures bank accounts
in the United States, issued a report: "Scenarios for the Next
U.S. Recession." On the whole, this was more forthright than
most published reports by quasi-government agencies.
how relevant this FDIC report is, check the latest shape of the
interest yield curve. When the 90-day T-bill rate is higher than
the 30-year T-note rate for 30 days, this is a very good indicator
of a looming recession. Check
The FDIC panelists
warned about the situation in the housing markets.
long-term increase in consumer indebtedness has raised concerns
that the next U.S. recession could originate in the household
sector. The housing boom of recent years has resulted in a surge
in new consumer debt, most of it in the form of mortgages.
In the first
six years of this decade, the net increase of household wealth has
been $5 trillion. This increase is enormous. American households,
feeling wealthy, have cut back on their rate of savings . . . to
zero, then negative. They are living inside their own savings accounts.
Home owners see on paper that they are worth more money, and they
assume "this real estate market is normal." But it isn’t
normal. The condition of the housing market is unusual, to say the
the increase in net housing wealth during the first half of this
decade alone was two to three times as large as the gains posted
during each of the prior two decades.
abnormality of this market, home owners are complacent. They see
their homes as ATMs.
some new buyers have put very little down on their home and thus
have accumulated little equity, many longtime homeowners have
accumulated significant additional equity that remains untapped.
in the market-imputed value of housing has persuaded residents that
they are rich, that they need not save for retirement or anything
households tighten their fiscal belts. They cut spending and begin
saving more. This makes money available for capital construction
and hiring. Thus, in the two years after most recessions end, economic
growth is rapid and sustained. But the 2001 recession broke with
Federal Reserve poured money into the economy, cutting the federal
funds rate from 6% to 1%, this capital accumulation phase of the
recession was retarded. The recovery has therefore been the most
anemic on record.
the housing market soared in response to the FED’s low interest
rates. This makes the present situation unique, the panel concluded.
recessions have provided an opportunity for households and businesses
to retrench and rebuild balance sheets that might have become
strained late in the previous expansion. The response of businesses
during the 2001 recession provides a classic example in this regard
as investment, spending, and hiring activities were curtailed
sharply from their heady, late-1990s pace.
felt wealthy because of the increase in the price of housing. They
refused to cut spending.
In part because
of the wealth-offset provided by housing, however, the long jobless
recovery following the 2001 recession did not weigh heavily on
the consumer sector. Consumers did slow their pace of spending
growth in 2001 and 2002, but spending growth never fell below
a 1 percent annual pace in any quarter, and in no quarter did
it actually decline. By contrast, during the early 1990s recession,
consumer spending declined for two straight quarters. At this
point in time, however, the consumer sector has not experienced
a real recession in 15 years.
The final sentence
is worth considering. Consumers have not experienced a real job-threatening,
gut-wrenching, savings-promoting recession in 15 years. They are
totally confident today.
This has changed
the mentality of consumers. They are not afraid of a turndown in
the economy. They are convinced the government can and will protect
them from adversity.
In some sense,
this long recession hiatus itself raises concerns. Consumers have
gradually become more indebted over time — so much so that they
are now spending more in aggregate than they earn, resulting in
the much-lamented negative personal savings rate.
In the classic
child’s fable of the grasshopper and the ant, the grasshopper has
a great summer but a bad winter. Greenspan decided to become the
star of a re-make of Bruce Brown’s 1966 surf movie classic, The
savings rate may turn out to be a bit of a statistical anachronism
in an economy where so much spending is driven by the accumulation
of wealth rather than current income. Even so, home prices will
not boom forever. Even a moderation in home-price growth would
reduce the amount of new home equity added to the economy each
year. This slower accumulation of wealth, coupled with rising
interest rates that increase the cost of tapping that wealth,
could soon begin to curtail the pace of U.S. consumer spending
growth. Just as there has been a positive wealth effect from soaring
home prices in recent years, the concern is that an end to the
housing boom could result in a slowdown in consumer spending growth.
However, it is important to keep in mind that such an outcome
would likely play out over several years, as happened during the
So, the panel
is concerned about a long, slow decline in consumer spending. This
in turn would slow the overall economy. This is another way of saying
that the next recession could be far longer than the typical post-World
War II recession that lasted a year.
report noted this amazing fact: The public’s increase in debt
in 2005 was greater by far than its increase in after-tax income.
It is very
likely that housing wealth has been a significant factor behind
growth in consumer spending. Through the use of cash-out refinancing,
increased mortgage balances, and greater use of home equity lines
of credit, as well as through owners selling homes outright and
cashing in on their accumulated equity, it is estimated that anywhere
from $444 billion to $600 billion was liquidated from housing
wealth during 2005. Whichever estimate one uses, the total almost
surely eclipses the $375 billion gain in after-tax income for
Now the sword
of Damocles is beginning to swing. The FED has adopted policies
that have raised short-term interest rates. This has led to rising
rates for annual renewable mortgages (ARMs). The new buyers with
bad credit who were extended these loans are now trapped. Rising
rates mean rising monthly mortgage payments.
Whitney noted at the roundtable that the recent use of revolving
home equity lines of credit in lieu of down payments has enabled
an increasing number of first-time buyers to qualify for homes
that they otherwise could not afford.
Ms. Whitney’s research suggests that a group that includes approximately
10 percent of U.S. households may be at heightened risk of credit
problems in the current environment. This group mainly includes
households that gained access to mortgage credit for the first
time during the recent expansion of subprime and innovative mortgage
loan programs. Not only do many borrowers in this group have pre-existing
credit problems, they may also be more vulnerable than other groups
to rising interest rates because of their reliance on interest-only
and payment-option mortgages.
this. Ten percent of mortgage payers may soon be in trouble. The
threat of default by these people is growing.
The new bankruptcy
law does not allow most of them to escape if they wind up owing
more than the house can obtain in a foreclosure sale. But creditors
will find that the cost of hiring lawyers to pursue these people
will exceed the assets owned by these people. Nevertheless, the
debtors’ credit ratings will be ruined for years.
all this, the report says banks are in fine shape to weather the
next recession. The problem is, the economy may not be.
has been dependent on savings from foreign investors, including
Asian central banks, for its growth. Consumer spending has increased,
not by increasing productivity, but by debt. The American consumer
is convinced that the bills will not come due, that he can tap into
his home’s equity at low rates at any time. Save? Why?
This is transferring
ownership of American capital and claims on future payments (bonds)
to foreigners. Americans are de-capitalizing themselves. The central
bankers of the world have spotted their marks, even as drug pushers
in public high schools spot their marks. Americans are their marks.
The "buy now, pay later" philosophy is gone. Today, it’s
"buy now, pay never."
But, as the
grasshopper learned, winter eventually comes. He can sing "the
world owes me a living" all summer long, just as he sang in
Disney’s 1934 version of the famous fable. But the world doesn’t
owe him a living. Neither does the world owe us a living.
endless. Also, killer waves eventually wipe out those surfers who
refuse to paddle back to shore when the paddling is good.
paddled ashore. Bernanke bought the well-used surfboard from Greenspan
and paddled back out.
I prefer to
watch this from the shoreline, thank you.