Chris Tomaras / Straight Talk / October 18, 2008

This week life as we knew it continues to get more complicated. It was noted by one of our country’s economists that we are in a serious global recession and that China’s economy is at the heart of the global slowdown. So why is that? China employs 77 million people and its residential and commercial construction declined 16.6% just for the month of October. The building industry is the largest driver of China’s economy, so the United States and other countries’ exports have obviously declined as a result. Until recently, corporate profits of major US companies have been fairly weak domestically but very strong internationally at least until now. With world economies weakening, especially India and China, our woes continue to grow.

Our Fed officials have said that they plan to wind down the emergency loan programs and bailouts when the financial crisis eases. In July, the central bank extended the programs through January 2009.

However, there have been very few signs of healing in the credit markets therefore The Federal Reserve has now extended the term of the three major emergency-loan programs to April 30th of 09.

“Judging the effectiveness of the Federal Reserve’s liquidity programs is difficult,” Fed Chairman Ben  Bernanke said in a speech this week. “Obviously, they have not yet returned private credit markets to normal functioning. But I am confident that market functioning would have been more seriously impaired in the absence of our actions.”

Bernanke said that “once financial conditions become more normal, the extraordinary provision of liquidity by the Federal Reserve will no longer be needed.”

According to former Fed Governor Lyle Gramley, now a senior economic adviser at the Stanford Group in Washington DC, Gramley says “there have been very few signs of healing in credit markets”.

In my personal opinion, these emergency liquidity programs are going to go on far longer than we can imagine.
But here’s the catch 22– the stimulus packages and bailouts that have been and continue to be implemented in record numbers in the US and all over the world  are going to come back to haunt us– so follow me carefully –
To finance all of this debt that is being incurred, governments must borrow money by issuing large numbers of bonds. In 2009 the number of bonds needing to be financed will probably be around 2 trillion dollars. These are record numbers and the problem is, who is going to buy all of these bonds? As we’ve said, the global economy is in the worst post war recession since WWII and governments are far from flush with cash. If and when governments issue bonds they must offer them at high enough interest rates to attract buyers. This goes right back to the old theory of supply and demand. When the supply of bonds outweighs the demand, rates go up and when demand outweighs the supply, rates go down. Now when supply far outweighs demand, rates go up significantly. And I must tell you that when the buyers of bonds smell blood, they don’t step in and invest their money without inflicting a lot of pain.

Substantially rising interest rates in a weak economy just makes things exponentially worse. That would be totally devastating for our economy in its current fragile state. So what governments all over the world are trying to do is to quickly stimulate their economies with cash injections and bailouts before rates rise. Once President Obama is inaugurated, I would expect to see further stimulus packages for this very reason. The other side of the coin is that, if and when these economies do stabilize and begin to grow, because of all the money that is being pumped into the system, it will be extremely difficult to control inflation. I’m sure they feel right now, that getting out of a serious recession would be the lesser of two evils and inflation is something to worry about later. Just remember that when the pendulum swings to one extreme it swings back to the other extreme and sometimes even beyond. Point in case, the housing market.

The economic expansion we saw from 2002 to 2007 was primarily a function of speculation.  Alan Greenspan and the federal reserve created a huge housing bubble, during which time, folks took on large amounts of debt instead of saving money. The supply of homes is now just far more than the legitimate demand when you take out the speculators. The other major problem, as a result of the artificial  expansion, is that there were far more jobs back then. And since 30% to 40% of all those jobs were real-estate-related, it's clear how hollow the economy is liable to be going forward.

That same number of jobs will never again exist. If there are far fewer jobs and higher unemployment, who is going to buy up all of these homes.

It’s going to take low housing starts for an extended period of time.

Also housing prices will need to continue to come down to where folks can afford them, especially with growing unemployment and a lack of wage growth. It was just announced that one out of every ten homeowners are currently behind on their mortgage payments or in foreclosure. Employers last month cut 533,000 jobs bringing job losses so far this year to 1.9million. Much of the economic stimulus has been trying to stop housing prices from declining but how are they going to accomplish that if people are out of work and can’t afford to buy homes. the problem is simple … too many homes and too few jobs.

So how do they create jobs. Well as a starter, Investing money into the country’s vast infrastructure, offshore drilling, nuclear plants and other forms of energy would certainly be a step in the right direction and it would help to stimulate the economy.

Regarding the housing market, I still feel strongly that the government needs to create a federally-backed program offering no down payment, low interest rate loans to legitimate home buyers, who can afford to make their monthly mortgage payments, not speculators.

I am told, that is just repeating what got us into trouble to begin with. That’s not true. What got us into trouble is stated income loans where lenders failed to do their proper due diligence. They gave people 100% loans taking their word regarding their incomes. How stupid was that.

This week they began talking about lowering long term mortgage rates from 5.5% to 4.5%. That’s addressing part of the problem. Now they need to get rid of the down payments and also bring down property taxes in line with the decline in home prices. This will get a reasonable number of  homes off the shelf and get money flowing. If they don’t create a program where average Americans can afford to buy homes as their primary residence, then just lowering interest rates will simply stimulate refinancing of existing mortgages and bring back many of the speculators, once again building an artificial base.

If they don’t get these houses moving, they are just kidding themselves. The banks need to become part of the solution rather than a major part of the problem and they can start by lending money and stop bilking customers with loan shark interest rates on credit cards. Lowering credit card rates to legitimate levels in itself would help the economy. I’m baffled by the fact that the government is spending taxpayer money left and right to help the banks but won’t address the credit card problem. And here’s why. The banks have given out millions of credit cards to any and everybody for years while the economy was flourishing. Now they are trying to make up their losses by charging enormous fees and rates adding fuel to the fire. The banks have a choice, they can pull their heads out of the sand and start lending and try to be a part of the solution to the housing and financial crisis or they better get ready to own a majority of the housing market.

And that’s this week’s straight talk!