Economic Outlook: Bracing for a Rocky Road?

Try as hard as it might, Bush 43 could not postpone the consequences of its actions until it January 20, 2009. Bush 41 largely escaped these problems, but his son’s administration was not so lucky.

Yes, things started unraveling early in 2007 with the subprime market leading the way. However, the economy did not ‘tank’ and many, including McCain’s friend, advisor, and one time choice for Secretary of the Treasury in a McCain administration, kept telling us that ‘things weren’t so bad’ and that some people just suffered from mental depression and were just whiners.

After the initial liquidity scare, the unwinding of financial positions has been relatively smooth. Sure, Bear Stearns (BSC) was bailed out, but Citigroup (C) and Merrill (MER) have gotten capital infusions and are still standing. The housing industry has suffered tremendously, but there have been no major wipeouts. There now have been 11 takeovers in the banking industry, but in general, they have been relatively small banks. Retail trades have only experienced a few bankruptcies. Food chains have been suffering, but no real biggies here. Manufacturing has been on hold but most large companies seem to be holding on with a fair amount of cash on hand. [Hold your breath General Motors (GM)]

Now, however, some of the bigger paychecks are coming due. Fannie Mae (FNM) and Freddie Mac (FRE) have been taken over, their top executives relieved of their positions, and the United States Treasury Department has committed the American Government to “an open-ended guarantee to provide as much capital as they (Fannie and Freddie) need to stave off insolvency.”

What might be the result of this commitment?

Well, Fannie and Freddie have accumulated more than $5 trillion in assets. Five trillion dollars includes a lot of zeros. There have been estimates that this commitment could cost around $20 to $30 billion, but I quoted a figure of $200 billion in a recent post. These are big numbers so we need to be careful in trying to comprehend their size. If there were a 20% write off of asset value, this would amount to $1 trillion; a 10% write off would amount to $500 billion, a 5% write off would amount to $250 billion, and a 1% write off would amount to $50 billion.

You pick a number. What will be the amount of the write down of these assets?

The important thing is that action has finally been taken. The administration finally reached the point where a takeover could not be postponed any longer. In fact, that has been the case for the last twelve months or so. The people in authority kept postponing and postponing action until they have no further choice.

The Bernanke Fed has gotten a lot of attention and praise/blame for the dramatic reduction in the target Fed Funds rate it uses to anchor monetary policy. However, if you remember the situation in the spring of 2007, Bernanke and the Fed kept putting off any reduction in its target rate of interest because they did not comprehend the need for such action. Then, when they did move, they felt the drop needed to be one of the most precipitous declines on record.

The same thing is true of many of the other responses of Bush 43 in 2007 or 2008.

This administration was pro-business and hands off in terms of rules and regulations. This administration did not want any economic dislocation coming on its watch. Now, it has to act and the question is how much more is it going to have to do before it gives up office?

The irony of the situation reminds me of that faced by the Nixon administration back in August of 1971. I joined the Nixon administration as a Special Assistant to George Romney [HUD] on August 1. Sunday evening, August 15, President Nixon went on national television and announced the freezing of wages and prices. I was fortunate (or not, depending on your philosophical leanings) to attend meetings of the Cost of Living Council and the Committee on Interest and Dividends. It was remarkable to sit in these meetings, day-after-day, and see individuals that abhorred controls of any kind, attempt to administer wage and price controls. Many of these people were violently opposed to wage and price controls or, at least, were indifferent to their application.

I perceive that many in the current administration are going through this soul-searching now. In addition, they are faced with the prospect of other intrusions into the economic and financial system as they wind down their terms in office. How many of them wish that they had left the administration a year or so ago?

Fred Mishkin, who resigned from the Board of Governors of the Federal Reserve System in August - how lucky you are!!!

I really believe that these people want out. In addition, what is one of our presidential candidates shouting? Senator McCain concluded:

I think that we’ve got to keep people in their homes. There’s got to be restructuring, there’s got to be reorganization, and there’s got to be some confidence that we’ve stopped this downward spiral. It’s hard, its tough, but it’s also the classic example of why we need change in Washington.

My question here is who is Senator McCain, if he is elected President, going to use to clean up the financial and economic mess? My take is that the current people want out because they feel that they are receiving enough of the blame for the current administration. In addition, who might be brought in - Phil Gramm and Jack Kemp? The Republican pool is relatively dry, as it has been picked over for the last eight years. Should McCain reach across the aisle? If he is going to bring in a bunch of Democrats to clean up the mess - isn’t this a little bizarre?

There is a lot a new administration is going to have to do when it gets in office to get the economy and the financial system working smoothly again. Yes, economic growth is going to have to be renewed, but there is also the underlying inflation that will still be worrisome. Yes, the regulatory system needs to be revisited. Yes, something needs to be done about the dollar. Yes, foreign money is buying up American assets at a record pace. Yes, we need a real energy policy. Yes, the auto industry is in the tank. Yes, homeowners are losing their homes. Yes, these are just a part of the agenda that will be facing a new administration come January 20, 2009.

This agenda is why I don’t believe any new President is going to have much room to introduce new items that are on their social or economic agenda. I think the campaign message should be, I would like to do this and or that, but, because of the current mess that I will inherit, there will be very little I can do in the next two to three years. I know you would like to hear something different, but, in all honesty, that is all I can promise you at the present time.

The problems created by Bush 43 are coming home and we must face them head on. The absence of an energy policy has put the United States in an embarrassing hole that it is finding difficult to climb out of. However, we need to stop digging the hole deeper. Our policy with respect to the dollar has been abysmal and it has put many United States assets on the block for foreign interests. Our fiscal policy has been totally out-of-control and has placed a large amount of the United States government debt in foreign coffers. Our monetary and banking policies have ignored the innovation taking place in the financial sector and, as a consequence, our authorities have lost control of sub sector inflations - inflations that have resulted in credit expansions pertaining to specific asset stocks and not to their sector cash flows.

We have a long way to go before we are out of this economic and financial morass. To me, risk is still being underestimated in the markets. The Fannie and Freddie experience is only another step along the bumpy road ahead of us.

 

Comments

[investor88:]

Agree the ride will be bumpy rather than smooth because of the littany of severe problems in the US. Jim Kingsdale said in a separate article that this recession is likely to be long one instead of a short one. Under such conditions, it may be best to use a portion of cash to trade the markets.

2008 Sep 08 04:57 AM

[alienation:]

The next president may not be able to implement any social programs... but someone will have an easier time organizing people to demand these social program when the economy sucks.

2008 Sep 08 05:51 AM

[mangolfer:]

Good article.

2008 Sep 08 08:23 AM

[Will Rahal:]

Bumpy ride, indeed.
The relatively healthy business sector is about to follow the weak consumer.
I have posted on the relationship of Employment Vs Business Investment and the stock market.

2008 Sep 08 09:02 AM

[codewiz51:]

42,000 lobbyists party in the street. Quoted one happy reveller: "It's a wonderous new world for financial lobbyists!"

2008 Sep 08 09:47 AM

[1worldcurrency:]

Republicans are against price controls to the extent that they help the poor, but have no problem putting them in to help the wealthy.

2008 Sep 08 09:53 AM

[phdinsuntan...:]

3 dollars per euro and all will be fine

2008 Sep 08 10:04 AM

[Jason Rines...:]

1) The Bush Admin was obtuse, no doubt about that but energy forbiddence is a Democrat issue.
2) Glass-Steagall - Need I say more?

Reality is, Bush 41, Clinton and Bush 43 all had the same bad global economic plan, based on 25 years economic theory that has failed. I will vote Ron Paul, both Democrats and Republicans stink.

2008 Sep 08 12:14 PM

[palsboss:]

So supposedly home mortgage rates will drop. Possibly to 6%. But that is unlikely to spur interest in homebuying. You have to be a fool to want to buy a home right now unless there is a compelling reason (such as buying into a very good neighborhood that would otherwise have been impossible. Its all about jobs and so long as people worry about jobs then no one will buy. With unstable jobs, lenders will be really tough on lending. People seem to forget that there is a basic equation when it comes to figuring out the price of housing. Home prices will stabilize at the point where monthly payments in particular neighborhoods meet the income levels of those who choose to live there. Rather than figure out home much home you can afford, instead, you should figure out how much in monthly payments you can make and find a loan accordingly. What is the point of living in your "dream house" if you are only going to get kicked out of it after a few years. I see the takeover as a sign of how bad things are and how much worse they will get in the short run.

2008 Sep 08 12:58 PM

[whidbey:]

What a skill for citing the obvious. Of course 43 screwed up everything he touched including Iraq, but we must always ask who among the many can do better. The truth is no average politician is suited for the modern presidency, and few can get the help they need when Congress is seen in the distance as a pack of baying coon dogs. We are at or near the breaking point of democracy where the many will take what the want from the few, and do it legally. Just watch, it matters not who wins this election, you loose.

2008 Sep 08 02:06 PM

[anarchist:]

ah Zooey, too true. Obama, Hill, Cactus John McCain-all corporate controlled whores. Only the "red neck" Palin is what she seems to be.


On Sep 08 02:06 PM zooey wrote:

> What a skill for citing the obvious. Of course 43 screwed up everything
> he touched including Iraq, but we must always ask who among the many
> can do better. The truth is no average politician is suited for
> the modern presidency, and few can get the help they need when Congress
> is seen in the distance as a pack of baying coon dogs. We are at
> or near the breaking point of democracy where the many will take
> what the want from the few, and do it legally. Just watch, it matters
> not who wins this election, you loose.

2008 Sep 08 03:10 PM

[CHM97:]

"The problems created by Bush 43 are coming home and we must face them head on. The absence of an energy policy has put the United States in an embarrassing hole that it is finding difficult to climb out of."
**********************...
Have NOT built a nuclear plant in -30- years. Have NOT built a refinery in -30- years. Takes -2- years MINIMUM for environmental impact study on a SOLAR FARM. The writer says all this is W's fault. WOW....

The over expansion of money supply and credit is the basis for our problems and they started well before W took office. The economic cycle contrary to most peoples belief system has not been outlawed, it is still it full existence. We are and will be in this phase of a down cycle after 65-70 years of up years. The cycle will not be as difficult as the 30's and we will survive. ....2020....

2008 Sep 08 03:52 PM

[tinman:]

43's priorities clearly did not include smoothing the regulatory path for Big Oil's potential competitors. Did anyone expect anything different? The country got exactly what it deserved. It's the price the rest of the planet has paid that is truly pitiful.

2008 Sep 10 01:00 AM