When there is boom people write about how great it is going to get, when there is bust people write, ad nauseum, about how bad it is going to get. Fundamental analysis takes backseat. Today people talk like everything is lost and we are soon headed for a armageddon. Yes, there maybe $4 trillion(30% of GDP) in credit losses. Yes, the debtors are not making $4 trillion payment(not a dime) they borrowed mostly in the years leading to the bubble from creditors. Other than this big breach of contract from the borrowers and the big loss to the creditors
Let's count what we have lost in the order of priority.
1. We have lost trust in our credit markets. Credit Funding by private investors will take time.
2. Due to the credit losses, our financial institutions were in the brink of insolvency and even depositor's trust in Banks was eroded to some extent. Many financial institutions(Banks, Investment Banks, Hedge Funds, Pension Funds) either have failed or are teetering in the brink of insolvency(negative equity) and require capital.
3. We have lost excess productive capacity built in real estate, retailing, manufacturing and financial services. Many production and consumption activities in the above areas were simply unviable if housing asset bubble did not exist. So we have seen and will see a wave of corporate,personal bankruptices and unemployment until capacity adjusts
Let's count what we have NOT lost in the order of priority.
1. Our "money system" has not collapsed. Deposits are still held at banks and money (or dollars) is still honored as means of payment. We have not gone to barter system. Depositors are not rushing to the banks to convert their deposits to gold or other commodities. Government by all means has tools to prevent such an event.
2. Dollar still remains world's reserve currency, although, this rests on much shakier foundation due to deteriorating fundamentals in US. Perversly, the dollar has gone up due to "risk aversion". This is how fundamentally flawed the current global financial system is. So far there has been no flight of capital from the dollar. I think government can and will prevent flight of capital from dollar, if that problem ever manifests in the near future(I will not get in to how this can be done in this write up).
3. We still have the same hard assets like houses, commercial real estate, factory plants, natural resources & human labor. These assets have not been destroyed like in war or natural calamity. Their value may have changed but their "utility" value is still the same.
4. We still have the same labor, same skills, same technology and the same natural resources although we may have less economic activities going on.
What is most likely going to happen in couple of years ?
1. Housing prices will stabilize. Excess assets (houses, commercial real estate, etc) will all be taken out of the inventory in a few years by new buyers and less sellers in the market.
2. Job losses will stabilize. There is going to be a tipping point when the minimum demand for products and services needs to be met by the economy. Also, unemployed labor will sooner or later find new ways to be employed. They may not be compensated the same, but they will find new ways to be productive.
3. Our regulatory system will improve to prevent such bubbles and also to restore the lost trust in credit markets. Until the trust is restored and credit losses stabilize, lenders would be the Banks and lender of last resort, the Central Bank .