Smart Money with Keith Springer Saturdays at 1PM and Sundays at 6AM on NewsRadio KFBK 93.1 FM and 1530 AM

Economic and Market Update – June 17, 2009

Posted At : June 18, 2009 10:32 AM

Economic Update – The new mentality of frugality
Are things really getting better, or is it just CNBC trying to convince us. I agree that sometimes just believing is enough. The market and the media are comforted by the fact that the long duration of this economic crises and the enormous government stimulus will bring an end to this long and painful recession. In the short term, I don’t disagree. It would be hard to believe that all the money being thrown around will not help and as important, psychology has shifted to being sick and tired of being sick and tired. Unfortunately however, the many long term obstacles still exist. Demographics are still pointing to continued slow consumer spending, the fuel for the economy’s engine: the banks have made a mess that will take years to rectify, not to mention a mockery of the system: The system is still grossly over-leveraged: and commercial real estate is just starting to fall (off a cliff), like we needed something else. This is leading to a major shift in consciousness: a new “mentality of frugality”. Not only can people not spend anymore, but they don’t want to. Remember the 80’s where your status was to own things you can’t afford? Now it’s the opposite: To be able to afford it but not buy it.

To make matters worse, the ratings agency, “Fitch”, in a downgrade of yet another 543 mortgage-backed securities of 2005-07 vintage, gives us the following side notes: “The home price declines to date have resulted in negative equity for approximately 50% of the remaining performing borrowers in the 2005-2007 vintages. In addition to continued home price deterioration, unemployment has risen significantly since the third quarter of last year, particularly in California where the unemployment rate has jumped from 7.8% to 11%… The projected losses also reflect an assumption that from the first quarter of 2009, home prices will fall an additional 12.5% nationally and 36% in California, with home prices not exhibiting stability until the second half of 2010. To date, national home prices have declined by 27%. Fitch Rating’s revised peak-to-trough expectation is for prices to decline by 36% from the peak price achieved in mid-2006. The additional 9% decline represents a 12.5% decline from today’s levels.”

Don’t let the deleveraging process fool you. It’s a serious problem that takes time to unfold. Currently, we have about two trillion dollars of actual cash in our economy and about $50 trillion in credit. If we all decided to settle and pay off everything, we couldn’t do it because there is not enough cash. There would be massive asset deflation. We, as a nation, are levered 25 to 1. Now, that $50 trillion is in a real sense the money supply because that is what we are all pretending is real money. I lend you money and you pretend you are going to pay me back. Then you pretend he is not going to call your debt for cash, and we are all going to keep the system going. Because if we all try to pay each other back at once, we are all collectively — and this is a technical economic term — screwed.

So we keep the system going. Now, where are we today? We are at the Great Deleveraging. We are seeing massive losses and destruction of assets, on a scale that is unprecedented. There was massive destruction of assets during the Great Depression, which caused a lot of problems, and we are seeing the same thing today. We are watching trillions simply being evaporated. We are watching people pay down their credit lines, which is one way of saying the supply of money and credit is shrinking. Not just in the US, but all over the world. So we — individuals and businesses — are trying to find that $2 trillion in real cash and get some of it to pay down our debts. We are reducing that massive leveraged money supply down to some smaller number. The “Home” piggy banks are dry, the credit cards maxed and savings and retirement accounts crippled. Quarter 1 06 we had $223 billion in mortgage equity withdrawals. Quarter 2-2008 it was $9.5 billion. Is it any wonder we were in recession by 2008? By the third and fourth quarters there was no money to keep the treadmill going. That $50 trillion in credit was shrinking fast. We were imploding it. Further — just as a little throwaway slide — if you look at 2010 and 2011, we are getting ready for another huge wave of mortgage resets. Now, we’ve gone through the last wave and we saw what happened; it created a lot of foreclosures. We are not out of the woods yet. It is going to be 2012 before we sell enough houses to really get back to reasonable levels, because we had 3.5 million excess homes at the top. We absorb about a million a year, it takes 3 years, that’s kind of the math.

There’s a lot of talk about a lost decade like in Japan. Recessions normally end everywhere because the monetary authority cuts interest rates a lot, and that gets things moving. And what we know in Japan was that eventually they cut their interest rates to zero and that wasn’t enough. And, so far, although we made the cuts faster than they did and cut them all the way to zero, it isn’t enough. We’ve hit that lower bound the same as they did. In their case, the problems had a lot to do with demographics of an aging population. That made them a natural capital exporter, from older savers, and also made it harder for them to have enough demand. They also had one hell of a bubble in the 1980s and the wreckage left behind by that bubble, in their case a highly leveraged corporate sector, which was and is a drag on the economy. This sounds all too familiar. There is a possibility that we get some perk-up as the stimulus dollars start to flow and an almost mechanical bounce back in industrial production as inventories are built up. But, without demand from our consumers we will slide down again.

Springer Financial Advisors ("Advisor") is a federally registered investment adviser located in Sacramento, California. Advisor and its representatives are in compliance with the current filing requirements imposed upon registered investment advisers by the Securities and Exchange Commission and the State of California. Advisor's web site and its emails of general distribution are limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications, and links. Accordingly, the publication of Advisor's web site on the Internet or dissemination of informational emails should not be construed by any consumer and/or prospective client as Advisor's solicitation to effect, or attempt to effect transactions in securities, or the rendering of personalized investment advice for compensation, over the Internet. A copy of Advisor's current written disclosure statement discussing Advisor's business operations, services, and fees is available from Advisor upon written request. You may also obtain publicly available information about Advisor through the SEC website as follows: http://www.adviserinfo.sec.gov/IAPD/Content/Search/iapd_OrgSearch.aspx. Advisor does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Advisor's web site or incorporated in an email, and takes no responsibility therefore. All such information is believed to be reliable and authoritative but does not constitute sufficient information to be the sole basis for sound investment decisions and all users thereof should be guided accordingly. Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended or undertaken by Advisor) made reference to directly or indirectly by Advisor in its web site, email, or indirectly via a link to an unaffiliated third party web site, will be profitable or equal the corresponding indicated performance level(s). Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client or prospective client's investment portfolio. Certain portions of Advisor's web site (i.e. articles, commentaries, etc.) may contain a discussion of, and/or provide access to, Advisor's (and those of other investment and non-investment professionals) positions and/or recommendations as of a specific prior date. Due to various factors, including changing market conditions, such discussion may no longer be reflective of current position(s) and/or recommendation(s). Moreover, no client or prospective client should assume that any such discussion serves as the receipt of, or a substitute for, personalized advice from Advisor, or from any other investment professional. The information is of a general nature and should not be applied indiscriminately to particular situations wherein it may not be completely applicable. Advisor is neither an attorney nor an accountant, and no portion of the content should be interpreted as legal, accounting or tax advice.