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San Diego economists divided on how deep recession will be
UCSD's Ross Starr: “I expect double-digit unemployment"
You’re exhilarated when the stock market zooms 10 percent in a day, right? Think again. Of the ten one-day miracles in investment history, when stocks have soared 9 to 15 percent, seven of those days were in 1929 or the 1930s. Two of them were in October of this year. Similarly, of the 15 best weeks in market history, 13 occurred during the 1929 crash or the following Great Depression. One of the rowdiest up weeks ended October 31 of this year. The 15 worst months? Twelve were in 1929 or the subsequent depression, and one was October of this year.
Conclusion: financial panics — up or down — tend to occur in grim times. Since the stock market these days is amazingly volatile (panicky, really), should we be expecting another depression? After all, stocks, bonds, commodities, and residential real estate are all deflating amid the volatility.
Local economists agree that the nation will not stumble into a depression, but they disagree on just how bad the economy will get. Importantly, they unanimously agree that the devilishly and deliberately complex financial derivatives are a root cause of the current downturn worldwide because nobody knows if the banks holding these exotic instruments are solvent. The government should make sure they are regulated and transparent, but the $700 billion bailout isn’t accomplishing that.
Let’s consider the national economy first. It contracted in the third quarter as consumer spending, which makes up more than 70 percent of economic activity, plummeted 3.1 percent, the biggest decline in 28 years. Consumer confidence is at record-low levels, even as the Federal Reserve lowers interest rates and pumps reserves into the banks. This could be the bleakest Christmas spending season since 1980.
Ross Starr of the University of California, San Diego says we are in for a “very severe” recession. “I expect double-digit [10 percent or more] unemployment,” he says. “This is no joke. There is no way out of it. It will last through the third quarter of ’09.” He says this downturn will be similar in severity to the very difficult period in the early 1980s, when the central bank was raising interest rates to squeeze inflation out of the system. There was a mini-recession in 1980 and then a steep recession in 1981–82. Today, the difficulties in housing and the credit crisis will be “two big causes,” says Starr.
But on the same campus, economist Jim Hamilton is not so gloomy. He says the fourth quarter of this year will shrink more intensely than the third quarter did (0.3 percent). “I don’t see consumption picking back up; I don’t see housing picking up; there is pressure on state governments,” says Hamilton. “This is looking like a global recession. It will take a bite out of exports.” But after the contraction in the second half of this year, the economy may or may not continue declining through 2009, partly because the Federal Reserve and U.S. government have acted so aggressively to add liquidity to markets, says Hamilton. “I don’t know how long this will last.”
Across town at San Diego State University, Raford Boddy, emeritus economics professor, says, “This [recession] will be deeper. It may not be as deep as 1973–75, but it will be deeper than 1990–91 and 2000–01. Consumers are scared. Home remodeling and things related to remodeling, like new stoves and refrigerators, are in trouble, and autos are in trouble. Credit-card problems are hitting. The construction industry is really in trouble; the overbuilding of the last four years will take away from what would have been done now.” One possible bright spot: companies may spend more on machinery and electronic equipment to enhance productivity.
But William Carter of the investment firm QInsight Group and a lecturer in business cycles at San Diego State is far less bearish. “We will have slow growth in the U.S., but it will be nowhere near as slow as most of the forecasts you’re reading,” says Carter. “We may have two or three quarters of near-zero growth, and it will be closer to two than three. It’s true that consumers are overleveraged [too deep in debt] and have low savings, but American consumers change their habits only when they believe their changes in income and wealth are permanent. They have to believe that not only will they be unemployed but be unemployed for a long time,” says Carter. It will be a close call whether the current downturn is officially called a recession, he says.
All four academic economists agree on one thing: the quadrillion dollars of derivatives floating around the world are a critical contributor to the global meltdown. Derivatives are miasmically complex securities that are derived from assets such as bonds, stocks, or currencies. Derivatives are not assets, or even investments. They are out-and-out gambling vehicles, and they have come to dominate the financial world. When commentators talk about “exotic instruments of unknown value,” they are talking about derivatives.
Banks won’t loan to other banks because “they are so frightened of these derivatives and balance sheets of [other] banks,” says Carter. The credit markets are frozen because of this uncertainty about their fellow institutions. Carter would like to see a national exchange on which the complex derivatives are traded, thus providing price transparency.
“We need a centralized clearinghouse” to keep track of these financial exotica, says Hamilton. “We need a single agency to look at them from the perspective of financial stability. The SEC [Securities and Exchange Commission] looks at fraud, and the CFTC [Commodity Futures Trading Commission] looks at manipulation. Stability is more important.”
Starr points out that derivatives “are immensely leveraged. You never know where the next bankruptcy is going to fall. We need accounting rules that require liabilities to be fully stated, requiring transparency. Let’s know where the bodies are buried.”
Boddy has suggested ways by which banks could begin to lend to each other once the value of the toxic derivatives is determined in the marketplace. The government’s $700 billion bailout package won’t accomplish that, he says. The schemes to buy stock in banks, thus pumping capital into them, and to buy derivatives directly, will not work, he says. “For God’s sake, don’t buy those toxic things,” says Boddy, who calls some of them “putrid, bloated carcasses.” If the Troubled Asset Relief Program (TARP) buys such malodorous junk, “It will just get some of the worst assets off the balance sheets of the banks.” He proposes a plan by which TARP will buy a small percentage of the smelly assets and then take bids for them. “The goal is price discovery, not capital injection. Through price discovery, TARP will discover what the assets are worth. Then they can be repackaged and sold on the open market. Without confidence in the values of the remaining assets on the balance sheets, the banks will be uncertain whether they are dealing with insolvent banks.”
He says, “Comprehensive price discovery will tell which banks are solvent and which are not, so banks can get back to lending. Banks will not extend credit to other banks so long as they fear that the counterparties might be bankrupt.”
And if banks don’t lend, we could see the ugly deflation we fear.
Here's something you might be interested in.
San Diego economists divided on how deep recession will be
UCSD's Ross Starr: “I expect double-digit unemployment"
San Diego economists divided on how deep recession will be
UCSD's Ross Starr: “I expect double-digit unemployment"
You’re exhilarated when the stock market zooms 10 percent in a day, right? Think again. Of the ten one-day miracles in investment history, when stocks have soared 9 to 15 percent, seven of those days were in 1929 or the 1930s. Two of them were in October of this year. Similarly, of the 15 best weeks in market history, 13 occurred during the 1929 crash or the following Great Depression. One of the rowdiest up weeks ended October 31 of this year. The 15 worst months? Twelve were in 1929 or the subsequent depression, and one was October of this year.
Conclusion: financial panics — up or down — tend to occur in grim times. Since the stock market these days is amazingly volatile (panicky, really), should we be expecting another depression? After all, stocks, bonds, commodities, and residential real estate are all deflating amid the volatility.
Local economists agree that the nation will not stumble into a depression, but they disagree on just how bad the economy will get. Importantly, they unanimously agree that the devilishly and deliberately complex financial derivatives are a root cause of the current downturn worldwide because nobody knows if the banks holding these exotic instruments are solvent. The government should make sure they are regulated and transparent, but the $700 billion bailout isn’t accomplishing that.
Let’s consider the national economy first. It contracted in the third quarter as consumer spending, which makes up more than 70 percent of economic activity, plummeted 3.1 percent, the biggest decline in 28 years. Consumer confidence is at record-low levels, even as the Federal Reserve lowers interest rates and pumps reserves into the banks. This could be the bleakest Christmas spending season since 1980.
Ross Starr of the University of California, San Diego says we are in for a “very severe” recession. “I expect double-digit [10 percent or more] unemployment,” he says. “This is no joke. There is no way out of it. It will last through the third quarter of ’09.” He says this downturn will be similar in severity to the very difficult period in the early 1980s, when the central bank was raising interest rates to squeeze inflation out of the system. There was a mini-recession in 1980 and then a steep recession in 1981–82. Today, the difficulties in housing and the credit crisis will be “two big causes,” says Starr.
But on the same campus, economist Jim Hamilton is not so gloomy. He says the fourth quarter of this year will shrink more intensely than the third quarter did (0.3 percent). “I don’t see consumption picking back up; I don’t see housing picking up; there is pressure on state governments,” says Hamilton. “This is looking like a global recession. It will take a bite out of exports.” But after the contraction in the second half of this year, the economy may or may not continue declining through 2009, partly because the Federal Reserve and U.S. government have acted so aggressively to add liquidity to markets, says Hamilton. “I don’t know how long this will last.”
Across town at San Diego State University, Raford Boddy, emeritus economics professor, says, “This [recession] will be deeper. It may not be as deep as 1973–75, but it will be deeper than 1990–91 and 2000–01. Consumers are scared. Home remodeling and things related to remodeling, like new stoves and refrigerators, are in trouble, and autos are in trouble. Credit-card problems are hitting. The construction industry is really in trouble; the overbuilding of the last four years will take away from what would have been done now.” One possible bright spot: companies may spend more on machinery and electronic equipment to enhance productivity.
But William Carter of the investment firm QInsight Group and a lecturer in business cycles at San Diego State is far less bearish. “We will have slow growth in the U.S., but it will be nowhere near as slow as most of the forecasts you’re reading,” says Carter. “We may have two or three quarters of near-zero growth, and it will be closer to two than three. It’s true that consumers are overleveraged [too deep in debt] and have low savings, but American consumers change their habits only when they believe their changes in income and wealth are permanent. They have to believe that not only will they be unemployed but be unemployed for a long time,” says Carter. It will be a close call whether the current downturn is officially called a recession, he says.
All four academic economists agree on one thing: the quadrillion dollars of derivatives floating around the world are a critical contributor to the global meltdown. Derivatives are miasmically complex securities that are derived from assets such as bonds, stocks, or currencies. Derivatives are not assets, or even investments. They are out-and-out gambling vehicles, and they have come to dominate the financial world. When commentators talk about “exotic instruments of unknown value,” they are talking about derivatives.
Banks won’t loan to other banks because “they are so frightened of these derivatives and balance sheets of [other] banks,” says Carter. The credit markets are frozen because of this uncertainty about their fellow institutions. Carter would like to see a national exchange on which the complex derivatives are traded, thus providing price transparency.
“We need a centralized clearinghouse” to keep track of these financial exotica, says Hamilton. “We need a single agency to look at them from the perspective of financial stability. The SEC [Securities and Exchange Commission] looks at fraud, and the CFTC [Commodity Futures Trading Commission] looks at manipulation. Stability is more important.”
Starr points out that derivatives “are immensely leveraged. You never know where the next bankruptcy is going to fall. We need accounting rules that require liabilities to be fully stated, requiring transparency. Let’s know where the bodies are buried.”
Boddy has suggested ways by which banks could begin to lend to each other once the value of the toxic derivatives is determined in the marketplace. The government’s $700 billion bailout package won’t accomplish that, he says. The schemes to buy stock in banks, thus pumping capital into them, and to buy derivatives directly, will not work, he says. “For God’s sake, don’t buy those toxic things,” says Boddy, who calls some of them “putrid, bloated carcasses.” If the Troubled Asset Relief Program (TARP) buys such malodorous junk, “It will just get some of the worst assets off the balance sheets of the banks.” He proposes a plan by which TARP will buy a small percentage of the smelly assets and then take bids for them. “The goal is price discovery, not capital injection. Through price discovery, TARP will discover what the assets are worth. Then they can be repackaged and sold on the open market. Without confidence in the values of the remaining assets on the balance sheets, the banks will be uncertain whether they are dealing with insolvent banks.”
He says, “Comprehensive price discovery will tell which banks are solvent and which are not, so banks can get back to lending. Banks will not extend credit to other banks so long as they fear that the counterparties might be bankrupt.”
And if banks don’t lend, we could see the ugly deflation we fear.
Comments
I suspect that many of the assumptions underlying current predictions will be proven wrongheaded.
For example, Boddy proposes using the financial markets for "price discovery".
But in the last few decades these institutions have completely lost the ability to discover price because they have been hacked by the smart boys to move up or down according to what amounts to side-bets. The markets simply do not serve their stated purpose of price discovery...if they did, we wouldn't be in the awful situation we find today. Instead, they've become gambling dens with outcomes that are often fixed by the dealers.
Similarly, banks, investment houses, insurance companies and especially ratings agencies have so far strayed from their original roles that they cannot be counted on to be honest arbiters of risk or value. Now they want more of our money to wager on their being able to unstick the system they rigged.
It's a gloomy thought that the institutions we are counting on to save us are so rickety and rotten that they're not going to be much help, and may make the situation far worse.
Depending on the same folks who got us into this mess to somehow find a way out seems foolhardy. Again, we know they gamed the system to their benefit.
So they will probably play "garbage in, garbage out" to get policy makers to believe they're working out a solution, when in fact they compound the frauds. Since no one else can pull the levers of the machine, we are being told we "have to" trust them to gamble further with our money.
The assumptions the policy makers use today to justify their massive interventions in the markets seem to ignore the extent of financial system hacking. I don't think the panic stricken schemes concocted to prop up these compromised gaming institutions will end well.
Best,
Fred
Fred - read "Wall Street Lays Another Egg" by Niall Fergusun in the latest issue (Dec.) of Vanity Fair. It is fascinating.
My thought is that residential real estate is at the center of most all of this so here is what I would do if I were Sec of the Treasury.
For the next 18 months, offer a 6% fixed rate mortgage to anyone that currently owns a home based on two conditions. The loan cannot be for more than the home is currently worth and you have to have the income going forward to pay the new 6% mortgage. The company or bank making this new loan would earn a fixed fee for originating it. I am thinking something like $1,000 to cover their processing and profit. We have a million out of work mortgage people that could be immediately put back to work.
This would accomplish several things. Anyone that owes more than their house is worth would need to agree on a current value with their lender. Yes, this bails out some who bought a home with a stupid loan. The upside is the stabilizing affect this would have on home values which helps everyone including the homeowners that were more prudent as even a prudent borrower will suffer if his home goes down in value 50% or more.
Banks don't really want to foreclose on these people as it costs them so much more to kick the people out and find a new owner. Yes, the lenders would have to make decisions about the current values but at least they would be getting close to 100% of the current value to offset their existing loan on the home. The lender is certainly better off as is the owner that can now stay in their home.
The government could have Fannie and Freddie "buy" these loans and pool them based on their loan amount and origination date.
Since all of the loans would be 6% fixed, each pool would have a loan "history" 12 months down the road and if the default rate at that point on these new loans are 2%, then at least the pools can be properly valued and there are many investors that would invest in these loans if they knew they would earn 5.7%+. The government could even make them tax free initially.
Another benefit of this would be that the "investors" that have bought these original Collateralized Mortgage Obligations would at least recover a larger percentage of their investment than if the lender has to incur the legal expense, commission expense and time value of money costs of going the foreclosure route. The problem would go away so much more quickly.
What I do not understand about any of the current solutions being proposed is how will the financial system deal with millions of foreclosures.
What is the cost to our society to have millions of families displaced spending money on relocating rather than on their domocile?
Without a program like this, I forsee people who have not made a mortgage payment for 5 months living in their homes for another 18 months because the foreclosure process in the courts is so backed up, few people are getting to the point where the foreclosure process is complete.
Greg Siebenthal
Greg, there's a wiki over at www.changesandiego.org.
You ought to add your idea there.
Best,
Fred
Is it fair to call the dude from the investment firm an "academic" economist? You gotta be peering through some pretty heavily rose-tinted specs to think the current economic pain is going to be limited to "two or three quarters of slow growth" - or you gotta be trying to sell something.
MsGrant, thanks for pointing to the Vanity Fair article. I enjoyed it - a nice history lesson evolution of our modern banking system, and its "shadow" counterpart.
Greg, I'd suggest you send your idea directly to Secretary Paulson - he likes new rescue plans more than my wife likes new shoes.
MsGrant and Shizzyfinn, you are my new best friends.
Do you know of the Black Swan or Fooled by Randomness work of Nassim Taleb?
He's not the most diplomatic guy in the world, loving to call prominent economists and journalists "idiots" to their faces, but he sure does put prescient points compactly, like here:
http://www.fooledbyrandomness.com/imbeciles.htm
Don, I wonder if you tend to have a similar world view now as Taleb, or do you think perhaps he is too extreme? Certainly, his thinking is at variance with the folks you interviewed.
Maybe you could get Taleb on the phone, Don?
Best,
Fred "Humongous Reader" Williams
Quote from Taleb:
"Why is it that an economics degree make people stupid, dangerously stupid?"
"A rising tide lifts all boats". That is why no one listened to people like Taleb. He is a spoil-sport. Everyone was having too much fun buying big-screen TVs, cars and boobs. The greed that swept America cannot be summed up in hindsight (or foresight, in Taleb's case) by economic experts. It was too all-encompassing. Allowing people to buy homes or borrow against their homes with so little oversight in place had an effect that can only be described as frenetic. I saw home purchase and refinance loan documents pour into my office day after day, the equity in homes rising 5-10% or more from the time the buyers or borrowers opened escrow until the time it closed. They bought these houses and condos with little or no money down, caught up in a frenzy that was pushed on them by greedy mortgage brokers and real estate agents who assured them that they could sell their house next year and get into their "real" house, or refinance their ghastly loans in a couple of months with a fixed rate mortgage, not to worry, your home can only go up in value. Act now, though, rates will go up, prices will go up, etc. These "professionals" did not explain the mortgage lender enriching, unnecessary pre-payment penalties that would not allow them to refinance without paying a five digit pre-pay, only being told go for the pre-pay, it will reduce your monthly payment, nor were they experienced enough to understand the cyclical nature of real estate. The refinancings were worse, people using their homes to payoff cars and credit cards and coming back a year later to do the same, all the while thinking their home values would continue to soar, and they would ride the wings of this never ending infusion of cash disguised as equity. But, as we all know, someone always has to buy (or borrow) at the top. By then, it was too late. Wall Street had entered the picture, and these mortgages had been sold, leaving investors holding the bag. That's another story that I'll leave to the experts.
"Hindsight is 20-20." Then we have the slew of experts who say "I told you so". And, boy, where they right. Can't wait to hear what they have to say the next time.
I had heard a bit about Taleb and Fooled By Randomness, but was largely unfamiliar. His Wikipedia entry and his website are fascinating, though, so I'll be looking for Fooled as well as The Black Swan at the library. (As long as Jerry Sanders doesn't close the library first. In which case, I don't know, maybe they'll start loaning out books at Petco Park?)
I love Taleb's idea of "epistemic arrogance," or thinking that we know and understand so much of a world that is largely unknowable and unpredictable. Probably the biggest epiphany of my adult life has been the realization that nobody knows s***, particularly about the future. But everybody from weathermen to cab drivers have no problem spewing advice regardless. And people like stockbrokers and real estate agents don't just spew advice, they charge dearly for it. So you gotta have your B.S. detector turned on at all times.
Still, at first glance, Taleb seems more than a little full of himself, and utterly convinced that he is right, which seems to fly in the face of his own ideas - it's like he's an expert on why we shouldn't trust experts. And the reality is that in an uncertain world, we all still have to make decisions, from where to put our savings to whether to grab an umbrella on the way out the door.
So maybe the idea is not to reject all advice, but to perpetually sharpen our filtering systems, so that only the good stuff gets in. I guess I'll have to read Taleb's writing and then decide for myself if it's good stuff or not. Oy, the B.S. detection never ends!
Stop it, Fumbler. You're killing me. Uncle! Jonathan Swift, you've met your match!
Shizzy wrote: "he's an expert on why we shouldn't trust experts"
That is by far the best description of Taleb I have ever seen.
You should send it to him. I have the feeling he would appreciate such a description.
Best,
Fred "The Humongouss" Williams who is still recovering from a long night at MsGrant's brothel. And, fumber, after all my hard work, I can guarantee you the girls aren't dry.)
In response to post #3. You should be the man in charge of the city's Treasury Dept. We need more people like you. It is a real shame that we will be losing our parks and libraries all for the sake of the corrupt people in charge to continue to live the lifestyle they want. We are the one's lining their pockets and for that what do we get, nothing but lies and failed promises. Now they want to take away what little we have left. It's a real shame.
Well at least I can still go outside and play in Mission Trails and Torrey Pines State Preserve. :)
But who knows, they might now decide to make Mission Trails the Santee Dump Extension and encroach that area of land. They already have built condos nearby.
Fred always gets it on the house.
So Fred is in charge of quality control, Ms. Grant? This smacks of favoritism to me. I have to ask, what's Fred got that Fumbler ain't got? (Besides the God-given right to call himself Fred the Humongous.) I'm afraid I see a showdown coming. It doesn't look good for Fumbler.
I can tell you one thing I've got that my good friend Fumber sorely lacks -- capitalization.
I know that MsGrant loves my humongous capitals. Everytime I start a sentence, or refer to myself as the subject, I'm sprouting a big letter right up into the sky.
Fumber's missing a few apostrophes to aid his contractions, it's for sure, whether he's aware or not, MsGrant's been noticing...
But what MsGrant loves the most is when I sentence her witho...a...nice...long...slow...ellipsis...ahhh....
Other than these few trifling matters, Fumber and I are exactly identical in every detail, as we all well know.
So I suggest you bullies find someone else to pick on. Fumber is feeling hurt and lonely, like he doesn't have any friends and no one truly understands him. After the disappointments of the elections, he's taken to spending long hours in his room in front of a computer posting incoherent ramblings revealing more about his rich inner life than many care to know.
So leave Fumber alone, you nasty people who make fun of him still living with his mother, unable to find a job, friendless and alone.
Shame on you all.
(MsGrant, I think you owe Fumber a freebie. It might cheer him up.)
Once fumbler has a nice long session with his (well used) "strap-on" I am sure he will be feeling much better.
Banks don't really want to foreclose on these people as it costs them so much more to kick the people out and find a new owner.
Greg, after gaving dealth with Freddie Mac And Fannie Mae on numerous foreclosures, I can tell you with 100% certainty that these firms have some of the most incompetent and stupid morons to ever work in real estate working for them.
So your assumption that a bank will not foreclose because it costs money and does not make sense is in reality a fantasy.
I can assure you these mega banks, Fannie and Freddie have no idea or clue as to how to make a profit.
Johnny Vegas,
I agree there are a lot of idiots out there and it is easy for people to sit around and complain about it. My intent was to put forth an idea that could improve things given the current situation.
These banks are under tremendous pressures to get these "non-performing loans" off the books as soon as possible and they are not doing it.
They do know how to make a profit when things are going good (look at the financial statements of BofA, Wells Fargo, US Bank and even Wachovia for the last 5 years) but they do not move fast enough to protect their downside.
My idea (in post #3 above) is simple for homeowners to understand and it is also simple to implement on a large scale which is something the lenders would need to do and it is also a program that the government could support. All parties involved are really struggling with this right now and they have only just begun.
Greg