Friday, November 21, 2008

Shall We Dance... The Economic Limbo

How low can we go?

Having lived through the better part five decades now I have seen good economic times and I have seen bad economic times. In recent times we have been repeatedly told by the dominant media that the economy was bad even when it was quite good. When I would hear young people complain about the bad economy when unemployment was under 5%, interest rates were ridiculously low and the stock market was heading north I would remind them of the 1970's. Blank stares ensued. They had no idea what bad times were. This is all about to change.

Unemployment is on the rise, nearing 7%. Home prices continue to plummet. There are real fears that one or more of Detroit's Big Three could go bankrupt. What's worse is the people who should know have no idea what is happening.

Two years ago (about the time the Democrats assumed control of Congress strangely enough) the economy was very good by the numbers. This was right before gas prices at the pump began to skyrocket. Very few pundits on CNBC or at CNN Money or CBS MarketWatch were predicting what has happened.

Alarm bells have been wringing about Fannie Mae and Freddie Mac and the looming subprime meltdown for years. With the media having marginalized every word that came from the present administration no one outside of a few Republicans in Congress took heed of the President's repeated warnings regarding Fannie and Freddie. Therein lies his failure in all of this. He allowed himself to be ignored and while he held the White House and the Republicans held both houses of Congress they didn't get it done. On this they were right, and yet they failed miserably.

President Bush acknowledged today that the financial crisis was caused by many factors including "government inaction and mistaken actions, outdated U.S. and global financial regulatory systems, and by the excessive risk-taking of financial institutions." The inaction I described above, the mistaken action was Clinton era policies regarding CRA legislation and loosening time honored lending and underwriting practices. The sharks on Wall Street buoyed by fresh blood entering the investment pool gobbled up the good and the bad... The bad was really bad.

The new subprime culture was a house of cards built on the faulty premise that housing and real estate values would increase forever. Once home values began to fall the landslide became an avalanche.

There is one bit of good economic news: The average price of gasoline is now less than $2 a gallon for the first time since March 2005, down 52% from the peak of $4.11 in July. Surely $147 per barrel was an aberration, especially the speed of the increase. I remember writing months ago when the pump price were merely $3 a gallon that there was nothing about these economic woes that $1.99 gas wouldn't cure. I am holding out hope that I was correct.

The sudden shock of $150 a barrel oil has created a bubble that needs to move through the economy. Manufacturers that require petroleum in their operations and of course the transportation industry have been slammed. We have been slammed right along with them. When prices increase exponentially behaviors change. People stop buying things and companies stop hiring. One of the things people stop buying is large gas guzzling cars. With the American auto industry already on life support $4 a gallon gas was like the doctor pulling the plug.

Is it really all that mysterious what is going on? If you think about your own life and assess what your biggest expenses are outside of taxes (which is the biggest expense of all) it is housing and transportation... These are the things our economy revolves around. Both have been subject to a massive shock.

As a colleague of mine pointed out today the bubble caused by the oil shock has to work its way through the system. People and businesses are scared. But the psychological impact of that sign at the local gas station is immense. More than one person has said to me that it seems surreal to see the price so low just weeks after it was in the upper $3 range. What should be welcoming and comforting is disquieting instead. If, and that's a big IF, gas prices at the pump stabilize somewhere near $1.99 a gallon I believe the economy will make the turn.

Real estate has never been worth zero and it can't keep falling forever. We have to be near the bottom... Right?