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alstry (36.01)

The DANGER period

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June 13, 2008 – Comments (12)

I am not sure people really understand the nature of the current problem.  To distill it to its essence, for the past seven years we built an economy based on borrowing.  After we borrowed a bunch, we borrowed more to keep up with our payments.  As long as we kept borrowing and the banks kept lending we kept growing......until debt became so high that the system couldn't lend anymore.

Without lending people couldn't spend.  Business slowed and decreasing taxes followed.  Now we are dealing with an economy that is no longer getting trillions of stimulous each year.  We are about one year into it and savings has bridged the gap for many.  But savings is now running dry for many individuals, businesses, and governments.  As savings deplete, defaults rise.

What is amazing is that we are still at the beginning of this cycle.  Now defaults have become so high that prices are beginning to crash.....especially in housing where tract homebuilders overbuilt. 

THIS IS THE DANGER ZONE.  CRASHING PRICES.

As distressed inventory keeps rising, the need to liquidate increases.  As the outlook for more distressed inventory gets even worse....the urgency creates a vicious downward pricing cycle.  We are now in that period.  Notice the huge discounts banks and builders have offered on their homes in the past few months.  How large do you think the discounts will grow when they accumulate more inventory over the summer and need to liquidate before the slow Fall/Winter selling season.

As prices fall, bank collateral becomes impaired further limiting banks ability to lend.  For an economy that was addicted to borrowing, it is simply applying the brakes harder to slow moving train.

If people can't borrow they can't buy.  If they can't buy sales slow.  If sales slow jobs get reduced.  If sales slow and jobs contract, taxes fall forcing cutbacks in services acclerating the downward spiral.

We are now into that sprial.  There seems little in the way to stop this unless we repudiate trillions in debt and start all over.  Each month that goes by, we should objectively see more and more distress.  More and more foreclosures.  More and more layoffs.  More and more bankruptcies.  More and more municipal defaults.

What I have yet to see is a credible plan to halt this downward spiral.  It is a situation our country, and the world has never faced before.

How do we stimulate an economy that was addicted to credit and credit has practically been eliminated?...  Add in the fact that we are not producing much anymore and simply more or less servicing each other.....pretty soon we run out of money to pay for the services.

It is crazy times folks and it seems like the world has its head buried in the sand hoping things will just get better as conditions continue to get worse.

Have a great weekend.

12 Comments – Post Your Own

#1) On June 13, 2008 at 2:03 PM, alstry (36.01) wrote:

Think about this for a second.....a significant amout of bank lending is to real estate and real estate backed loans.

In the past year, Mortgage Companies and real estate related companies have reduced staff by hundreds of thousands of workers....maybe millions resulting in millions of feet of vacant commercial space.

When we start to add in airlines, auto companies, banks, construction, retail, and restaurants.....vacancy rates are now starting to rise rapidly.

It does not appear that many of these vacancies are being filled as reported commercial vacancy rates are steadily rising. 

The income from these properties are necessary for the owners to pay their bank obligations.  When income drops below debt and carrying costs, the owner defaults.  As vacancies keep rising we are seeing more and more defaults.

There is trillions of dollars of loans out to commercial real estate......just look around your community and see if you are seeing more for lease signs?

The higher the vacancies the lower the value of the building which impairs bank collateral.  The less collateral your bank has, the further its lending ability is constrained.

See above.

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#2) On June 13, 2008 at 2:20 PM, madcowmonkey (< 20) wrote:

I think I will keep picking one poorly stated comment out each time you write. You can do the same to mine. That way we will get a different view than what ourselves see.

"If people can't borrow they can't buy."

I guess people working is out of the question. I know, I know. The unemployment rate is sky rocketing! Is every job going to disappear?  

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#3) On June 13, 2008 at 2:28 PM, jesusfreakinco (28.93) wrote:

Madcow - relative spending is as important as absolute spending.  Don't be ridiculous.  bonds are sinking like rocks - 10 year back to 4.23 %again today - 2 year up over 50 basis points this week.  What do you think that will do to resets and mortage rates?

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#4) On June 13, 2008 at 2:32 PM, anchak (99.85) wrote:

Al...when your blood not exactly at boiling point you make such a nice cogent argument....your training shines through.

Well written - kudos. God only knows - what the outcome is going to be. One thing - with all the borrowed liquidity pumped in - there is available cash ( till now) - at least in the investment community - that's what keeping it afloat, I think.

Banks are curbing lending - no doubt. Its not completely shut ( that's happened in pockets) - just a trickle.If consumer defaults keep growing - they'll start closing credit cards and personal loans.

It'll truly be interesting then.

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#5) On June 13, 2008 at 2:36 PM, alstry (36.01) wrote:

The key issue is that the system became dependant on borrowing.  I agree that is not a good thing, but was a state of the system whether we like it or not.

As a direct result of the borrowing, the economy boomed.  Autos, Airlines, Banks, Construction, Retail, and Restaurants all benefited.  We built an entire infastructure on the creation of new credit which created a mound of debt.

Now new credit is slowing to a trickle.  Those jobs and business that were the beneficiaries of new credit contracting and shutting down.  As more and more unemployment and vacancies arise...it will put further downward pressure on wages and pricing............WHILE WE ARE STILL OBLIGATED TO PAY FOR THE MOUND OF DEBT!!!!

If we could find new jobs or productive work to replace those jobs than everything would be fine.....but we have exported a bunch of those jobs and replaced them with the service jobs that are now being eliminated.

The can't borrow can't buy was simply a state of our economy....now we are in the process of feeling the unwinding process....no more no less.

There is no virtue to being addicted to narcotics....but coming off of it cold turkey is not a pleasant process.

The question for America is what is going to replace the trillions and trillions of stimulous new credit created over the past seven years?

If we don't find anything, it is very likely to get very ugly very soon.

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#6) On June 13, 2008 at 3:11 PM, madcowmonkey (< 20) wrote:

productive work sounds good:)

I didn't mean anything by the comment, I just read through some of the other blogs plus this one and I keep reading the same thing.

Personal view fellas. I don't see everything withering away. Yeah some people are going to struggle with out being able to go to the well. The government will have to cut back on some of its spending habits and subsidies. The US needs to get fit, lean, and change some of it ways. I need to go and play eye of the tiger now.

 "There is no virtue to being addicted to narcotics....but coming off of it cold turkey is not a pleasant process."

You are right alstry, but it is done when there is no alternative (cold turkey). It will be feast or famine.

haysus- I already planned on mortgage rates rising. Hasn't everybody else?  

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#7) On June 13, 2008 at 3:29 PM, jesusfreakinco (28.93) wrote:

10 year up 40 bp this week.  I don't think anyone planned on that.  Mortgage rates already sky-rocketing and will be death nail for HBs.  Worse nightmare of the Fed and Trichet is calling Benny boy out on the carpet.

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#8) On June 13, 2008 at 3:41 PM, alstry (36.01) wrote:

Monkey,

It is as simple or complex as follows:

As Americans, we all sorta live in one big Homeowner's Association.  We each pay our dues for the benefit of all.  If enough people in the association fail or cannot pay their dues.......the ENTIRE association fails.

If you think about America right now, each month that passes more and more people, businesses, and government are facing increasing pressures.  As the pressure rises, so do the defaults(like people not paying their dues).  Defaults come in many forms: Foreclosures, Vacancies, Job Losses, Bankruptcies, Business Shutdowns, Municipal Bond failures, ect.....

For a long time, defaults were extended because credit was being issued freely.  Trillions and trillions of credit which masked our lack of productivity.

Now that mask has been ripped off and the system is failing at an increasing rate.  The problem that arises is that even if you are current, you are still part of the association.

For example, if your money is in the stock market or a bank, and one or both fail....you potentially are impacted as well.

The fact that we are having rapidly rising commondity prices in conjunction with contracting jobs and asset environment makes a bad situation even worse.

Since credit creation was such an important part of our system, I simply can't see anything that can come close to compensating without restructuring the entire system.....at this point that direction seems to be leading us to an unprecedented level of bankruptcies.

At some point, we will hit bottom....it just that I don't think we are even close yet as there is still trillions of outstanding debt on the verge of defaulting.

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#9) On June 13, 2008 at 4:19 PM, madcowmonkey (< 20) wrote:

alstry- besides the productive work another thing popped into my head that you might want to write on. Think of all the non-taxing paying citizens we support. Throw in most businesses for that matter and you will find a huge chunk of funding that has not been depleted. In some ways, restructuring the tax system could help, a little. 

I am not going to go over the million possible ailments of the current system, but wouldn't it be nice if people that owed the "HOA" actually paid up. I know of too many business pukes that think they are savvy by not paying what they owe and I get a little tired of it. They brag like I am suppose to be impressed, while it sickens me. My philosophy is that you never want to owe the government, because they will just come in and take what they want.

I would be curious how much money is lost to people that cheat on their taxes and how much the tax paying citizens have to pay to make up for it. Just some simple thoughts.

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#10) On June 13, 2008 at 4:26 PM, alstry (36.01) wrote:

Just flip it around a bit.  Prior to the run up in food and fuel over the past six months.....what percentage of Americans lived paycheck to paycheck without much left over.

The estimates that I see thrown around is somewhere between 50% and 2/3.  With the run up and in food and fuel, and increasing unemployment......what percentage of Americans can't make their minimum monthly budget.

 

I see your point above.....but when an artery is ripped open....putting blood back in a pint at a time is not fast enough.

Right now, defaults are exploding causing values to implode.....it just looks like things are going to get very ugly without some sort of alternative stimulous.....and restructuring the tax system is a good baby step forward.

Remember, the new credit issue each year for the past few years exceeded 50% of the annual federal budget.  It was one hell of a party.

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#11) On June 13, 2008 at 4:42 PM, madcowmonkey (< 20) wrote:

Do you write for a tabloid? artery ripped open.......defaults are exploding...... you should have used hemoglobin:)

So, productive work and people paying taxes are good baby steps. I will keep that in mind. Sorry, just people paying taxes would be the baby step, I think the productive work would be considered a adolescent step? 

Well, wish I could chat some more, but work is done and I have grilling duties.

BTW, you aren't one of the guys that thinks they are hedging their fuel costs by investing in oil stocks are you? How do you hedge the price for steak? Corn? 

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#12) On June 14, 2008 at 12:36 AM, jester112358 (28.84) wrote:

I've believed that the undoing of the US has been our de-industrialization.  We train too many people in unproductive professions such as the law or real estate and not enough engineers.  Japan has always put engineers in charge of their company management rather than MBAs.  Thus, Toyota and Honda have destroyed GM and Ford. 

 The solution to your very true analysis of the credit problem:  forswear useless waste of capital on consumption (cable TV, cell phones SUVs) and increase savings, scientific and technical education (how to actually do things) and become more productive and independent as a nation.  This has to happen from the ground up, but a policy start would be to replace income and capital gains taxes with VAT taxes, cut government programs especially entitlements and encourage capital reallocation to the private sector.  Start productive, privately bid, infrastructure programs to improve energy savings such as high speed rail, van pooling improving our energy intrastucture, especially nuclear power.  We didn't get into this problem overnight and we must be patient getting out of  it.   It could take 10-20 years if we start now.    A very good first start would be a price depreciation in  overvalued real estate assets by 20-30% to return true house values to about 3x real income levels, allowing capital to be redirected to improved vocation education and re-industrialization (making our own stuff) and investment via savings.

Your analysis of the central debt problem and our attempt to solve it with more debt is spot on. 

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