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"Economic Dominoes Falling"
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Economic dominoes falling: Here’s five you didn’t know about
By the time you get to this article you will have probably heard that the US government will bail out the two largest guarantors of the country’s housing mortgage debt, Fannie Mae and Freddie Mac. It was announced by US Treasury secretary Henry Paulson and Federal Reserve chairman Ben Bernanke. While the media rings the bells of alarm on how the sub-prime crisis only seems to be building into a bigger mess before it gets better other issues are ignored, forgotten or not even realized yet.
By briefly paying attention to the news anyone can see that the consumer price index is out of control, making it a public affair that inflation is rising at a record pace. In June of 2008 the Consumer Price Index surged 1.1 percent. The entire year’s inflation rate is currently at 5 percent which is the highest the U.S. has experienced in 26 years. The soaring costs of food and fuel are adding to the woes of Americans that are already facing a credit crunch due to the sub-prime crisis. But what is hiding on balance sheets, trading floors and in the big bank’s boardrooms is a list of problems that could easily spiral out of control beyond the sub-prime crisis.
While everyone understands that the sub-prime crisis was created by passing out loans to unqualified homeowners, most don’t think about the fact that commercial businesses received the same treatment. Foreclosures are forming suburban neighborhoods into ghost towns and those neighborhoods are needing less commercial property and services. Anything like office parks, movie theaters, fast food, strip malls, warehouses and parking garages are finding customers are drying up as the 7,000 foreclosures a day add up to more vacant homes. Ultimately this leads to an increase in commercial property defaults, vacancy and a lack of funding for new projects in the commercial property industry. Industry leaders like Bloomberg and Morgan Stanley are reporting drops could be 15 percent in 1 - 2 years in the commercial property industry.
Ignoring a potential crash of the commercial property market, American consumers still have a long list of secrets in their pile of bills and balance sheets. Forbes released information here, that in May 2008 consumer credit rose $7.78 billion to $2.57 trillion in total consumer credit debt. While home equity went belly up, consumers turned to credit cards to fund their lavish purchases which helps drive the U.S. economy. When comparing the number of $2.57 trillion in total consumer credit debt to worldwide economies it can become quite breathtaking and unsettling. The United Kingdom’s GDP is less than U.S. consumer credit debt totals and so are the GDP’s of Russia, Brazil, Spain, France, Italy and Canada. With Americans hurting and pulling back on paying their bills major credit card companies such as Bank of America, Capital One, Washington Mutual, Citigroup and American Express are bracing themselves for at least a 20 percent explosion in credit card defaults.
With crashes and debt pushing the breaking point of survival in the financial markets and consumer’s lives, the government is briskly picking up the pace of bailouts of financial institutions and consumer’s debt piles. You can see the bailouts in situations like Bear Stearns, IndyMac Bank and Fannie Mae and Freddie Mac. Other bailouts are happening by sovereign funds like Abu Dhabi which forked over $7.5 billion to keep Citibank afloat. All of the bailouts eventually hurt the consumer. When Americans received their $600 tax rebates they paid for it in the next year’s taxes. Currently total credit in the U.S. has went from 150 percent of GDP to 340 percent. This is putting pressure on the value of the dollar as other investors, countries and funds lose trust in the sustainability of the dollar.
If the shell game could be extended for another 10 years some CEO’s, accountants and financial advisers would be thrilled but on November 15th 2007, FAS 157 was made effective for all financial statements for the following fiscal years. The new agreement requires that certain assets held by financial companies, including complex investments linked to mortgages, be marked to market. If there’s no market for those securities — that is, if buyers simply won’t bite — the required markdown could theoretically go all the way to zero. What FAS 157 will essentially do is to force insurance companies and financial institutions to reveals their rotten assets that they have been hiding in level three asset categories where there is a requirement to value them. Once the cat is out of the bag that these assets are worthless, breathtaking losses will be reported putting extreme pressures on the entire U.S. economy. What exactly is hiding in level three assets? These are the huge derivative positions, the private equity investments and enormous slices of the mortgage market. Banks don’t talk about them. The market doesn’t put a price on them.
If the market doesn’t put a price on level three assets, who exactly is putting a price on them? Accountants are given the privilege of guessing what the level three assets are worth and using a “mark to model” pricing method. Big financial institutions like Morgan Stanley, Lehman Brothers, Bear Stearns, Merril Lynch and Goldman Sachs were able to pretend their level three assets were worth a great deal but the new FAS 157 regulations that shell game is all but over. In the 2008 fiscal year losses will have to reported when the level three assets are found to be all but worthless.
All of the potential falling dominoes mentioned have been quantifiable in certain ways and the losses can be predicted even if in the worse light in some way. The worldwide derivative markets are a completely different game in themselves. Derivatives are packaged neatly with sub-prime loans and tons of other financial vehicles at large institutions like Goldman Sachs, USB, J.P. Morgan, Bear Stearns, Citibank and HSBC. If the worldwide derivatives market collapses along with total housing wealth, the stock market, bond markets and the value of the dollar the U.S. economy will undoubtedly flirt with a depression.
Before you believe that the sub-prime recovery is around the corner and the economy is ready to turn around, be sure to remember all of the other pieces of the U.S. and world economies that still remain to be tested. One domino has fallen and continues to crash down taking the next in line with it to a level that many never predicted. Presidential candidates talk as if they have a solution with potential tax rebates like you just received in the mail. By the time you receive your next tax rebate you will probably notice the next domino taking it’s fall. Prepare now and ignore the chain reaction as it brings balance and integrity back to the world markets.
[link to businessshrink.biz]
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