More Pain For You And Me: The Economy's About To Stumble

It's semi-official: The economy is about to take the second leg down in a so-called W-shaped recession -- down, up, then down again -- and delicious as it may be to reflect that this disaster has its roots in the administration of George W. Bush, the result for you and me won't be much fun.

Warnings are popping up all over the place. But here's some of what Fed Chairman Ben Bernanke had to say November 16th to the Economics Club of New York:

• "Significant economic challenges remain. The flow of credit remains constrained, economic activity weak and unemployment much too high. Future setbacks are possible."


• "Banks' reluctance to lend will limit the ability of some businesses to expand and hire,"


• "Jobs are likely to remain scarce for some time, keeping households cautious about spending,"


• "The unemployment rate likely will decline only slowly if economic growth remains moderate, as I expect."


• "The fallout for banks from commercial real estate could slow that progress, however."

Translation: Seventy-two percent of America's economy is consumer-based, and since a lot of people are out of work and not buying stuff, and banks aren't lending to businesses that want to hire, the economy will remain slow, unemployment will remain high, corporate earnings will remain weak, and the best we can hope for is that nothing bad will happen.

But good luck with that. People aren't buying stuff, so the companies that sell it don't need all the office space, warehouses, and glitzy mall stores they rented when times were good. This is making life hell for the owners of America's commercial real estate, and in fact, the most prestigious real estate trade group, the Urban Land Institute, predicts the sector is heading for a "bloodbath."

That is why Mr. Bernanke's last caveat about commercial real estate throws cold water over any hopes we'll muddle through; a recent report from CalPERS (the California Public Employees' Retirement System) says that about half -- some $750 billion -- of the nation's commercial mortgage debt will default over the next four years.

That debt, says the report, is already worth only fifty cents on the dollar and is simply not fully recoverable. But left out of that projection is that there's another $750 billion worth of credit default swaps associated with that debt; when the defaults kick in, separate, full-value payments -- over and above the mortgage debt -- will be made from one party to another. So the real losses are more like $1.5 trillion.

This amount is similar to the commercial real estate losses of the early 1990s, when like today, the defaults almost drove us off a cliff. The difference is that the 1990s property was financed with conventional, mortgage-based debt, so that when push came to shove, taking control -- and liquidating -- the property was a fairly straightforward matter.

Not today. Like the home loans that almost destroyed us last year, most of the commercial mortgages now facing default were sold off and turned into bonds. As a result, the liquidation of these debts will drag on for years.

There are all sorts of unpleasant reasons for that. For one thing, commercial real estate ain't beanbag; all the parties have plenty of lawyers, lots of money, and in negotiations, don't worry much about hurting somebody's feelings.

Even better: In a bankruptcy, any bondholder can derail any settlement, meaning the most unreasonable party has the whip hand.

To illustrate the problems, consider the $559 million mortgage bond issue connected to the redevelopment of New York's Drake Hotel, formerly one of the glories of Manhattan hospitality, but now a vacant lot on the corner of Park Avenue and 56th Street.

That mortgage was sliced into 21 separate pieces and sold to eight institutional investors. And in the bare-knuckle world of New York real estate Harry Macklowe, the developer, is not widely known for his sensitive, retiring nature; among the many lawsuits associated with the failed development are his allegations of fraud against the lender.

No serious observer would say that this cage fight has any prospects of a quick, tidy ending. But it should be considered that the country's other developers, lenders, and bondholders are as unlikely as Mr. Macklowe to fold at the first hard looks. Since banks typically hold onto some of the original debt instruments, the result will be prolonged wars that will drag down the earnings of the banks, big or small, connected to them.

That in turn will do nothing to encourage said banks to lend to businesses for, for instance, expanded payrolls. Already, big banks have cut back on their commercial lending--a trend that's accelerating; total loan originations in September at Bank of America fell 6 percent, or $53.6 billion, from a month earlier, according to a Treasury Department, while new loans at Wells Fargo & Co. dropped 14 percent to $47.4 billion. And this is a well-established trend.

In other words, business may live on credit, but so what? Banks aren't making loans. So businesses can't hire, the unemployment rate rises, and the consumer-driven economy falls.

Meanwhile, the Fed's most recent Senior Loan Officer's Survey indicates that what loans are being made are being made by smaller banks--the very ones that underwrote many of the commercial mortgages we've been talking about. These banks are, on the one hand, least able to withstand a sudden flood of bad loans, and on the other, are the least likely to be bailed out by the government if, in fact, the government -- or the public -- had any appetite for bailing them out. And it doesn't.

The obvious result will be a new spate of bank failures on Main Street. This has already been widely predicted, and estimated by some observers to eventually total another 400, or about 8 percent of America's banks. And it's these smaller banks that make loans to your local hardware store, since the top ten banks can't be bothered with that side of the business.

Even if this wonderful scenario was completely untrue, the fact remains that you and I are just not using our houses as ATMs anymore, need $300 jeans, or in general, expect our careers, the economy, or the stock market to rise forever. We accept now that the bubble burst; it was a real shock, but Americans have since grown up some and are acting more rationally than they did in 2006, when the Fed statistics said we were spending more than we had. The consumer economy, in other words, is a thing of the past.

But if the consumer economy is kaput, the American economy has to switch to a more solid and sensible model in order to stabilize for the long term. What that means exactly is for smarter people than I am to say; but it will obviously mean less whimsical spending, and, probably, selling more stuff to other countries instead of to ourselves. That will mean plenty of change in our daily lives, and even more dislocation in the jobs picture.

Since the likelihood of more federal stimulus packages is low -- unless they're called something like a "jobs bill" -- this will mean more pain and an even slower economy. Anybody waiting for things to get back to "normal" -- meaning 2005-2006 -- had better change to sweats and rent a bunch of movies; they've got a wait in their hands.

 

Comments

[deminmo]

Maybe people are not buying big ticket items, but many
retailers are seeing some huge gains over last year. I
can't name my employer, but it is doing very well.
I do believe after reading a lot of economists predictions,
that the worst has not happened. We might be seeing
the beginning of some more bubbles starting in December
2009 through 2011.

[Elisabeth80]

Very well written article.. best advice I can give others this holiday season is to shop cautiously and intelligently.. count your pennies, because in 2010, when property taxes and sales taxes are raised to cover the shortfalls in the state budgets, you won't be suffering financially as much as if spent your precious money on HDTVs and other Black Friday 'specials'

[Indra]

Yeah, your right. And not only that; the economy at present is looking like The Day The Earth Stood Still. Or another way of looking at it is Das Boot where you sit on the bottom and wait for the depth charges to stop. I think people will poop their pants when they see what the retail figures are for this coming shoping season. Hohoho! What really disturbs me however is that no one in government is doing anything to avert the upcoming disaster. WTF!

[grateful4thedead]

Well written piece and thanks for the insights.

As bad as the commercial real estate sector is and will continue to be as accurately described by Mr. Reinbach, the residential sector, much larger than commercial real estate, is still not close to its bottom and enormous problems still lie ahead.

by the way, the FHA is ready to implode, but will likely be sandbagged until after the mid term elections.
hate to say it, but 2010 is going to be very ugly.

[catbite]

households cautious about spendng.

My house may go into foreclosure one day. I was laid off and I might run out of unemployment compensation. So, too, will go my COBRA coverage because I do not have money to pay for that.
I can afford one meat meal a day.

What spending? This sickens me. I'll just add that to the depression.

[deminmo]

If worse comes to worse, think about moving to
the Midwest, it's a little less scary in Missouri.

[January]

Just think: if voters had listened to Walter Mondale when he told us in 1984 that he would have to raise taxes, as opposed to Reagan, we would have remained in the real world. Our real world today is mega-more dangerous, now that it has come knocking on our doors once more.

In the absence of regulation, all that remains is the reality of collapse. So long as voters continue to kick the can down the road, to leave problems to the next generation, the likelihood of collapse grows. So long as voters listen to bubble salesmen, and almost without exception that is how Republicans get elected, the severity of the eventual collapse will grow.

There's no such thing as a free lunch as every "complimentary dinner" invitation shows. While the current administration works to dig us out of our hole, we need journalists to tell us vividly and clearly how we got into it. Beyond the dramatic prosecutions of fraud, we need to see how it was "business as usual" (bubbles as usual?) that produced unemployment, bankruptcy, and a national emergency.

[Username 1]

That is a very insightful comment about Mondale.

The world would be a much better place if he had won.

For example, we would not be allowing fascistic gang stalker groups to stalk and poison people. ( Web search gang stalking for a few details ).

[Master-T]

You mean blindly dumping hundreds-of-billions of taxpayer dollars into the laps of rich investment bankers didn't solve problem? Who woulda thunk it?

[realitytrumpsbull]

Ya THINK? LOL No, the problem with this whole thing is that the people with the Big Magic Checkbook just plain well didn't understand what they were up against, and that in a system where people in this country are BORN 'broke', because if you divvy out the national debt equally, man, woman, and child, it's still something like 40k/head. Too much debt, too much funny-money, bad for people, bad for the country, the credit racketeers want to open up shop again, and the institutions they work for have a pretty big lobby, inmates running the asylum, there, also, this article didn't mention much about the outflow of jobs and money to foreign countries associated with this. Businesses, investors, and people are saying 'see ya later', and heading for exotic, foreign locales, and investing in them. Why? Because operation costs overseas have not yet become totally insane and prohibitive, people aren't expecting a prince's wages for sweeping the floor, and the taxes aren't near as bad. Ergo, companies and corporations that USED to operate in the United States, or exclusively in the United States, have 'diversified' overseas, meaning, they've hedged their bets against political or economic conditions in any one country putting them under.
Pretty smart, those businesspeople, now, if only the rest of us were that smart...

[Indra]

You are so right on!

[USBrit]

One of the biggest costs driving businesses overseas and making Americans uncompetitive? Health care/insurance costs. When your cost of doing business includes a sector that sucks up 18% of GDP vs the norm for most countries of half that or less, and your costs are rising faster than theirs from an already inflated base, you are seriously hosed in the international market. As regards the rest of it, this is what I call the end of the self-consuming society. The seed corn is all gone and all have left are the cobs. Excellent job there supply siders, it has all worked out very well for those at the very tip of the economic pyramid. Too bad that the whole pyramid is about to collapse. The next great American export product? Americans looking for work in other countries, and it is already starting to happen.