03/18/2010 05:12 am ET | Updated May 25, 2011

Divergence, of Course

It is the best of times. It is also the worst of times and everything in between. You are probably sick of hearing the cheerleading about the recovery. You are probably equally sick of hearing many -- present author included -- pontificate skeptically. Let's look at what is going well and what is going poorly and leave it to you to guesstimate, fume and grapple toward comfort about where the U.S. is headed.

Consumers have not vanished altogether from the marketplace. Some people are still buying many things and many people are still buying some things. We are not buying like we used to. Between January and August 2008 we imported $1.74 trillion on our way to a $491 billion trade deficit in the first eight months of 2008. In total, we tallied a $691 billion trade deficit in 2008. From January to August 2009 we imported $1.23 trillion -- $500 billion less -- on our way toward a $400 billion annual deficit. We are buying a lot less. Our trade deficit is tracking 52% below where it was at the end of August 2008.

Part of this story is the incredible shrinking dollar. The US Dollar has been trading near or below its lowest levels in over a year. Most of the consumer weakness is a result of declining income and purchasing by American households and firms. Our spending is down and our savings are up since 2008. We have seen a decline in personal consumption expenditure of $150 billion since the first half of 2008. We have also seen a decline of $125 billion in non-housing related consumer credit. These numbers are close for a reason.

The credit markets are the area to watch. Despite the excitement in the more widely covered stock markets, the credit markets remain ground zero. These are the markets where households, government and enterprise borrow. This is also where the delinquencies and defaults buffet fortunes. New stock issuance -- raising money by selling stock -- remains very low. Banks continue to lend little and exclusively to those in relatively decent shape. Thus, credit markets have become essential. This is where the US Government does its gargantuan borrowing, where home loans are sold and valued and where more and more corporations turn for funds. This is also where America's retail investors are investing as they slowly move back into markets. It is here where we should be looking to see what asset markets have to say about recovery.

Credit markets are distorted by many interacting programs from the Treasury, to the FDIC and the Federal Reserve. As of Wednesday October 14, 2009, the Federal Reserve owned $763 billion in mortgages-backed securities. The US Treasury has raised $1.4 trillion in debt markets in 2009. Thus, what we see in these markets must be judged in the context of approximately $12 trillion in government intervention. That is a lot of intervention. Across the first half of 2009 about three in four new home mortgages were sold through or to government agencies. Fannie Mae reported $38 billion in losses across the first six months of 2009. Fannie Mae's portfolio presently includes ownership or interest in $3.1 trillion in home mortgages, more than a quarter of all mortgage debt outstanding. Freddie Mac is similarly active in the markets. The private market for mortgages and mortgage-backed securities remains volatile. There is little interest in buying new mortgages not backed by the government. The prices of mortgage-backed securities have risen impressively across the last few months. We do have relatively greater strength in the asset prices in this market. We don't have the kind of activity that helps the macro economy. This is the story of our economy.

Credit markets do well to describe where and why things have improved and where and why the challenges linger. Our Federal Government is deeply involved in the asset markets. Leading banks have access to cash at low rates. A la the New Deal, there exists an alphabet soup of special programs offering support to the banking and financial sector. It is essential to the US economy that these firms survive and put their balance sheets in order. It is every bit as essential that the nation's households survive and get their balance sheets in order. This is only beginning for some and is disorderly and painful for many. There was a 35% yearly increase in personal bankruptcies across the first nine months of 2009: 1 million Americans filed bankruptcy. The period between July and September 2009 broke all existing records for foreclosure filing. Lenders have seized 632,852 homes in 2009, 237,052 were taken back between July and September. Federal, State and local governments are staggering under sliding tax revenues and rising demand for assistance. The Federal Government is running a $27 billion deficit per week in 2009. The State of California and Jefferson County Alabama are struggling to survive financially.

It remains the worst of times for many. Times have improved in asset markets and some financial firms. This is important but, not enough. We will likely see positive GDP readings for the last six months of 2009. Real recovery still requires job growth and strength on household and government balance sheets. That remains in the distance.