In Los Angeles and other big cities many people get lost in the concrete jungle of urbanism. In fact, hundreds of people die alone each year without any human contact with the outside universe. It is as if they have disconnected from the actual grid of social interaction. Every year a service in Los Angeles is done with cremated remains of those who have passed away and city workers, with all their abilities try to find ties with potential family members. You would think that in a technologically advanced age that everyone would have at least one connection to another human in this world. That is not the case.
The reason I bring up this point is how disconnected we have gotten from one another and how this is simply one additional facet to this economic calamity. A few years ago I was getting a loan for an investment property. Nice little place that was out of the state and met my criteria for a good buy and hold rental. I shopped around for the best mortgage rate and found a place online in Arizona. The broker I worked with was a good salesman and all the paperwork was done via the phone and e-mail. Never met the guy. Got an excellent rate and didn’t even have to show one W-2 form. In fact, I could have gotten a loan 5 times as big if my heart desired and that was a scary prospect because it made me realize how little oversight was in the system.
I remember at the time that the broker was trying to push me into an option ARM but I had to explain to him that I strictly dealt with 30 year fixed mortgages. He was sincere in that he believed what he was trying to sell was truly the best product. It was more a case of ignorance and lack of future planning. I think of the $500 billion in option ARMs that will be striking down upon this nation in 2009 and 2010 during the worst economic crisis of our lives. The broker worked for a company that has long ago imploded. Not sure what he is doing today.
That is the ease in which a decentralized economy has allowed people to eliminate any face to face contact. Loans were made across the country to people who could have claimed anything on paper. No one really cared. Everything was front loaded and long-term planning didn’t matter. Like the person that passes away alone, usually the city workers find years and years of unpaid bills, QVC bought items that remain unopened, and observations that may seem incredible to the general public. Yet this is what we have on our hands at the moment. A decade of hidden bets, horrible investments, and toxic waste is now coming to the surface.
The Mighty are not Immune
Warren Buffet who once stated derivatives were “financial weapons of mass destruction” is now facing the wrath of the derivatives market. It is incredible that the cost to protect against Berkshire being unable to meet its debt payments based on credit-default swaps has more than tripled in two months. The swaps jumped over 475 basis points from 129 only two months ago. Berkshire is now down a stunning 43 percent for the year when the previous worst year in its 40 year record was a drop of 6.2 percent in 2001. Seeing this massive conglomerate take a near 50% hit is stunning and a blow to confidence. If the Oracle of Omaha can’t get it right in this market, who can?
Now, it isn’t that the [once] wealthiest man in the world is feeling the pain of the markets but what investments he made to feel the pain. He holds large stakes in American Express and Wells Fargo who haven’t done well in the current market. Berkshire’s income stream largely from insurance holdings is down 77%. His public buy of Goldman Sachs led many sheep to the slaughter thinking he saw value in the once Golden boy of Wall Street. Since that time, Goldman has been cut in half:
We also see the massive banking giant Citi taking a major pummeling in this current market. It is now trading well in the single digits even after announcing a major job cut of 52,000 for the upcoming months. It was the second biggest mass job layoff announcement in history. Take a look at Citi:
This market has no mercy for anyone. It would appear that the only safe place to be right now is in cash.
Consumers Forced to Save
There is a silent depression hitting the nation that is finally coming to the surface. That is the life of living on the edge of financial ruin with only one paycheck keeping you liquid. With unemployment sky rocketing, many people are being forced off that edge in a wave of insolvency. I think a story that highlights this is how a colleague thought that his home equity line and his credit cards were his “emergency savings” and this was his buffer. If he ever needed cash desperately, he had access to a $50,000 home equity line and $20,000 in credit cards. Well guess what? WaMu which was the home equity line provider closed his line down here in California since he was now in a negative equity position and his credit cards have been chopped down to $5,000. In his mind, he has had $65,000 in his savings wiped away. How many others are in this kind of mindset?
You also don’t want to count or trust the government completely. Remember that $700 billion TARP plan that was supposedly going to buy toxic assets? As it turns out, that never happened. Much of the funds went as capital injections to banks. This wasn’t the essence of the plan but these people are making it up as they go along. Ironically, since the bailout bill was passed the market has tanked even further:
A near 3,000 point drop in less than 2 months is a crash. Wasn’t the bailout suppose to stop a crash? Are you meaning to tell me that if the bailout didn’t go through the market would be 5,000 points down? Consumers unlike the government have to operate in a world of money reality. They have no access to bailouts. And people are actually focusing more on servicing current debts:
If you look at the above chart, this is the first significant decline since the early 90s recession. This may on the surface look like a good sign but all it is showing is the massive contraction in debt but also all the debt destruction via bankruptcies and foreclosures where debt is literally evaporating. Think of it this way. You lose your home and go bankrupt and that is all your debt. You technically have no debt at least on paper. But would you really claim this person is in good shape? Many Real Homes of Genius are hitting the market here in California, in fact every 30 seconds to 1 minute a home is being foreclosed on here in the state.
Job Protectionism
The few remaining doubters keep saying this won’t be that bad because we won’t see the Great Depression soup lines. Well what about job fair lines?
Source: Gawker
Someone sent me the above picture taken from a Monster job fair in New York on Wednesday November 12. Normally you would see a sizable line but this time the line curves around the entire avenue block. People are doing all they can to look for work. This is merely a reflection of the poor economic landscape. Maybe it isn’t as powerful as a soup line but you can rest assured many people in that line are distressed.
The climate is such where everyone is on pins and needles worrying about their jobs. Some rightfully so. October was horrible but just look at November. November is already on pace to being the worst month on record this year for the markets and we still have a few days left. What good news is going to come out? Unemployment insurance claims are at 16 year highs which only mean the next job report is going to be brutal.
In addition, many states are cutting budgets back with hiring freezes and also cutting pay for employees. They are not in good shape. California is currently in a special session which seems to be going nowhere. It also doesn’t solve next year’s budget which will be horrific. Things are grim.
Being protective of your job is a natural and human instinct. But even many places are seeing over qualified employees vying for retail jobs (those that are still open). Times are tough and all the data is pointing to tougher times. Gear up and now you know why people are saying, “what the TARP just happened?” What just happened is the crony capitalist on Wall Street with their idiotic politicians just suckered you for a nice chunk of change.
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■California Financial Stagpression: Budget Deficit Hits $11.2 Billion Deficit 6 Weeks after Signing Budget. 5 Reasons Why California will see a Deteriorating Economy in 2009.
■Three Emerging Trends of a Depressed Economy: Pundits Screaming for Economic Socialism, People Going Back to College, and 99 Cent Stores Taste Inflation.
■The Fed Scorecard: 9 Months of Cutting and Red Queen’s Race. Is the Fed Done Cutting Rates?
■Emerging Economic Trends: Housing Swaps, Frugality, and Selling Homes in Lower Priced Areas.
■Stop Saving Now and Spend Those Rebates! The Home Refinancing Well Has Run Dry.
It is now official that the largest economies in the world are tipping into a synchronized recession. Japan and the Eurozone both are now in recessions. This is significant not only because these industrialized zones make up a large portion of the world’s GDP but they signify that systemically we are grouped together in the same boat. It is rather apparent that the U.S. economy is now in a full-blown recession. Citigroup today announced that it will be cutting more than 50,000 of its workforce, the second biggest job cut announcement in history. The only larger job cut announcement in history came from IBM in 1993 with a total of 60,000 employees.
The question now becomes how severe will this recession be? I will venture and say that this will be the worst recession we have seen since World War II. Why? Let me give you 10 clear reasons for this assessment:
Significant Sign #1 - Retail Sales
Retail sales fell by 2.8% last month following a huge decline in auto sales. This was the largest decline since the index began in 1992. The previous record was a 2.65% drop that occurred in November 2001 right after the 9/11 attacks. This was a significant decline right before the crucial holiday season. Credit could not be frozen at a more imperfect time when many retailers make a large portion of their money during the November and December holiday seasons. With 71% of our GDP based on consumption, a 2.8% decline in consumption should cause us pause. No significant outside event such as the attacks in 9/11 caused this precipitous drop.
It wasn’t only this one month. This ugly report caps off four consecutive months of progressively bad reports. The big drop was caused by the automotive industry, which leads us to the second point.
Significant Sign #2 - Light Motor Vehicle Sales
Auto sales posted the worst performance since World War II. Contrary to the notion that only big trucks are feeling the pain, all sectors of the automotive sector are seeing major drops in sales. And this isn’t with lack of help from collapsing fuel prices. Oil per barrel settled at $55 which you would instinctively think would be fantastic for automotive sales. That is not the case. Auto sales are falling because people are unable to spend money they do not have. The credit for financing cars is tight.
There is also a psychological component that people that feel threatened regarding their job security are not going to be in a spending mood. An auto purchase is normally the biggest consumption item purchase many will make only behind a home sale. Plus, the flip side of advances in automotive technology and efficiency make cars last a much longer time. The demand for quality and style has produced fuel efficient cars that can last you many years with basic service. When money is tight, people may start thinking, “you know what, I’m going to hold off on buying that newer model.”
Significant Sign #3 - Housing Starts
Housing starts are an excellent leading indicator to keep your eye on to see when a bottom in housing is nearing. Why? These are builders and investors who have to stake their money in the market to build homes and bring them to market. The above chart clearly depicts that housing starts have fallen off a cliff. We are nowhere near a bottom. The market has too much inventory that needs to work through. In addition, we have at least for 1 or 2 years a steady stream of inventory coming form the worst place. Foreclosures. This almost guarantees that inventory will be high for the foreseeable future.
Until we see a sustained surge in housing starts, we can safely assume that there is no bottom in the housing market. And until foreclosures stop coming online at incredible numbers, we can also assume that inventory will continue to be high for the next few years.
Significant Sign #4 - Single Family Home Sales
New home sales have tanked. The above chart clearly shows that. This goes in line with the housing starts chart. Existing homes have held up a little better but again many sales are simply foreclosure resales. Last month in California 50% of all homes sold were previous foreclosures. There is no distinguishing between the healthy market and the distressed market.
The newly built chart is another indicator to keep your eye on for a bottom. Clearly we are nowhere close to a bottom. The foreclosures that we will be dealing with will probably continue to make the existing sales chart fluctuate within a tighter range while the new home number continues to fall.
Significant Sign #5 - Mortgage Rates Stuck
All those rate cuts and mortgage rates are still higher than early 2003 when the bubble was gaining massive acceleration. We are now back to the 1% range where Alan Greenspan led us shortly after 9/11 but this time, the ammunition of rate cuts has lost any power. As you can see from the above chart we are solidly over 6% and now that people actually have to document their income, there is a relatively small number of qualified buyers for the massive amount of inventory.
You need to also remember that those low 1% rates led to the toxic mortgage business fueled by Wall Street demand. Even though 30 year fixed rates dropped to astonishingly low rates people didn’t prudently take fixed mortgages but elected to go with adjustable rate mortgages such as pay option ARMs or interest only loans. The menu was plentiful especially since documenting your income was voluntary.
Now, you have to document and go with a 30 year fixed and guess what? Not many people qualify for a mortgage even at historically decent rates. The reason rates are not moving lower is the inherent risk in the system. They can cut rates to 0% but it will not do much in this regard to help mortgage rates. People are maxed out.
Significant Sign #6 - Personal Savings Rate Down
The above chart is interesting. You’ll notice the quick spike this year. You may be thinking, “this is great, at least people started saving.” Not exactly. The quick spike which is pretty much already gone is in effect people yanking money out of more risky investments and parking them in savings accounts for a short time. Now, those savings are being plowed through. This wasn’t “organic” savings in that people were saving excess money. This was saving because people needed quick access to cash which they are already blowing through.
This is also seen in data of 401k redemptions. Even last year, people started cashing in some of their 401ks because they needed money. That in hindsight may have been a smart move given the horrid market performance. But the savings rate of Americans has been abysmal for the last few decades. We actually went into a negatives savings rate which is an amazing accomplishment. You can expect this number to go down as the economic storm quickly depletes these emergency funds. Then slowly you will see it go up as people actually have to save to purchase consumption items.
Significant Sign #7 - Consumer Confidence Record Low
Consumer confidence hit a record low last month. This isn’t your run of the mill recession. This is a completely different beast. Consumers are not going to spend if they do not feel confident in their jobs or with the economy. They won’t buy a home if they fear they will lose their job or have their incomes slashed. They will not buy a car if they are anxious about the future.
It becomes a self-fulfilling prophecy. This also fueled the bubble in the first place. A mass movement engulfed everyone believing that real estate never goes down. If everyone believes, then yes it will go up for the near term. But it doesn’t mean it makes sense. On the downside when bubbles burst, the negativity actually will get worse then the actual economic numbers. Unfortunately, the numbers are currently horrific so what is occurring is simply the consumer reflecting the actual reality of the situation.
Significant Sign #8 - Unemployment
The unemployment rate is at its highest point in over a decade. The trend is unrelenting. It is hard to be consuming when you have no money to go out and consume. It is hard to buy a new car when you are unemployed. People who fear layoffs are not going to plunk down hundreds of thousands of dollars to purchase a home. It becomes a vicious feedback loop. The number of mass layoffs is growing each month. Companies are slashing and burning trying to stay afloat. This does not help the economy.
At a certain level employment is the most important factor. It is safe to say that unemployment will go over 8% and probably higher before we actually hit a bottom. In previous cycles, unemployment peaks 2 years after the recession officially begins. If that is the case, we can expect to see peak unemployment in 2010. Certainly a long time away given how things are.
Significant Sign #9 - Household Debt Burden
Consumer debt and mortgage debt is crushing the household balance sheet. With stagnant wages and jobs at risk, this will only get worse in the near future. This is simply the logical extension of spending more than you actually make. Once the fortunes reverse, it only takes one or two paychecks to send many families off the edge.
In addition, with debt service consuming more of a household’s disposable income, there is less money to spend. When housing was rising, it was easy to tap the mortgage equity line and use that money to spend. It almost felt as if the home was a second ATM machine except with no limits. With home prices crashing, that well is dry. Plunking down all the money on credit cards is now ending. Many companies are pulling back credit lines at a time when most consumers will need that money. From a business stand point this makes absolute sense but from a main street perspective, this is another nail in the consumption coffin.
Significant Sign #10 - Crashing Stock Market
And finally, all this is reflected in a crashing stock market. Stock markets are usually the first to predict impending collapse but I would say by this housing and credit led bubble, the first sign would have come from housing starts. They peaked in late 2005 and have fallen ever since. The stock market peaked in August of 2007. Not really a good indicator of what was to come.
The Dow is now down 41 percent from that peak and the S & P 500 is down 45 percent. These are significant drops. We are approaching a 50 percent decline in slightly over one year. This is a crash. And the United States is not the only one facing destructive market declines. Japan, England, Germany, Brazil, China, Russia, Mexico, Canada, and practically every other market has seen similar if not worse declines.
This last year has seen the largest amount of wealth evaporate in the history of humankind. These signs are not pointing to a minor recession. This is a significant worldwide recession.
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