Monday, September 29, 2008
The Tsunami on Wall Street: West Coast to be hit
While the federal Band-Aid is being applied to Wall Street’s financial mess, it will take a lot more structural surgery, regulatory medicine and healing time before it can begin to support normal growth of the economy. The credit boom of the last decade and a half supported not only the real estate boom but also the generous expansion of state and local economies. On the West Coast, and California, Nevada and Arizona in particular, it led to remarkable expansion in home ownership. While the average home ownership rate in the three states increased by 4.6 percent from 1986 to 1996, it rose by 10.6 percent in the next decade, 1996 to 2006. A large portion of this was fueled by easy credit.
But that is not the whole story. Plentiful liquidity also facilitated business growth financed by venture capital, private equity and hedge funds. Many of these funds made their money on Wall Street, and funded new and small businesses. Given the generally greater tolerance for risk, the growth in general business expansion made rapid strides. But the bust on Wall Street will put the brakes on such rampant expansion and certainly demand a more careful analysis of the expected performance on such businesses. Many of these businesses have already cut back or gone under (for an example, see the Financial Times story at ft.com/cms/s/0/095142b8-8c30-11dd-8a4c-0000779fd18c.html).
The private sector was not the only beneficiary of easy money. State and local governments also benefited. Higher tax revenue and liberal use of the bond market allowed expansion of government programs, from infrastructure to education to benefits for the disadvantaged. The aftermath of the financial crisis will make it much more difficult to undertake these tasks.
It is hard to tell at this time in what ways the current financial wreckage will change the shape of credit intermediation in the U.S. economy. It will certainly not eliminate risk inherent to business and financial operations. But it is most likely to lead to greater regulation and accountability.
Friday, September 05, 2008
The 1929 stock market crash occurred in October. A 23-percent drop in the Dow Index took place on the last day of October in 1984. The stock market also fell by 10 percent on the last day of September in 2001, signaling the beginning of the dotcom bust. Without being superstitious, is there something in the yearly cycle of time that coincides with the economic rhythm of the country?
There is, of course, well-recognized seasonality in the trends of many economic variables, but there is little evidence of a macro-level conglomeration of the woes of the economy that should periodically manifest itself in a sharp jolt to the system at this time of the year. Explanations are offered usually in terms of year-end window dressing by firms, but these do not fully explain the phenomenon.
Yet, forces seem to be lining up for just such a possibility. The housing market shows no let up in its steady downward trend with increasing inventory of unsold homes and declining prices. Credit markets continue to be in a funk. Uncertainty about the fate of Freddie Mac and Fannie Mae is endangering further disruption of the mortgage and related markets. Commercial and investment banks are writing off unprecedented amounts off of their balance sheets and some are in dire straits in raising additional needed capital. Rumors of a major bank failure in the U.S. refuse to go away.
The “real” economy has finally entered the recessionary phase as indicated by the latest employment statistics and the implied downfall in output. The recent fiscal stimulus has dissipated and there is little on the horizon to give households any confidence in maintaining their high spending levels. The latest sales data attest to that.
This slowdown does not need an October to show its colors. We have been in it since mid-2007. Given the current situation it will take a few more quarters before the economy turns around. A great deal will depend on not only our domestic policies, but also on the global economic situation.
Tuesday, July 08, 2008
The Big Question: Stumble or Fall?
The inexorable torrent recently of bad news has the stock markets reeling, with the Dow-Jones index almost in the bear territory. Housing market blues show no sign of going away in the short run. And, the consumer sentiment is quickly descending from mere nervousness to downright pessimism.
There are also concerns about the longer run U.S. economic dominance that we have enjoyed at least since World War II. These arise as much from our overextended military operations, continued weakness of the dollar, high energy prices and the steady rise in commodity prices as from the rise of China, India, and other powers.
If the over-indulgence of our financial sector led to the current turmoil in the credit markets, it is the auto industry that now has become the poster child of failed strategic vision in a world of high energy prices. In fact, the U.S. economy’s overall growth is significantly more dependent on cheap energy compared to those of other countries. As a result, we are likely to be hit much worse compared to the rest of the world if high oil prices persist in the long run.
There is little doubt that we have a prolonged spell of weakness ahead of us and it will take substantial effort to reverse the current trends. But there are reasons for optimism as well. The U.S. has repeatedly faced difficult odds only to recover stronger because of its innovative spirit, flexible markets, deep financial base, and prudent economic policies. Therefore, whether the economy will merely stumble or fall this time depends on these same factors.