Recession 06 - The Storm Clouds Gather

Recession 06 - The Storm Clouds Gather By William Cate Our economy operates on popular perception, not reality. If you regularly tell enough people that the king is wearing clothes, almost everyone sees the king clothed. Since January 2005, the Press has been increasingly focusing on the bad U.S. economic news and the popular perception and thus the business reality is a slow downturn in the U.S. Economy. The Conference Board Consumer Confidence Index fell twenty points in September. The Consumer Expectations Index fell 21 points in the same month. When consumers see bad times ahead they don't buy durable goods and this creates unemployment. The cycle of bad news is more bad news. This self-fulfilling trend leads to a Recession. The three-dollar a gallon gas price is the driving force behind the 9% 2005 inflation rate. It will drive up the costs of everything that is moved to market by our transportation system. Until wages offset higher prices, consumers can't buy as much with their money. Less buying means fewer jobs. Fewer jobs and less buying are the path to Recession. It's a self-feeding downward spiral. Consumers In Default The American Bankers Association reported that the percentage of consumers in default on their credit cards during the second quarter of 2005 had risen to 4.81%. This is the highest rate of default, since they started collecting this information in 1973. Economists suspect that the defaulting consumers problem in an inability to pay their credit card debt and buy gas at the same time. If this is true, the percentage of consumers unable to pay anything on their credit cards will rise in the third and fourth quarters. For those debtors who realize that trying to live off their plastic isn't a viable economic strategy, they will buy less. This is the path to a Recession. The Bursting Real Estate Bubble The one bright spot in the economy for the middle class has been the appreciation in home values in recent years. In 2004, the average value of a single-family residence rose by 15%. Starting in January 2005, the mantra of the press has been the sky is falling in the real estate industry. The hundreds of "real estate bubble is bursting" articles have changed the popular perception and the bubble is starting to burst. In the San Francisco area, where I live, homebuyers are few and inventory is growing at rates nearly equal to those of the last Recession in local real estate. Fewer properties sell and the sale price is usually slightly below the asking price. During the last local real estate recession of nearly two decades ago, the Recession started along the same lines. From the point that homes sold below the asking price, the value of single-family homes fell 17% in the following year and then an additional 8% over the next three years. Homeowners lost 25% of the value of their homes. Homeowners, whose net worth drops by 25%, aren't consumers. The Real Estate Recession is likely to be much worse this time. To fuel the buying bubble, lenders used creative financing techniques. Borrowers had to assume that the real estate market would continue upward to justify doing the loan. With the real estate market turned downward, they will have to come up with tens of thousands of dollars to remain homeowners. Few will be able to do so. The lenders will foreclose. The added inventory will depress the market further and the bottom of the Recession could see home prices fall at more than 30%. As for the former homeowners, they won't have the money to be consumers and many will have to file bankruptcy. Katrina Adds Worse News There's the badly botched Government Katrina disaster relief effort. The Government's recovery solution will only compound the underlying environmental issues that created the disaster. Keep in mind that all of those Gulf Coast displaced persons are without jobs and in many cases, their employers no longer exist. Most people are debt ridden and many Gulf Coast residents will be forced into bankruptcy. The filings will start in 2006. Few people affected by this Hurricane season will be consumers in the foreseeable future. The Government's 9/11 response was emotional. It wasn't logical. Post 9/11 Government policies put increased pressure on our business and financial infrastructure. Compliance requirements are moving many employers toward bankruptcy. For example, 66% of America's Flag Airlines are in Chapter 11. A failure business structure adds to the pressure for a Recession. The Government Mess It was logical to displace the Taliban in Afghanistan. It was illogical to invade Iraq. Unlike WWII, where defense spending meant massive employment in shipyards and assembly plants, modern war requires far fewer workers and those needed are usually highly skilled. The military spending is contributing to the economy's Recession bias. I strongly favor free trade. However, it must create as many jobs in America as it does in China or India. The Government's failure to ensure employment balance is a major contributor toward a growing U.S. tendency toward Recessions and Depressions. The New Bankruptcy Law In October, we'll have a new Federal Bankruptcy Law. It protects lenders. It hurts the public who will be forced into filing bankruptcy during hard times. In fact, it could put some middle class Americans permanently into poverty. The Democrats have wisely distanced themselves from this Law. The Republicans will take the brunt of what is certain to be growing voter hostility as the Bankruptcy Court destroys them or their relatives. This will lead to political change and thus economic uncertainty. The Crystal Ball So what does my crystal ball see for next year? I see a Recession and regime change on the Death Star on the Potomac. Over the years, my crystal ball has been about 85% right. The unresolved issue is the ability of the Government to change public perceptions away from Recession and toward the Promised Land of employed and contented voters.