http://suddendebt.blogspot.com/search?q=foreclosure
SATURDAY, DECEMBER 30, 2006
Bubble Implosion
Household debt represents 131% of disposable income, up from 95% in
2000 and just 65% in 1990 (see chart below). The debt has been taken
on to maintain a reasonable standard of living in the face of slow
income growth versus zooming costs for healthcare, education and
energy. The debt burden has become so onerous that it has to go away -
somehow. But how?
Two things will happen simultaneously, in my opinion:
* A significant cutback in consumer spending.
* A destruction of debt through foreclosures and bankruptcies.
American consumers are already spending more than they make (negative
personal savings rate) and cannot sustain more shopping without
additional income. The effects of a cutback will be felt from mega-
em****iums in Topeka, to truckers and container ****p companies all the
way to China - which is now home to the greatest manufacturing
overcapacity bubble in history. The Chinese have built factories
expecting torrid ex****t growth for the next 5-10 years. Manufacturers
there operate on razor thin margins and are dependent on high volume
for profit. When growth turns to stagnation there will be massive
factory layoffs and shutdowns. A vast swath of the nascent middle
class will disappear faster than a will o' the wisp. Can China switch
to selling its wares to the domestic market? Perhaps for a ****tion of
the manufacturers this is possible but the rest will simply disappear
and the country overall will stagnate for at least a decade or more
while American consumers attempt to rebuild savings. But enough about
China...
The American Debt/Asset Bubble has been blown so large and for so long
that its deflation is a given if only because current incomes cannot
sustain higher home prices and more debt. The pervasive creation of no
money down, interest only, negative amortization etc. exotic loans to
"sub-prime" borrowers was just the last hurrah, the last landing at
the top of the debt ladder. The process is now working in reverse with
defaults rising fast, taking home prices down and cutting demand as
even credit worthy potential buyers pull in their horns. This self-
reinforcing downward spiral will only stop when all the bad debt has
been washed away. The effects will be felt everywhere; from mortgage
brokers, to banks and servicing companies, all the way back to the
malls of Topeka where it will link and amplify the reduction in
consumer spending.
The two processes will merge into one mega-cycle of debt-liquidation
and lower consumption until household finances are repaired. There
will be a long, rolling recession that may be somewhat ameliorated by
the Fed lowering short interest rates, but that will not suffice to
convince lenders to loan to already overextended borrowers. Money
supply will contract, the dollar may strengthen vs. other currencies
and commodity prices will drop - precious metals included. This is the
classic deflationary cycle - one that many people are unfortunately
not familiar with, believing instead that debt liquidation will result
in massive inflation.
A past comment by Mr. Bernanke about "cash helicopters" (before he was
Fed Chairman) has been grossly misunderstood by some to mean that the
Fed will create hyper-inflation in order to destroy debt. In fact, Mr.
Bernanke was describing a hypothetical last-ditch attempt to get an
already moribund deflationary economy back into its feet by brute-
forcing money supply growth - not what should occur in the initial
stages of a slowdown.
To summarize
The Debt Bubble is the natural driving force and a by-product of the
stock and real estate asset bubbles created in lieu of income growth
since solid, well-paying jobs disappeared for the middle class. All
three bubbles will deflate in tandem, probably back to the debt-to-
income percentage levels of the early 1990's. In today's dollars this
means a wipeout of at least $6 trillion in household debt. How about
assets, then?
The current assets/liabilities ratio for households is 5/1; if this
were to stay the same, the implication of a $6 trillion debt
liquidation is for assets to plunge by $32 trillion. This is unlikely
to happen; rather we will see the assets/liabilities ratio move back
to the 1990's level of 6.5-7/1, implying a drop of asset values of
$22-25 trillion, always in today's dollars.
What will this mean in terms of real estate and equity values? I will
deal with that in tomorrow's post - sort of a New Year's prediction...
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