Wednesday, June 30, 2010

The 2011 Second Plunge Recession

Arthur Laffer makes a convincing and terrifying argument that we’re heading for an economic cliff next year. It’s going to happen. Make your plans accordingly.

"Tax Hikes and the 2011 Economic Collapse," Wall Street Journal, June 6, 2010. The subtitle: "Today's corporate profits reflect an income shift into 2010. These profits will tumble next year, preceded most likely by the stock market." When the cash for clunkers program was paying people significant incentives to buy cars, sales spiked. Lo! Incentives work! But when the program ended, sales plummeted. Much of the sales spike was just people shifting their purchase plans forward.

The same thing happened with the $8,000 that the government offered as an incentive last year for people to get out and buy a house. When the incentive ended, guessed it...plummeted. Much of what the publicly funded incentive either subsidized people who were buying anyway or concentrated in a shorter period of time sales that would have happened over a longer period. Undoubtedly it brought some people into the market who otherwise would not have entered, but Laffer's point is that the numbers are far overstated, and that we can see this in the collapse that followed the spike.

Now, consider that the Bush tax cuts are set to expire on January 1, 2011. Given that this Democratic Congress that grasps at people's money, but succeeds only at getting deeper into debt, has no plans to make those cuts permanent, people are doing what you can expect them to do in response to incentives and disincentives. They are using every means to move 2011 income into 2010, giving the misleading impression that the economy is recovering. But it's just a sugar high. 2011 will see a tremendous crash as a result of the massive tax hikes that are scheduled to hit the people who have money. Laffer details those taxes.

But, really. Obama's technocrats have it all figured out. They don't hand out Nobel Prizes like candy at a parade, you know. What could possibly go wrong? Here, Nassim Taleb, author of The Black Swan, his book on unexpected events (oh, say, housing bubble bursts, devastating oil spills, that sort of thing), has dark things to say about our economic situation and the people trying to steer us through it. Bloomberg reports that he considers President Obama "clueless."

As if that were not enough, the housing crisis is not over. The government, via the Federal Housing Administration, is fueling its continuation. Stephen Meister, in "The Next Disaster: Federal Mortgage Insurance," explains how.

In 2006, the FHA insured just 3 percent of home mortgages; today, it insures one of every three. Together with Fannie and Freddie, the FHA is putting the risk for the entire, $11 trillion US home-mortgage market on the back of the American taxpayer.

FHA also insures one in five refinances. Whereas private lenders--who are in the business of managing risk--are asking10-20 percent down when they lend at all, FHA requires as little as 3.5 percent down. As before, people in risky situations who really shouldn't be in the housing market are being facilitated into homes for political reasons, not market based ones. Also as before, many of them will default. But unlike the last time, the bulk of the loss will fall on the public treasury. That's a huge chunk of $11 trillion.

Thanks to the FHA, subprime-mortgage lending is alive and well. And thanks to Obama's latest program, private-mortgage investors will be able to pick the riskiest of their not-yet-defaulted underwater loans, and get them off their books and onto the FHA's. Bottom line: The Federal Housing Administration is continuing the toxic policies that produced the housing bubble and the subprime crisis, and putting the taxpayers on the hook for it. Expect it to be the next big bailout. 

Feeling down? Now meet the third Spirit of Crisis Yet to Come. Kevin Hassett of the American Enterprise Institute examines the Greek debt crisis and sees, if not an inevitably collapse, then at least a terribly brittle and shaky sovereign debt situation stretching from the east end of Europe to this side of the Atlantic. ("Greece's Bailout Heroes Arrive in Leaking Boats," Bloomberg Businessweek, May 16, 2010.

During the financial crisis, faith was restored in large financial institutions because toxic assets were essentially exchanged for government bonds. If government bonds become toxic, there will be no effective treatment options remaining. The collapse will have no bottom. And that collapse could happen at any moment.

Oh my. And our President is speaking to us from the Oval Office about energy-efficient windows.

A 2003 working paper by the International Monetary Fund puts in chilling perspective the debts we have been running  for the last couple of years.

The paper...studied historical sovereign-debt crises, exactly the situations that Western nations are hoping to avoid. They found that external debt levels -- money owed to foreigners -- exceeding 50 percent was a key indicator that debt default may occur. Here is the chilling fact: the average external debt as a percent of GDP among countries in their sample the year before a sovereign debt crisis was 54.7 percent, and 71.4 percent in the crisis year. The U.S. external debt on Dec. 31, 2009, was $13.77 trillion, or almost 100 percent of GDP. For much of Europe, the story is worse.

The lesson in each of these cases is that economics, something like physics, is unforgiving. There's no free lunch. Debts come due. You can put them off, but not indefinitely (though politicians like to fool us into thinking we can). The bigger you let them get and the longer you put them off, the deeper they bury you when they come back at you.

A more polished version of this appears at under the title, "We're Doomed."

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