Today’s Contemplation – Things Are Not Getting Better for Awhile!

Other than limited comments about articles in the media I seldom give my opinion about what the future holds. Considering the condition of the various markets adding my voice to the of voices already out there certainly will not make the situation anymore confusing. To demonstrate that I have some knowledge of the financial/economic system, here are a few comments about who I am and what I do:

1. I have been in the banking/finance business for almost 3 decades
2. Most of my time was spent on the consumer side business in Risk Management
3. I talk regularly with my friends in the business, that are now in other major banks, financial institutions, and regulatory agencies.
4. In my current position I complete a monthly update of current economic conditions and forecast losses for the mortgage and home equity portfolios.

Where we are today:

1. We are currently in the midst of the worst decline in housing prices since the Great Depression. The decline results from over-leveraging asset purchases coupled with weak underwriting practices at a number of banks. Basically, the banks and other creditors (those who bought the debt securities) took on too much risk.

2. This decline in housing prices and the associated defaults on mortgages and home equity lines and loans are causing a dramatic increase in non-performing assets and losses at banks (includes S&Ls), that will take some time to work-off.

3. The mortgage losses have put the banks and mortgage insurance industry at considerable risk.

4. Although little is said about the commercial real estate market, the significant weakness in this sector will have profound effects on many local and regional banks.

5. The continued problems at the banks, has led to a number of failures and mergers in the industry (Indy Mac, Wachovia, Countrywide, Washington Mutual, etc.).

6. Due to the losses and uncertainty surrounding the value of homes, banks have largely stopped lending in this sector or made qualifying for a loan very onerous. This is “choking-off” the demand for houses, because the demand for houses is ultimately a function of one’s ability to borrow. In turn this is further depressing the price of homes.

7. The fear of continuing losses at the banks, uncertainty about the value of collateral, etc. is causing severe tightening in the credit markets, including bank to bank, bank to business (commercial lending), and bank to consumer (retail lending).

8. Losses in real estate are spilling over into other loan portfolios such as auto and credit cards as the economy weakens. Other smaller consumer portfolios such as RV and boat are extremely weak.

9. The severe tightening in the credit markets has caused portions of the credit markets to “seize-up” and no longer function.

10. The significant drop in real estate prices, severe tightening in the credit markets, and the associated decline in economic conditions is causing widespread panic among investors. One way this is manifesting itself is in widespread redemptions at mutual funds and hedge funds causing a significant “crash-like” drop in stock prices over the past two weeks.

11. The purpose of the Bail-Out Bill (TARP) is to keep the banking system in functioning. By definition it does not and will not address deteriorating conditions in the housing market.

12. The success of the Bail-Out Bill is not guarantied. In addition it is changing in its scope and execution as cooperation is sought with banks in Europe.

13. The various world governments and central banks are working extremely hard to avoid the mistakes made in the 1930s, namely tight money and a lack of international cooperation. However, with that said success is not guarantied. The mistakes of the past are understood, but no one knows if the current actions are sufficient to avoid an economic catastrophe.

14. By the time this is all over, the bill for this “bail-out” of the financial industry will cost over $1T (that is T as in trillion, $750 B for TARP, $122 B for AIG, and we haven’t started adding up the FDIC losses or additional bail-outs yet). Admittedly, much of this will be repaid over time, but the money still has to go out the door now.

15. By the way, in terms of being repaid on the $1T mentioned in point #14, " I'll believe it when I see it."

Where we are headed:

1. Due to the panic selling and concerns about the preservation of capital expect the stock market to continue to fall. How far will it go? Not sure, but a DJIA in the 6000 range would not be surprising.

2. Will the recovery be V-shaped like 1987? Probably not, the economy in 1987 was in much better shape than the economy now. The market will probably decline and then bounce along the bottom for some time. Don’t be surprised if this bouncing along the bottom lasts for 2 – 4 years.

3. There is a good chance there will be a stock market rally between now and first of the year, but after the first of the year the market will reach new lows as economic conditions deteriorate further and earnings are weak.

4. We are probably in the midst of a long-term bear market that started in January 2000 will probably continue until 2011 – 2015.

5. Banks and other financial institutions will continue to suffer from on-going loan losses. Losses in 2009 will probably be worse then 2008.

6. The banks will probably take until 2011 or 2012 to work-off their inventory of bad loans, non-performing assets, and OREOs (real estate owned largely resulting from foreclosure).

7. The housing market will not recover for some time (2 – 4 years). The housing market needs to work through its inventory of existing homes and the shadow supply of homes (people that want to sell but will not due to poor market conditions). This will be difficult because conditions in the credit markets and declining economic conditions will make it difficult to borrow.

8. The de-levering of the economy will continue. How fast or slow this proceeds depends on how well the stabilization efforts of the world’s governments and central banks works.

9. The financial crisis playing-out in the media everyday is only half the problem. The difficulties in that sector are only beginning to be felt in the consumer economy. Expect a difficult holiday season in 2008, which will continue into 2009 as the consumer finds little to be optimistic about.

10. The banking/finance industry in the US and many other countries will undergo significant changes, mostly in the form of new regulations.

11. Two businesses in the US that will shrink significantly and will be slow to return to their former prominence (a generation) are investment banking and consumer mortgage/loan brokers.