(Can the Markets hold up under this kind of pressure?)
This Crisis Won’t Stop Moving
GRETCHEN MORGENSON
Published: February 6, 2010
YOU know we’re in trouble when we’re told that the economic problems in Greece, Portugal and Spain, the most indebted countries in the euro zone, are likely to remain safely contained in those nations.
After all, we heard the same nonsense in 2007 from United States financial leaders talking about the subprime mortgage mess. Both Ben S. Bernanke, the chairman of the Federal Reserve Board, and Henry M. Paulson Jr., then the Treasury secretary, rolled out to reassure concerned investors that troubles in mortgage land wouldn’t permeate the rest of the economy.
As we all now know, mortgage woes were contained — to planet Earth. And so it may be with overleveraged nations in Europe.
Simply put, contagion is a fact of life in our interconnected global economy and financial markets. And that means investors must strap in for more gyrations in the stock and bond markets as the great and painful deleveraging that began in 2007 continues around the world.
Sure, there are rays of light amid the gloom. The slightly upbeat jobs report on Friday, for example, is an example. But it is only one data point and not enough to move the needle on much larger issues that remain, including investor fears that Greece, Portugal and Spain will default on their debts.
“This is a reminder that every country has its limit,” said David A. Rosenberg, chief economist and strategist at Gluskin Sheff & Associates in Toronto, one of Canada’s top wealth management firms. “And our heightened concerns over sovereign credit quality are not going to abate anytime soon.”
During his years as chief economist at Merrill Lynch in New York, Mr. Rosenberg was perspicacious indeed. So his take on the potential fallout from financially stressed countries is a valued one.
First, Mr. Rosenberg reckons that the flight to the dollar will continue. Even though the United States has plenty of its own economic challenges — enormous public debt weighing on a struggling economy, for example — our lot is far better than others’, he maintains. “In the land of the blind, the one-eyed man is king,” he said. “The U.S. dollar is that one-eyed man.”
But that does not mean we are finished with our own debt purge.
“Watching the situation in Europe, it’s not even clear that the root cause of problems here at home has been solved,” Mr. Rosenberg said. “We still have a very fragile situation: household balance sheets, and delinquencies, defaults and home prices are still vulnerable to another down leg. People think because you finish one chapter in this post-bubble credit collapse that the book is done.”
As for housing prices, Mr. Rosenberg expects further declines of 10 to 15 percent over the next few years. He pointed to the roughly nine million residential housing units available for sale across the country, a very high vacancy rate when judged against a total housing stock of 130 million units.
If his forecast is accurate, the numbers of borrowers who owe more than their homes are worth will rise significantly. Mr. Rosenberg estimates that fully half of the mortgage-holding population in the country could be underwater by 2011.
For now, these borrowers are getting little to no help from lenders — no surprise — or from the government. Indeed, the Obama administration’s loan modification program has more or less allowed banks that own second mortgages on troubled borrowers’ homes to continue to press for full repayment of these obligations.
When it comes to writing down principal amounts on mortgages, the government has pressured those holding the first mortgages more than the institutions holding the seconds. Never mind that the second liens are worthless and should be written down to zero.
THIS see-no-evil approach to second mortgages is part of an overall denial on the part of policy makers, politicians, bankers and regulators that has prolonged the agony of this crisis. Owning up to reality about what loans are worth is rough medicine to take, but denying that problems exist only puts off the inevitable.
“We are much further along the road to price discovery and full disclosure than Japan was at this same stage of their credit contraction,” Mr. Rosenberg said. “There are still some very significant credit problems in the U.S. and as they pertain to commercial real estate are still extremely problematic. Some banks will likely be whipped very hard.”
The challenge for Mr. Obama is that he has thrown oodles of taxpayer money at these problems and still the unemployment rate stands at 9.7 percent.
“We came off a year when you could not have asked for more government stimulus and we lost five million jobs,” Mr. Rosenberg pointed out. “What do you do for an encore? The deleveraging is ongoing and yet the government stimulus is largely behind us. That is problematic for an economic forecaster.”
The fact is, to save the world from economic collapse we have transferred the liabilities of the private sector to the public. And not every country has the money to service or repay that debt.
“We are in a post-bubble credit collapse and there are going to be periods of calm and stormy weather. Investors will have to navigate through the volatility,” Mr. Rosenberg said. “Unfortunately, I think we are still in the early stages. The next recession will happen more quickly than people think.”
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