Surveying the wreckage

This article was first posted  on 27th May 2009:

There's much talk of the recession ending in another year or so, and things starting to get back to "normal". This, I'm afraid, isn't going to happen.

It's always been said that when America sneezes the rest of the world catches a cold. So when the credit crunch started in the United States with the sub-prime fiasco, it wasn't long before most other countries started suffering in the same way.

Let's have a close look at the present situation in the US, so as to gauge whether there is any evidence that the recession may be flattening out or even, somehow, coming to an end.

The US housing market is where it all started, so what's the situation there? Well, in April 2009 new constructions fell to the lowest level on record, down 12.8 per cent. One of the main symptoms of the recession is that banks, in spite of the billions pumped into them through "bail outs" are refusing, or unable, to lend money to people so they can buy those houses.

They're unable to lend sufficient money because their assets, in the form of houses, are still shrinking in value. And nobody knows for sure how much longer they'll continue to fall in value or to what level. Every bank now is in a battle for survival. They have to avoid further losses, even if that means a stagnant business.

Refusing further loans is the easy way out of the mess. So even credit-worthy individuals and businesses can't get credit. Up to now, a huge part of the banking business was dedicated to lending money to house builders for constructing new homes. US banks have around $700 billion of exposure here. That's about 70 per cent of their entire capital.

As we know, banks have historically lent up to and beyond ten times the amount of money that they actually have. We needn't bang on about that again here, but what we're concerned with is simply that the assets on which most banks have based their ability to create and lend money have shrunk in value and are continuing to do so. This has affected the "liquidity" of the banking system and is the reason why so many banks have failed.

There have been rises and falls in the value of the assets held by banks as security in the past. But nothing like this. This is scary stuff, and is the reason why the economies of many western countries are balanced on a knife edge. No wonder all that matters to banks is their balance sheets. But it gets worse.

The US sub-prime mortgage market, where all the trouble started in the first place, is valued at about $1.2 trillion. That's the money that, for the most part, is lost. The banks won't get it back. Most people think that the trouble is confined to that sub-prime mortgage sector - but it's not!

There's an even bigger mortgage bubble, and it's set to burst in the summer of 2009 and on into 2010 in markets known as the option ARMs and Alt-A markets. These are conventional mortgages and commercial real estate loans. And they are two and a half times the size of the sub-prime sector.

All the leading indicators of foreclosure are rising. Probably commercial real estate will go first. The recession has decimated small to medium sized businesses, who are therefore unable to maintain the payments on their commercial loans.

Unemployment in the US has risen to over six and a half million (10 per cent), and in the UK to nearly 3 million, making it difficult if not impossible for vast numbers of people to continue paying their mortgages. And, as we've said, the properties they have been occupying, taken as security for the loans, have fallen significantly in value. It's a vicious circle.

The US commercial real estate market is $3.5 trillion. Sub-prime was about $1.2 trillion, remember? So the coming catastrophe has the scope to be about three times as bad.

On top of all this we have the mountains of debt that have supported our economies in the west for so long. The US and the UK governments are bankrupt.

Take the US. The government has a tax revenue income of around $2 trillion a year. Added to that is around another $2 trillion that it is somehow able to borrow. It has a Treasury Bond Debt (or national debt, if you like) of $12 trillion. Some people maintain the true figure is much higher, but nobody really knows for sure. $12 trillion seems a conservative estimate, but lets stick to that for now.

Added to that is $65 trillion of unfunded social security and Medicare debt and the 2009 budget deficit of $2 trillion. That's a total of $79 trillion total debt owed by the United States government.

If you, as a private citizen, earned $20,000 a year but had debts of $790,000 (the figures are proportionately the same as above) you'd be not only bankrupt but probably in prison for having obtained money by deception. Even if you could borrow another $20,000 each year it wouldn't make much difference (though nobody in their right mind would lend it to you).

In the UK it's not quite as bad, but still pretty awful all the same. Its growing debt burden is expected by S&P to balloon to 100 per cent of its GDP by mid-2010.

It's a Ponzi scheme, a fraud, a racket. No wonder there's such a mess. The only question is, how long can total collapse be staved off? That's the question to ask any ignorant politician or economist who starts seeing "green shoots of recovery".

Until then, remember - spread the word . . .

Philip Gegan


Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.