Tuesday, April 6, 2010

Expectations for 2010: Credit Writedowns


Three academic economists--Edward Harrison, Marshall Auerback and Mark Thoma--have recently reported on the same phenomenon that has been troubling me.

The "recession" has been declared "over" yet all the problems that produced it remain intact; indeed, these problems have been exacerbated by the consolidation of the too big to fail banks.

The unwillingness to break up these banks and regulate derivatives promise not-to-far-in -the future problems.

Edward Harrison remarks on some of these upcoming problems. I personally think the layoff of public employees is going to be the tipping factor that drives us back into recession because that will significantly erode demand and increase defaults. Indeed, Arizona's sales tax revenue for last month was 4% down year over year from 2009. 2009 was awfull! This further decline is ominous. Anyway, here are Harrison's remarks"

I expect the following to occur:

1.Public pressure to withdraw monetary and fiscal stimulus will work and stimulus will be reduced quicker than many anticipate – beginning sometime in early 2010. The Fed has already said it will stop buying mortgages in March and the Obama Administration is now focused on deficit reduction as evidenced by the paltry jobs bill just passed.
2.The fiscally weak state and local governments will therefore receive little aid from the federal government. This will result in budget cuts, tax increases, and layoffs by the end of Q2 2010.
3.At the same time, the inventory cycle’s impact on GDP growth will attenuate. By the second half of 2010, inventories will not add considerably to GDP.
4.Meanwhile, the reduction of Fed support for the mortgage market will reveal weaknesses there. Mortgage rates may increase, decreasing housing demand.
5.Employment will be weak in this environment, leading to another spate of defaults and foreclosures.
6.The foreclosures and weak housing demand will pressure house prices and weaken lender balance sheets, especially because of second-lien exposure. This will in turn reduce credit growth

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