Economic Tsunami

We don’t know what we don’t know…

At the beginning of the year there were concerns about the fallout from the debacle in the sub prime real estate market. This was first evidenced with the collapse of New Century Financial, which was at that time the nation’s second largest sub prime lender. At first blush, people felt that the sub prime issue was contained to the sub prime arena. How wrong we have been.

It only took a few short months for some of the largest banks to acknowledge that the credit issues were also affecting their prime portfolios. It only took weeks for the 10th largest lender, American Home Mortgage, to shut its doors and file Chapter 11. Since then it has been a slippery slope. More and more, banks and lenders are unable to fund loans because Wall Street is not willing to step up and buy the same loans that they had been buying over the past several years. As a result, more and more mortgage banks and lenders are being forced out of business.

Yet, this credit crunch is no longer limited to the mortgage markets, let alone only the U.S. What has happened is back in the day, the rating agencies such as Moodys, Fitch, and Standard & Poors, threw caution to the wind. They were giving the highest credit rating to mortgage backed securities (MBS) when in fact they contained a larger portion of non-performing assets than their AAA rating would suggest. The question of how pervasive this problem is, at the time of this writing, is still largely unknown.

The fear of the unknown has roiled the markets. We simply don’t know what we don’t know. Even so, even with the worsening credit crunch many pundits are still trying to suggest that these problems are contained to the credit markets and will not spill over and affect the American consumer or the overall economy. Strong second quarter corporate earning, solid GDP growth, and other favorable economic indicators seem to support this theory. Any talk of a U.S. recession, let alone a global one, is recklessly cast aside.

The reality is neither the market nor the economy has had time to absorb the information. Therefore, the impact on the consumer and the economy will slowly and painfully unfold in the coming months and years. Some might argue that with the Dow Jones Industrial Average down more than 10% (officially a correction) that the market has already priced in the news. To the contrary, the market may have re-priced concerns about the credit crunch, but the impact on consumers is yet to come. The U.S. housing market has in many ways sustained and contributed to domestic (and international growth), it has fueled spending for domestic and foreign goods, and increased consumer confidence, to name a few.

If we really sharpen our pencils and look at how the credit crunch has so quickly and negatively impacted consumers’ ability to get financing for a new home or refinance their existing, we will have a better appreciation for how this economy with atrophy in the months ahead. Anemic economic growth will haunt the U.S. and global economy. This economic hangover is the price to pay for the euphoric, unrestrained credit boom that fueled the frenzy.

The troubles ahead of us will rival, if not supersede, the most challenging economic crises in modern history. It should not surprise anyone to learn that more and more people are walking into their bank and turning in the keys to their house. For those of us who have purchased a home in the last few years, this could be the best advice yet.

We are facing a devastating economic tsunami. It has been quietly building beneath us – undetectable in an economy that has had no restraints. But as the shore approaches, the wave swells we will crash with devastating effects. In addition, there are interesting economic indicators pointing to a slowdown. Of course, we know of the ‘credit crunch’ and the impact on housing. However, credit cards, auto loans, and other consumer loans are getting tougher qualification guidelines as well. Regardless, there already is a trend that people are using their credit cards more in recent months — probably because they do not have or cannot access their home equity. These cards carry higher (much, much higher) rates and the interest is not tax deductible. What’s more, in one survey, nearly 18% of the respondents indicated they would delay buying a new car this year — this is up from under 7% two years ago. As I see it, the economy is at risk.