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May 1, 2009

What does the movie Caddyshack have to do with today's economic outlook?

Be the ball, Danny.  Be the ball.

Caddyshack is one of my all-time favorite movies.  I often say that everything we need to know in life can be seen and learned in Caddyshack.  As Ty tells Danny, so famously "Be the ball, Danny.  Be the ball."  His message is clear.  You have to see your goal, and believe you can achieve that goal, for it to materialize.

Napoleon Hill was one of the first modern writers to capture that philosophy on paper, in his book Think and Grow Rich.  Tony Robbins has built a huge business espousing the same core beliefs.

And now, that's exactly what the Obama Administration, Treasury Secretary Geithner, and Fed Chairman Ben Bernanke are doing.  They're talking positive about our economic outlook.  Or at least they're being less negative.

Now don't get me wrong.  You can't just "be the ball" in thought, without following through with actions, and expect great results.  But... there's little doubt the actions of the Fed and Treasury are taking hold.  Money is flowing freely, and cheaply to strong borrowers.  They're pumping trillions of dollars into our economic engine to lube the gears that had nearly ground to a halt.  And, they reserve the right to implement additional measures as needed to reflate our economy.  Our economy will recover.

However, just like it took years for the housing and credit bubbles to inflate and then burst, resuscitating our economy is a process that will take time, too.  Some of the more astute analysts I read think it'll be a few years of slow, below trend growth before our economic engine is humming along again.  I can't disagree.  If we resume trend growth sooner, that's a bonus.

And, that's the trick.  During that slow-growth (or no-growth) period, people may find it hard to believe in our economic recovery until they feel the turn in their own fortunes.  It will happen, but it will be a process.  And, if people don't believe it's going to happen, that their situation will improve, they'll retrench further, which could work to spiral back the other way, since nearly 70% of our economic growth depends on consumer spending.

So, to prime the pump we're hearing about "green shoots" of economic growth.  In the FOMC (Federal Open Market Committee) meeting statement released this week, the Fed stated "The economy continued to contract, though the pace of contraction appears to be somewhat slower."  The President's tone has changed too.  He's now more focused on the "Can Do" American ethos that got us to the Moon, than highlighting the economic pitfalls we still face.

So, will the positive talk work?  It definitely won't hurt.  But, we have to look beyond the talking heads.

We can see the rise in the stock market over the past 8 weeks, which pretty much coincides with the turn to more positive talk from the White House, Treasury, Fed, as well as CEOs of financial and other companies.  And, I agree in the tactic.  Positive thinking breeds positive results.  But, as we look for opportunities we need to be wary of some realities too, that can impact our decisions, and personal wealth.  We cannot afford to bury our heads in the sand.

The stock market has risen because companies are now exceeding analysts' expectations.  But, those expectations have been pretty low.  And, we could be in a period of low expectations with chronic bouts of underachieving even those lowered expectations.

As Nouriel Roubini, Economics professor at NYU and Chairman of RGE Monitor points out in a recent writing about our financial sector: "In brief, banks are benefiting from close to zero borrowing costs and fewer competitors; they are benefiting from a massive transfer of wealth from savers to borrowers given a dozen different government bailout and subsidy programs for the financial system; they are not properly provisioning/reserving for massive future loan losses; they are not properly marking down current losses from loans in delinquency; they are using the recent mark-to-market accounting changes by FASB to inflate the value of many assets; they are using a number of accounting tricks to minimize reported losses and maximize reported earnings; the Treasury is using a stress scenario for the stress tests that is not a true stress scenario as actual data are already running worse than the worst case scenario." (RGE Monitor)

That's a pretty sobering assessment.  And, since credit is truly the lubricant of our economy, our financial institutions' viability is critical to returning our economy to trend growth.  We'll hear the results of the recent Stress Tests next Thursday, May 7.  It'll be interesting to hear that assessment of our financial institutions.

Then we have the US Consumer.  Personal savings rates are at a recent high, hitting more than 4% last month.  That's great for individuals, and should be encouraged, but...a penny saved is a penny not spent.  Since our economy is so dependent upon Consumer Spending to drive growth, if we're spending less, our economy will likely grow less.  Additionally, the ATM that many people tapped through Mortgage Equity Withdrawals (MEW) has shut down. 

It's rare that I'm seeing "cash out" refinances now, although I'm seeing a TON of rate/term refinances.  People are seizing these historically low rates and yielding some significant savings.  But, it appears most of them are using that mortgage payment savings to either build their retirement, or pay down other debt.  Most of it doesn't seem to be trickling back into the economy.  That lack of MEW will put a further drain on consumer spending.

Meanwhile unemployment is likely to remain high for some time.  Layoffs, and subsequent re-staffing, are typically lagging economic indicators.  As companies sell less, they try to cut costs, they lay people off as part of that process.  So far, it appears the pace of layoffs is slowing - which is indeed a good sign - but, companies are still handing out pink slips.  I have an Uncle and a close friend who both recently lost jobs.  As people lose jobs, or fear they may, they too will cut back on their spending.  As they spend less, companies sell less, so...they lay off more people to cut more costs.  It's a cycle that only turns around when over supply is whittled down, and demand picks up, so companies can staff up to produce more.

The combined bubble bursts of the housing and credit markets have brought to close an era of massive, unprecedented consumption and over capacity.  That's probably going to take some time to soak up.

Then, there's the Commercial Mortgage Market.  As you've heard me say, I believe this to be another big shoe that's yet to drop.  Or, one that's now starting to drop.  Two weeks ago, General Growth Properties, America's second largest mall owner, filed for Chapter 11 Bankruptcy.  That's likely the tip of the iceberg of commercial defaults. 

And, commercial lending accounts for roughly 22% of American bank loans.  Foresight Analytics, a research firm, reckons that $594 billion of commercial mortgages will mature in America alone between 2009 and 2011.  Not all of those were collateralized, but the majority certainly was.  Richard Parkus, a Deutsche Bank analyst, estimates that some 70% of Commercial Mortgage Backed Securities will not be able to be refinanced, unless debtors bring significant additional capital to the table, due to lost equity, and more stringent underwriting guidelines in place now, relative to those loans' origination. (The Economist, 4/23/09). 

Now, take that number, and ratchet it up by the same levels of leverage we saw for Residential Mortgage Backed Securities.  It's pretty staggering.

I hope that level of defaults was used in the Stress Tests performed on 19 of our largest financial institutions.  Unfortunately, I fear the Stress Tests - like our government's growth projections - may have been a little on the rosy side.  After all, it's hard to Be The Ball.

So, what does this mean?

Basically, yes, we may have moved through the sharpest period of decline in this recession.  But, I say that cautiously.  Q3 and Q4 2009 could prove that another down leg was still out there.  Even if we don't see another precipitous drop in economic activity like the -6.1% GDP of Q1 2009, I think it'll still be negative growth.  That's contrary to what a lot of analysts and certainly our government projects.

But, I do think we're in for an extended malaise.  So, tread carefully.  There are definitely opportunities out there, whether in real estate, private debt markets, equity markets or other investment vehicles.  The trick is to know your horizon, know your risk/reward threshold, and most importantly to make sure that a bad decision doesn't risk costing you everything.

And, for first-time and move-up homebuyers, this is a great time to evaluate your options.  I'm sure there will be many people who will sit on the sidelines too long, and be kicking themselves down the road for doing so.  But, that's the trick about "finding the bottom."  We'll know it 6 months after it's gone.

Be the ball.

As always, call or email if you or anyone you know has questions about financing residential or commercial real estate.  Here are your current rates.  Cheers!  E

Eric Grathwol

Loan Officer

Priority 1st Mortgage

3300 Douglas Blvd. Ste. 270

Roseville, CA 95661

direct: 916-223-4235

office: 866-771-9000

fax: 916-771-9099

www.priority1stmortgage.com

egrathwol@priority1stmortgage.com