The concrete industry faces tough questions whenever the economic horizon is cloudy. Managers must decide on the timing for capital expenditures, how to plan staffing levels, and many smaller decisions in between.
The main question posed to me several times in the last few weeks goes like this: “Great, so government-backed mortgages are the solution going forward, but what about the billions in existing mortgages?”
Actually, Wall Street has a solution for more than $2 trillion in securities sold globally and backed by loans to U.S. homeowners. Its premise is based on two long-accepted beliefs and one newer one. The prevailing logic was that the value of the American home would never fall nationwide, and people would almost always make their mortgage payments.
Now there's a new twist. The market believed that by packaging mortgage loans and turning them into securities it would make the global economy more resilient if anything went wrong. The fears center around the shattering of those widely-held beliefs, as the news gets worse on accelerating defaults, contracting housing values, and shrinking new housing starts. All point to the fear of recession and economic uncertainty.
Why there will be no recession
In the interest of calming our readers, I will step out and call it: no recession. Here's why:
- So far, the potential losses look manageable compared with the savings-and-loan crisis of the 1980s and the tech-stock crash of 2000-02. Home prices are down by 0.5% to 10% now, depending on the measure used. If they fell 30%- what it would take to restore their historic relationship to inflation, rents, and incomes-$6 trillion worth of housing wealth would be wiped out. Measured against the size of the U.S. economy, that is less than what was lost in the stock market from 2000-02.
- Losses on subprime and similar mortgages range from $150 billion to $400 billion. The latter would equal about 3% of U.S. annual economic output, which is similar, in real dollars, to the losses suffered by S&Ls and commercial banks between 1986 and ‘95.
- At press time, the Bush administration was unveiling a private-sector fix. First, it urged big banks to create a new entity to buy some mortgage-linked securities that don't have a ready market now. And a plan was being finalized to freeze interest payments for hundreds of thousands of qualifying homeowners whose mortgage notes are set to rise in the months ahead.
- Housing comprises a much smaller share of the economy than business investment, which dragged the U.S. into recession in 2001. Also, the rest of the world is stronger than in 2001, boosting U.S. exports. For the entire U.S. economy to contract would probably require a broad decline in consumer spending, which hasn't happened since 1991.
- And most importantly, the Federal Reserve Board has cut short-term interest rates three times so far, and is expected to continue to manage rates to assure the economy doesn't contract. The credit market problems are not nearly as serious as those of the 1980s, when many major banks would have been insolvent had they valued their Third World loans accurately. Further, the difficulty of valuing today's mortgage securities means markets may be factoring in far larger losses than will actually occur. Although the Fed is still worried about inflation, it has room to cushion the economy with additional interest-rate cuts.
Remember, it is an election year, and the Bush administration will do everything in its power to steer us to an expanding economy.