2008: The Worst Recession Ever?
Friday, December 14, 2007 | Teeka TiwariRating:
Can you smell it?FEAR. The market is awash in rank fear. So-called highly educated men and women are at a complete loss as to what action to take.
As I wrote to my Point and Profit members yesterday, there is a lot of very bad decision-making going on right now. Yesterday's PPI (Producer Price Index) was far from shocking, but what did leave me floored was the astonishing strength shown in the retail sales report. This economy just may be a whole lot healthier than people realize.
Currently, the market is being priced for a 2008 recession and rampant inflation. But what if we don’t get a recession next year? What happens then?
2006 was the biggest year for the issuance of subprime debt. It also held the dubious honor of marking the low point in credit standards in almost two decades. Essentially all you needed in ’06 to get a loan was a heartbeat and a bank account.
The interest rates on those loans are due to reset next year. Much of today’s recession fears stem from this massive amount of subprime loans that are due to reset in ‘08.
Current estimates range between $380 - $500 billion in subprime loans due for reset. Let’s face facts: Most (not all - some were genuinely bamboozled into bad loans) of these people bought houses too big and too expensive relative to their income. That’s the reality. If the housing market were left to its own devices, next year could have been the worst recession since the 1930s.
The one saving grace, however, is President Bush’s plan to freeze rate resets. Look, I’m not going to bandy words; this plan is a flat out slap in the face to every prudent American. It’s a reward to the un-savvy and undisciplined. So under different circumstances, I would strenuously oppose this action, and I am sure you would, too. But I’ve taken a step back and looked at the bigger picture, and I want you to do the same.
The banks are running out of money; their subprime losses are V-A-S-T. Now, there is enough foreign oil and Asian money out there that the banks can tap into to shore up their balance sheets. That’s exactly what the major banks have been doing. Citi took $7.5 billion from Abu Dhabi, and UBS recently got $11.5 billion from Singapore and a rich Saudi investor.
So there is enough global liquidity to get the banks through this year's subprime mess. The problem is that if we see massive defaults next year, the banks will not be able to absorb the losses. They just do not have the capital reserves to weather a 2007 and a 2008 financial storm.
We’re talking about a very real, very dangerous threat to our entire banking system. If the banking system breaks, it would be devastating to this country. We are talking massive unemployment, runs on banks and a loss of faith in the US financial system that would take a decade to repair.
In that light, it is easy for me to agree with the rate freezes on next year's subprime loans. It’s not fair, and it's not right, but as investors, we must put our own prejudices and judgments aside and examine the facts. The fact is that credit is the fuel on which the US economic machine runs. Without access to credit, it’s 'game over' for the US economy.
With the mitigation of 2008 subprime losses due to the rate freezes and a currently strong job market, we may very well surprise to the upside next year, big time.
Remember that wages are actually increasing and unemployment stands at 4.7%, which is indicative of FULL EMPLOYMENT! Countries do not go into a recession when everyone has a job, and workers are making more money.
If 2008 shapes up the way I think it will, then the prices we are seeing in today’s market will look like absolute bargains.
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“Let the Game Come to You.”
Teeka Tiwari
Chief Investment Officer
Point & Profit
