What Recovery?

Time Magazine asks the question: If consumers don't kick-start the economy, what will? It's a fair question, coming as it did with the news that April retail sales ticked down again, and unemployment data turned in its 15th consecutive month of blockbuster job losses. As I tried to point out in my article "The Little Engine That Can't" the consumer is tapped out. I asserted long ago that the US economy was not running on real earned dollars, but on borrowed money and credit--"equity extraction." Take a look at this chart from Calculated Risk that I saw in an article sent to me by a reader. It clearly shows just how much of the spending we did in recent years (the blue) came from all those bankers in the hall competing for our business. Our GDP without home equity extraction is represented in red. See what I mean? Those granite counter tops were good money, but guess what...

The equity is gone folks. It continues to melt away, week after week. The housing decline still has a ways to go, and just how eager will banks be to lend as it continues to decline, now that there is no collateral out there worth anything to prop up a loan? Don't look for all these gravely injured banks to start any real robust lending without a healthy, housing market.

For decades bank lending has rested on three pillars, the "three Cs of lending," which were Character, Credit, and Collateral. (Lately the fourth C has come to predominate, "Crime," but there I go again picking on the bankers.) The first was tossed out the window when things like Option ARMs and other trick mortgages were dreamed up by enterprising lenders. Since banks figured out how to avoid risk in a security sale, character hasn't counted for much. If you had a pulse you could get a loan on a house during the boom. And we have all seen just how little credit mattered as well given the sub-prime loan sharking that went on in recent years. But that third C, collateral, is something banks still look at very closely. It is the erosion in the value of this collateral--real estate--that has so burdened their balance sheets with bad debt. If housing values still have double digit percentage point of declines ahead, why would banks lend at any level sufficient to really restart our economy, particularly given the massive debt they already carry? Without that lending, the consumer isn't going to scrape together the cash to start the old shopping craze again. Real unemployment is reaching staggering levels now, the U-6 figure well over 15% and rising. So where is our so called recovery coming from?

Time looks at government spending, with all that stimulus money and shows that only 6% of the $787 billion allocated has been spent so far. What about private investment? Sorry, it fell an alarming 38% in the first quarter of 2009. So government and private investors won't stand in for the Little Engine That Can't. I'll agree with Time when they conclude: "it's hard to see how the U.S. can put together a strong, sustainable recovery," at least in the next few years. I'm inclined to think that we still have a lot of pain ahead before things start to really recover in new industries that survive the fall.