Wampum

Strong and Getting Stronger

Via Atrios we find that Stephen Roach, chief economist of Morgan Stanley, is more than a little pessimistic about the U.S. economy:

Stephen Roach, the chief economist at investment banking giant Morgan Stanley, has a public reputation for being bearish.

But you should hear what he's saying in private.

Roach met select groups of fund managers downtown last week, including a group at Fidelity.

His prediction: America has no better than a 10 percent chance of avoiding economic ``armageddon.'' ...

Roach sees a 30 percent chance of a slump soon and a 60 percent chance that ``we'll muddle through for a while and delay the eventual armageddon.''

The chance we'll get through OK: one in 10. Maybe.

In a nutshell, Roach's argument is that America's record trade deficit means the dollar will keep falling. To keep foreigners buying T-bills and prevent a resulting rise in inflation, Federal Reserve Chairman Alan Greenspan will be forced to raise interest rates further and faster than he wants.

The result: U.S. consumers, who are in debt up to their eyeballs, will get pounded.

I, for one, certainly would not want to have any adjustable rate debt right now. It is hard to see how rates can avoid going up and going up fast.

Lots of folks took out low payment, adjustable rate mortgages in order to be able to afford a larger house than they otherwise would have been able to buy. Roach says that half of all mortgages are adjustable and therefore rate sensitive.

When the rates on those ARMs go up, the homeowners will be need to find additional disposable income to make their increased mortgage payments. It is hard to see where that income will come from. Wages are stagnant. Roach notes that "Americans are already spending a record share of disposable income paying their interest bills." When rates go up, those interest charges will rise. The fall of the dollar will increase the price of many everyday items people buy at WalMart. Rising rates and rising prices will soak up whatever disposable income consumers may now have.

If homeowners can't make their soon to be rising mortgage payments, there are nothing but bad choices left. They can declare bankruptcy. They can default and have their homes forclosed. They can try to negotiate a deed in lieu of foreclosure and lose their house but avoid the stigma of bakruptcy or foreclosure.

The best option may be to try to sell the house. The trouble with that option is that many homewoners have little or no equity in their homes. Lenders quit requiring subtantial down payments some time ago. The trend towards using refinancing as a means to fund current consumption combined with the rise of home equity lines as a form of consumer debt will mean that, after transacations costs, homeowners may not realize the amount of their debt when they sell their homes. In addition, I suspect that it has been very low interest rates that have to some degree supported high real estate values. When rates go up, the value of real estate may well fall.

All in all, there may be storm clouds on the economic horizon. If you are in law school, you might want to consider taking that class in bankruptcy. That is one area that looks bullish.

Posted by Dwight Meredith at November 23, 2004 01:53 PM | TrackBack