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Market Comment

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Recovery Not Sustainable With Stimulation Unwinding

Fri, Sep 25 2009, 06:17 GMT
by Comstock Partners Team

Comstock Partners Inc.

Although the economy has shown signs of a "technical" (as Bernanke put it) recovery, it has been overly dependent on Government stimulation, and is likely to weaken again as stimulation is wound down. While everyone is debating the timing and extent of the withdrawal of stimulation, it is clear that a number of major programs that have propped up the economy have either ended or are scheduled to end soon. Without these programs sustainable growth is not likely as consumer spending, which accounts for two-thirds of GDP, will continue to be restricted by declining employment, lower wages, tight credit and declining home prices. The following are programs that have either ended, will soon end, or cannot continue at their present levels.

1) The cash for clunkers program was instrumental in driving up motor vehicle sales, but has now ended. For the first six months of the year auto sales averaged 9.5 million units a month annualized, and soared to 11.2 million in July and 14.0 million in August as a result of the rebates. The program was so successful that it ended early, and, and according to Edmunds, September sales may abruptly drop back to about 9.3 million. Although the depletion of vehicle inventories will probably lead to increased production for a short time, there'll be no lasting effect on the economy. If anything, sales have been brought forward from coming periods.

2) The $8,000 tax credit to first-time home buyers expires November 30, and, since closings must take place by that time, the bulk of the induced purchases are probably over. The credit was a big support to the housing market as it is estimated that first-time buyers taking advantage of the tax break accounted for a third of recent home sales. There has been some support for the credit being extended or even increased, but this would run into opposition from those opposing increasing the deficit even further.

3) The $1.25 trillion of Federal Reserve direct buying of mortgage-backed securities (MBS) that was to have ended by December 31st will be extended to March 31st, but with no increase in the maximum of $1.25 trillion. The purchases will therefore slow down in coming months and come to a complete halt at the end of the first quarter. The Fed has already bought two-thirds of the maximum amount.

4) The Fed's $300 billion direct purchases of Treasury securities end On October 31st, and is 94% completed.
This program, together with the MBS purchases, has been a big factor in holding down mortgage interest rates and encouraging home buying.

5) With Fanny Mae and Freddie Mac on the sidelines and private lenders tightening lending requirements, the FHA has stepped in as the insurer of low-quality loans that no one else will make. The agency insures mortgages with down payments as low as 3.5%, and is less strict with documentation of income and assets. Until recently the FHA has been a minor player in the market, but now insures 23% of all mortgages, up from only 2.7% as late as 2006. At the end of June 7.8% of FHA loans were either 90 days late or in foreclosure, and the agency's losses have dropped their reserves close to the minimum required by Congress. As a result the FHA may soon have to drastically reduce its lending or seek a bailout.

We have also discussed in recent weeks the "hidden" inventories of houses for sale as a result of delayed foreclosures and the prospect of even more foreclosures coming from scheduled resets of adjustable-rate and interest-only mortgages in the period ahead. We also won't rehash the coming major problems with commercial real estate mortgages that we have discussed many times. In addition consumer credit is falling off a cliff, bank loans are dropping and money supply has been declining after soaring earlier in the year. This will be the subject of future comments. All in all, it seems that none of the economic symptoms discussed in this comment are typical of the start of a sustainable type of recovery that we have seen following every other post-war recession. As in previous recessions caused by a credit crisis, the recovery will be sluggish and uneven with a strong possibility of quickly falling into another recession.

Published on  Fri, Sep 25 2009, 06:21 GMT