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  Posted on: Thursday, December 3, 2009
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Economic Recovery on Life Support

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In our view the economic recovery is on life support and is unsustainable.  Highly unfavorable conditions in three key areas-housing, commercial real estate and consumer spending-make it highly likely that economic growth will be extremely tepid or fall into another recession.

About 25% of all homes with mortgages are underwater with about half of these 20% under and more.  Experience indicates that a large number of these mortgages will end up defaulting if they haven't already done so.  Even now 14% of all homes with mortgages are in default or foreclosure.  Home prices have climbed slightly over the past few months only as a result of the first-time homebuyers' tax credit and the fact that foreclosures have been temporarily backlogged as mortgage servicers have been determining who is eligible for modifications.  When this process is soon completed those not qualifying will be thrown into foreclosure.  In addition we are also facing another round of adjustable-rate mortgage resets that will result in even more defaults and foreclosures in the period ahead.  When this happens home prices will resume their decline, putting even more mortgages under water.  Let's not forget that increasing unemployment and lack of new hiring will result in more households that are unable to keep up their payments.

Commercial real estate (CRE) is another area that will subject financial institutions and the economy to further risk.  CRE prices are already down 33% in 2009 and 45% from the peak with an estimated 55%-to-65% at prices lower than the amount of their mortgages.  About $1.5 trillion of CRE mortgages mature over the next few years, and a substantial number of them will not qualify for refinancing unless already weakened financial intuitions take a big hit.  A large number of the mortgage holders are small-to-medium sized community banks.  This is another reason why these banks are so reluctant to make new loans to small business.

The third leg of the shaky economic stool is the subdued outlook for consumer spending.  As we pointed out in our special report on deleveraging, consumers are in the process of paring down debt and increasing their savings rate, a process that has barely started.  The household debt/GDP ratio is still about 100% compared to a 57-year median of 57%.  While the household savings rate has increased to 4.4% from near zero, it generally averaged between 8% and 9% in the decades prior to 1992.  While an increased savings rate benefits the economy in the long-term it tends to dampen consumer spending while the process is underway.  Also hampering consumer spending is the fact that wages are down 5% from a year ago, unemployment is still rising, new hiring is still declining, net worth has plunged and consumer credit is tight.  Consumer credit outstanding has dropped 4.3% over the past year, the most in at least 44 years.  Household net worth has declined 12% year-over-year, the most in 57 years.

 In sum, the highly negative conditions in housing, commercial real estate and consumer financial situation are totally inconsistent with the view the economy is undergoing the kind of recovery that has been typical in the period since World War ll.   We therefore believe that the stock market is severely overextended and subject to a major decline.   

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