Comstock Partners, Inc.September 17, 2009
Treasury Report Doesn't Support Market's Optimism
Earlier this week the Treasury Department announced that since the financial emergency was over and the financial system had stabilized, they were removing some crisis-related programs and going on to a new phase. As the Treasury's press release put it, they were moving "from rescuing the economy to repairing and rebuilding the foundation for future growth". While it's true that the Treasury together with the Fed helped avoid a systemic collapse of the economy and financial system, the press release glossed over the serious problems that still remain, and most of the media did not go beyond the brief release. However, the Treasury's web site did include the full report, which indicated their major concerns about the period ahead. Since it's unlikely that many people have read the full report we have quoted from it as follows:
"While meaningful progress has been made in rehabilitating the financial system, the normalization of financial markets achieved to date is partial and fragile, and the economic recovery is, at best, in its early stages...The housing market is still under pressure...significant parts of the financial system remain impaired...new unemployment remains elevated, output has fallen significantly, foreclosures continue to rise, and credit to households and businesses remain constrained.
"...Credit losses in some parts of the system are still increasing and bank failures, which tend to lag economic cycles, are still on the rise. These conditions create an environment in which new shocks can still have outsized effects...the financial system is still fragile, and some of the improvements we have seen in many financial markets are still largely dependent on the support of extraordinary policies.
"...In residential real estate, although the rate of deterioration has slowed, the market has not established a firm bottom, and foreclosures continue to rise across all classes of mortgages, with prime mortgages now leading the way. The restructuring process for commercial real estate has only recently begun. The pace of bank failures has increased and it is expected to remain elevated for some time.
"...During this difficult period of adjustment, the system could be sensitive to unanticipated market events. Further, in those markets where conditions have improved, it is unclear whether the improvement to date will persist without a period of continued government support.
"...adjustment in the housing market is far from complete. Construction activity and sales appear to have bottomed out over the summer, but there is still a substantial overhang of vacant and unsold homes...a very large proportion of home owners now have mortgage debt that is greater than the value of their homes, and the labor market is still weak.
"...The issuance of new debt instruments backed by new consumer loans, known as ABS, has improved with the support of the TALF program. This is a critical channel for supply of new credit to households. But there has been little issuance of ABS that is not supported by TALF.
"...Many small banks have relatively high exposures to commercial real estate loans, where credit problems are still growing, and other troubled investments."
The Treasury's report reads a lot like our recent comments (see archives) and indicates the concern with which the Administration still views the economy. Bernanke's view that the recession was "technically" over came out at about the same time, and was met with cheers by investors overlooking major problems much as they did in late 1999 and late 2007. We doubt, though, that the Fed Chairman, if pressed, would disagree with the Treasury report. We think that the market is overbought, overvalued, and subject to major downside risk.
(Full report is available at www.ustreas.gov. Click on "recent news 9/14/09.")