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Kimberly Amadeo

CFO's Predict W-Shaped Recession

By December 2, 2009

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Most (75%) senior finance executives don't expect a recovery until July 2010 or later, while nearly half think the economy will actually worsen before its gets better. Increased economic uncertainty, like the Dubai default, makes them think the economy still runs a risk of a W-shaped recession. These are the results of an October poll of more than 140 financial executives conducted by Adaptive Planning.

Why are business leaders so pessimistic? Nearly two-thirds missed their revenue plan in Q2 - more than missed it in the first quarter. Maybe that's why 75% reported economic conditions are the same if not worse than six months ago.

These business leaders are experiencing a shift in the whole way they do business. Nearly 60% say they face high or very high uncertainty now. They are buffeted by an onslaught of unexpected changes to their business, such as bankruptcies of key customers or suppliers, loss of bank loans, and decreasing demand. As a result, they are not confident of their ability to predict the future, making 60% of them reforecast their entire business every month. I outlined the causes of this uncertainty in September in Why the Crisis not Over Even If the Recession Is.

What This Means for You

Although nearly half expect revenue growth for themselves in the near future, only only 14% plan to hire by Q1 2010. In fact, almost 40% expect more layoffs.

This increases the economic uncertainty in your life. These business leaders are learning they need to change their plans every month, to respond to changing and unpredictable circumstances. So should you. Flexibility and responsiveness are the keys to doing well in an economy that has no clear direction. The articles below will show you how.

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December 8, 2009 at 11:36 am
(1) Leonard C. Tekaat says:

To Professor Ben Bernanke:
Chairman of the Federal Reserve Board

I would like to share with you a couple of ideas that I have been working on since 1982 when we had the last Great Recession. Not much has changed from then other than Wall Street has developed new processes for handling risk and volatility. I believe there is a major flaw in our economic policies. This is why we keep repeating the recession, inflation, and depression cycle.

Increase The Disposable Income Of The 90% Will Help Re-employ The 10%

Helping the unemployed maintain their body and soul with social programs is a noble effort but will not create enough economic demand to put them all back to work any time soon.

By increasing the purchasing power of the 90%, by reducing their mortgage interest payments and rent payments, would stimulate the economy by increasing demand, which would put the 10% unemployed back to work, reducing government liabilities, there-by reducing the deficit.

The 5/1 Adjustable Rate Mortgage has a starting 4% interest rate that stays at 4% for the first 5yr and then after 5ys it is tied to an index. People do not want this type of mortgage because of our recent history and the uncertainty of the future. Fannie Mae and Freddie Mac could purchase 30 yr mortgages with a starting mortgage rate at the currant 10yr Treasury note rate or below (3 to 3.5%) and then the interest rate would increase 1/4% per year. The mortgage interest rate would max out at 5%. To reduce defaults the person would have to qualify at the 5% interest rate. The Fed or US Treasury would buy the securitized mortgages until the housing market stabilized and then sell the securities to investors. This stimulus program would not cost the taxpayers any money. It would also lower rental rates and increase home owner-ship.

If this stimulus mortgage had been available a year ago our economy would be in better shape today and the Federal government would not have tried to stimulate the economy with its huge deficit. Had the people been given the opportunity they would have stimulated the economy. It is not true that when nobody is obtaining loans that the government must deficit spend. Empower the people. Banks are only as strong as their customers.

To help prevent economic bubbles and excessive use of credit the ZERO INFLATION TAXATION POLICY should be enacted. This policy will help the Fed control inflation and inflation psychology at the correct time in the economic cycles of inflation and recession.

Wall St. economic advisors surround President Obama. They are more concerned about the financial system than Main Street.

All government stimuli spending on Main Street is designed to maintain minimum income for people that are unemployed or in need of direct help. This maintains minimum demand. What the economy needs to end the recession is to increase demand more. The way you do this is by lowering taxes or lowering interest rates. If you lower taxes or give tax credits you increase the federal deficit, which has to be paid back with increased taxes or an inflation tax. On the other hand if you lower interest rates it does not cost anything. The Federal Reserve has done this for the financial industry but the banks have failed to pass the discount thru to Main Street. I propose the Fed or the US Treasury lower interest rate directly to Main Street by one option that is open to them. That option is thru the housing market where the current economic crisis originated.

Enclosed you will find my opinion and solution to unemployment and the underwater mortgage problem, which I sent to the HUD secretary.

To Secretary Shaun Donovan:

I am a retired economic analyst, economic scholar, businessman, financier, investor, author and former candidate for California Congress. I have over forty years in the financial world.

The increasing number of foreclosures is weighting down our economic recovery. It is imperative to FHA and the GSEs and the economy, that they are decreased. Consumer’s confidence and financial condition must be improved if we are going to have a lasting economic recovery.

Enclose you will find an economic paper I wrote that outlines a program that will improve our economy and decrease foreclosures and unemployment. It will help the financial condition of FHA, FNM and FRE.

Mortgage Interest Rate At Historical High

If there is one thing a capitalistic economy needs to operate efficiently is a means of exchange that is in balance with available supply. Leonard C. Tekaat

The private financial industry has failed to bring mortgage interest rates down sufficiently, to help the economy recover from the deepest recession our economy has experienced in 70 yrs. With the Fed funds rate at near zero, the 30-year fixed rate mortgage rate should be much lower. From 1993 to1998, to pick a period that the economy was operating fairly well, the 30yr fixed rate mortgage interest rate was approximately 100% above the Fed funds rate. The Fed funds rate was approximately 3.5% and the mortgage interest rate was approximately 6.5%. The inflation rate or Consumer Price Index was approximately 3.5%. The fixed rate mortgage interest rate was approximately 300 basis points above the Fed funds rate. Currently the Fed rate is at near zero, the 30 year fixed rate mortgage interest rate should be at about 3%, which is 300 basis points above the Fed funds rate or 300% above the inflation rate.

One of the primary problems with the housing market is that the 30yr fixed rate mortgage that is currently being offered to the public has an interest rate that is too high to sufficiently increase consumer’s purchasing power. Before the current economic crisis occurred the same mortgage interest rate was approximately 6.5%. The current interest rate for the same mortgage is approximately 5%. The spread between the interest rates is not wide enough to warrant the cost of a majority of people with mortgages to refinance. If these people refinanced their mortgages at 3%, it would lower their monthly mortgage payments, there-by increasing their purchasing power. With more purchasing power, the consumer would increase demand in the economy, which would stimulate the economy. People do not have sufficient purchasing power. This is reflected in the fact that unemployment and foreclosures rates continue to rise.

With a spread of over 475 basis points between the Fed rate and the interest rate of a 30yr fixed rate mortgage, the only entity whose financial condition is improving is Wall St. investment brokerages and the big banks, which have ties to those brokerages. All money is returned to the banking industry after it is introduced into the economy. If the money were lent to the people with mortgages, at a lower starting interest rate, it would help the banks and the economy.

With the economy faltering because of a lack of consumer demand and investor and consumer confidence in the future, a stimulus is needed to include the consumer in the economic recovery.

To bring down single-family mortgage interest rates the government should encourage the creation of a mortgage or create a mortgage with a starting interest rate of 3%, to stabilize home prices, increase employment, and stimulate the economy with increased demand. A Stimulus Mortgage should be created. We need to change the terms of our mortgages so Fannie Mae (FNM) and Freddie Mac (FRE) can buy and securitize the new mortgages with a lower beginning interest rate. With fewer foreclosures the Federal Housing Administration (FHA) would not have as many claims and its financial condition would improve. The down payment should be at least 5% of the purchase price. The Zero Inflation Taxation Policy should also be enacted to help prevent another housing bubble. (More on this later)

Lower starting mortgage interest rates would be better for our economy than tax credits. Tax credits decrease government revenues, which increases the deficit. The government has to borrow more money, which has to be paid back either by a tax increase or an inflation tax. A smaller federal deficit and an improving economy would calm the world’s fears of a weak dollar and another round of inflation and higher interest rates. As our economy improves the dollar would strengthen, stabilizing commodity prices. The Stimulus Mortgage would create more economic activity by a greater number of people than tax credits.

When the financial crisis occurred in September 2008 the Fed and Treasury helped the economy by using the TARP money to stop the financial sector from collapsing. The financial service industry is now in much better condition. It is Main Street that is now in need of a shot in the arm to get well. It can be done without costing the taxpayer any money.

Lower starting mortgage interest rates, funded by the Treasury or the Fed would not cost the taxpayers anything, because after home prices stabilize and the economy improves, the mortgages can be sold to private investors. The Fed will do this with all the mortgage-backed securities that they have bought in the last year. If the Fed had been buying mortgage-backed securities that included the Stimulus Mortgage I believe our economy would have improved more than it has in the past year. As the economy improves, without inflation, the dollar will strengthen, which will help stabilize commodity prices.

Banks and financial institutions are not confident with loaning money to homeowners to refinance their homes, for new mortgages, or make a loan modification, when home prices are decreasing. If a 30 yr. adjustable rate mortgage was created with a starting interest rate of 3%, this would jolt the economy back to life, the toxic securities will become valuable again, as they become performing assets and home prices stabilize and then slowly appreciate.

The interest rate on these new mortgages should increase one-quarter percent per year and cap out at the currant market rate of 5%. To decrease defaults on mortgages, the borrower would have to qualify at the 5% interest rate to obtain the loan. These new mortgages should not be tied to any index. People do not trust indexed mortgages because of our recent history and the uncertainty of the future. We can cap the mortgage interest rate at 5% because the Fed will not be the only entity that will be controlling inflation and inflation psychology.

We are currently trying to capitalize the banks by infusing money directly into them. This policy is wrong because the collateral is losing value. As the value of the collateral decreases the banks need more capital to stay viable. The value of the collateral must be stabilized first, for the banks and investors to be confident enough to lend money against it.

What will this stimulus mortgage do for the economy? When the homeowner refinances their home from a 6% mortgage interest rate to a 3% interest rate their monthly interest payment will decrease by 50%. A $1500.00 monthly mortgage interest payment will decrease to $750.00. That will be like the person receiving a $750.00 stimulus check each month for the first year and thereafter a little less each year for the next seven years. Multiply this by millions of people and you will have a stimulus plan that puts the purchasing power were it should be, with the people. The foreclosed property inventory would be quickly sold and housing prices would stabilize. Loaning money to banks does not create demand in the economy, people do!

If mortgage interest rates were available at a starting rate of 3% and the borrower was qualified at a 5% interest rate, the chance of a foreclosure would be close to zero. The eight years it would take for the interest rate to rise to 5% would allow the economy to heal. Business activity would increase; this would increase the value of commercial properties reducing the coming crisis in that area of the economy. With home values stabilized investors will be willing to invest in mortgage backed securities again rather than treasuries. With the mortgage interest rate increasing every year, the investor will know that their rate of return will increase for the next seven years unlike treasuries.

Mortgage interest rates historically have been about 100% above the inflation rate for the last 30 yrs. With inflation at 0% and home prices deflating, mortgage interest rates for the last year have been about 5 to 6% that means they are 500% to 600% above the inflation rate!

With the enactment of the Zero Inflation Taxation Policy this policy will help control inflation and inflation psychology. This policy will maintain the lowest possible interest rate and the chance of another housing bubble would be near zero. Low interest rates will help maintain the value of the mortgages and mortgage-backed securities. Investor will be confident enough to make long-term investments in mortgage-backed securities, which will create a market for 30-year mortgages.
Banks and investors should be encouraged to modify the underwater mortgages by changing the tax code so that it would be beneficial to them and the borrower when the excess amount of the mortgage is reduced.

Until all the underwater home mortgages are modified the economy will not fully recover. We need the owners of these homes to be able to participate in the economy to increase economic activity. To modify their mortgages we should use a modification agreement, not a refinancing agreement. For those people who own a home that the mortgage is greater than the currant selling price, a clause should be included in the modified mortgage agreement that states, the bank will discount the mortgage, an amount equal to 20% of the monthly payment, each month, for a maximum of ten years, or until the selling price of the house plus repairs equals the amount of the mortgage, if the borrower agrees to pay off the entire unpaid balance due. This policy would allow for an orderly decrease in mortgage balances that are above the selling price of the home and more people would elect to stay in their homes and pay their mortgages.

December 8, 2009 at 1:17 pm
(2) Jim Wygand says:

Kimberly,
Managing in the current US economy is a bit like working one’s way through a hall of mirrors. Things simply are not what they seem all the time. I agree that the risk of a W-shaped recession is present; as well as the risk of an L-shaped recovery pattern. We must consider the following:
1. Final aggregate demand remains low (albeit increasing slowly);
2. There is still excess liquidity in the economy which encourages investors to seek yield and take on more risk;
3. Asset values have yet to return to previous levels (except the stock market which might be a bubble);
4. Banks still carry “toxic assets” on their books;
5. Unemployment is still at 10% and improving only very, very slowly;
6. Letting the dollar devalue to encourage exports and limit imports is a limited strategy that can take us only so far;
7. The fundamental imabalance between production and consumption in the global economy has yet to be addressed;
8. “Manufacturing flight” still continues in many sectors.
The only viable strategy for companies is to continuously revise their revenue and profit plans while looking to the horizon for new opportunities. Any one of the 8 foregoing situations could readily be dealt with when taken alone. However, when they all converge we face a wilderness of conflicting choices. This is typical of any crisis situation and the one we face is one of the most difficult and complex. So, the fear of a W-shaped recovery is justifiable. Avoiding such a situation requires a very broad consensus and an incredible amount of hard work through a very delicate balancing act between fiscal and monetary policies. There is no “quick fix” in this situation. We will remain in what is known as the “chronic phase” of the current crisis for a long time. This phase of a crisis is quite often marked by numerous “sub-crises” as one or other of the items mentioned above get out of equilibriium. The best hedge for companies is to invest in their own output and build profitable market share as possible. Survival takes precedence over growth and profit over market share. The long way back will have to be navigated one painful step at a time.

April 20, 2010 at 3:12 pm
(3) Barry W. Shook says:

I firmly believe that we’re in a “double-dip” recession, and we’ve only been through the first part of it. In economic terms, the second dip is always worse than the first, because so many resources were used-up during the first dip. The government will continue to claim we’re already in recovery, although a “jobless recovery”.

Ask anyone of the unemployed (21.9%) if they are in recovery. Better be prepared for a stormy reply!

April 20, 2010 at 7:12 pm
(4) Kimberly says:

Hi Barry,

How do you get 21% unemployment? I added in discouraged, marginally attached and even part-time workers, and still only got 17%.

See Real Unemployment Rate.

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