Stages of the Slowdown & End Game?

A: I want to take another few steps back today (after last weeks Debt Deflation Theory discussion) and think about the future in terms of this slowdown, the causes, the effects, the stimulus, and where it may lead us to; I can't go into every detail so lets keep it basic for now. I discussed my views on the new wall street a few days ago and Mortgageman discussed his views on the new mortgage markets yesterday. Nobody denies the credit monster anymore and most learned to respect this beast with many tentacles. It would be wise to view this slowdown on its own, in stages, and shy away from comparing it to past recessionary periods. If we view the crisis in stages, where did it start, where are we now, what actions were taken, unintended consequences, and what lies ahead? Lets be constructive and talk this out. What is the end game? For fun, here are my thoughts.

STAGE 1 (In Progress) - Housing & Credit Deflation: first the national housing bubble popped, followed by the bust of the credit bubble. The parabolic bubble in the credit markets helped to fuel the national housing bubble, MEW, over-spending, over-investment, and way too much use of debt. When the house of cards fell for housing, the credit markets peak followed. The two were intertwined and the two are now deflating.

STAGE 2 (In Progress) - The Credit Crisis: includes seizing up of secondary mortgage markets, absence of buyers for structured debt assets, price discovery via deleveraging/unwinding of toxic assets to raise cash, writedowns, capital raising, industry self correcting by tightening lending standards / higher rates / extinction of risky loan products, banks' balance sheet repair & shareholder dilution, spreading to other areas of debt markets, spreading from subprime to higher quality debt classes, auction rate securities, corporate bond market, MBS & CMBS assets became toxic, student loans, auto loans, etc..

STAGE 3 (In Progress) - Application of Stimulus: rate cuts, fed lending facilities, fiscal stimulus via tax rebate checks, bailouts, rescues, forced marriages, capital injections and TARP programs, issuance of treasuries for funds, global co-ordinated efforts

STAGE 4 (In Progress) - Loss of Confidence: consumer confidence, business confidence, investor confidence as corporations issue paper at very high rates, confidence in currencies, confidence in stimulus efforts and side effects of,

STAGE 5 (In Progress) - Equity Collapse: the broadest gauge as to the health of the overall economy and most widely held, liquid asset class collapses. Stock markets at home and around the world plunge 35-50%+ for fears of a deep and long recession. With uncertainty for corporate profits and growth prospects, comes selling. This results in a mass acknowledgment of the problem as losses hit home for many unsuspecting people when they look at their portfolio statements. Confidence falls further as a negative wealth effect kicks in.

STAGE 6 (In Progress) - Redemptions / Margin Calls / Unwinding of Longer-Term Trades: exacerbates the selling pressure causing a vicious cycle. Hedge funds have to meet redemption requests and margin calls, investors have to meet margin calls, investors can't take it anymore and throw in towel, and longer term unwinding of carry trades and other trades that 'worked' feeds the selling pressure. Volatility surges and trader emotion rises.

STAGE 7 (Early In Process) - Economic Data: This is where we start to see confidence reports really dive, GDP really contract, Unemployment really rise, manufacturing contract, etc..Time goes slow and it feels like these lagging reports don't ever get better.

STAGE 8 (Early In Process) - Mainstreet Blues / Saving / Capacity Reductions / Budget Crises: the real pain of job losses, and the slowdown hit the people. Time slows down and it feels longer than it is. However, this time it is likely to be longer than past recessions. Saving increases, and spending decreases. This makes the economic data noted above continue for longer than expected. The cycle feeds on itself for an economy that is driven 70% by the consumer. Capacity is reduced to adjust to the slowing demand. With the slowdown comes less revenue for cities and states. Traffic volume is down a record 5.6% in August as consumers cut out unnecessary spending/driving; driving costs money. The Terminator already called for a special session as California's budget shortfall surpasses $3Bln. It would be narrow sighted to think they are the only one in trouble.

STAGE 9 (Yet To Come, End Game) - Regulation: since taxpayer funds are being used for rescues/bailouts, the credit system will be rebuilt and regulated so that this never happens again. Stocks that used to trade on high expectations for growth, will realize that the new world won't allow growth to go parabolic because the credit system will not be the same. Transparency will be demanded, and leverage will be greatly reduced. The new world will be a lot less sexy than when credit was on its way to its peak.

STAGE 10 (Yet To Come, End Game) - Treasury Market?: massive treasury issuance to fund bailouts, nearing the end of rate cut cycle which is yet to come (I'll bet on 75-100 more bps of easing), stabilizing economic data which is far off, unwinding or slowing of treasury purchases by foreigners, rolling over of treasuries, selling of widely owned treasuries for this slowdown, and most of the damage done to equities already may all contribute to the selling of treasuries. The treasury market is arguably at the tail end of a 27 year secular bull market. What will treasury buyers demand in yields 12-24 months from now? Will treasuries still be in huge demand, as they are today, right in the center of the crisis? The end game may bring with it the end to the secular bull market in treasuries and higher yields; especially in the longer end of the curve! How will lenders and businesses adapt to higher borrowing costs should this occur and drag credit rates with it?

STAGE 11 (Yet To Come, End Game) - Inflation?: in 18-24 months or more, what will the side-effect of fiscal/monetary stimulus be? Right now, deflation is the word of the day and has been for about 8-10 months now here on urbandigs.com. With the commodity bubble bursting and a global slowdown, inflation expectations should fall drastically. But times may change by this time next year or 2010. Do we expect 5 years of deflation, or 2-3? 10? Are we headed towards a Japan style decade? What lies right after the deflationary spiral? It's silly to talk about inflation now, yes, but it is not silly to talk about it the endgame of fiscal & monetary policy that is being thrown at the wildfire. Ben has proven to us that he will try to inflate us out of this mess, viewing the threat of ultimate inflation as the better case against a prolonged deflationary spiral that we are in now.

UrbanDigs Says: These are simply my thoughts, nothing more! I like to view this experience in stages, and learn from it. I think we are in Stage 6 right now. I think what lies right in front of us is very poor economic data for remainder of 2008 and well into 2009. On Wed, the fed comes out with their decision on rates and statement. On Thursday comes Q3 GDP Advance numbers. Yes, the fed will have this data before it is released and yes the data may affect their decision tomorrow. I would not be surprised to see a much worse than expected GDP number on Thursday. Who knows, just my two cents. With shipping rates cliff diving, commodities tumbling, and industrial metals plunging, clearly the world is contracting FAST! This is not a slow evolving cycle. The sh*t is hitting the fan very quickly! So, we should expect some sharp downward numbers in our future; especially for Q4 that we are in right now. If the credit markets ground to a halt in September, and stayed that way for 6+ weeks so far, how do you expect the period right after this to be?

I'll try to do a similar piece on stages of the Manhattan real estate cycle, but need to research older cycles first.

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