Wednesday, July 26, 2006

forest, trees

OK, I'll say it. The question of whether we're getting ready to enter higher inflation or a depression and how severe it'll be and all that is a secondary item. Much less the question of 'what is inflation/deflation'. Oh, they're still fascinating to me and I'll be playing with them, but these are NOT THE PRIMARY FOCUS at this time.

Here's the deep skinny, boys and girls. We're going to have a recession. The questions are how soon, how deep, and how long. The inflation/deflation muttering is a feeder for the main questions.

We are entering a recession.

Housing sales (quantity) are declining. Prices are still climbing (though slower) but total dollars (price times quantity) has flatlined. (National Real Estate Association reports - and let's face it, they're cheerleaders for sales, not doomsayers.) is one of several places noting that nationwide, active foreclosures are up almost 50% from this time last year. And to make it worse, there's a backlog in almost every state of foreclosure filings awaiting processing. They range from 10 to 500 percent of what's already filed, and I can't get enough hard data to guess what the actual nationwide backlog might be, but again estimates the 'real' number is between 100 and 150% increase over this time last year.

Bankruptcy filings are on the rise. Nationwide they're up 20 to 25% (estimate based on various summation reports) from last year. Georgia reports that there's a backlog of filings THERE as well. Georgia may be an exception - it is, after all, consistently one of the leading five states in foreclosure filings - but it's still worthy of attention.

Inflation (price) numbers are climbing unchecked. Bonds aren't showing a trust that the Fed's got it under control. The last quarter's report for sales of manufactured goods shows declining production and constant or increasing inventory - a glut of stuff unpurchased.

Frankly, the question in my mind isn't how long till it hits, it's how long till the one we're entering is recognized by most people. Remember that "official recognition" is done by the NBER looking BACK, not forward.

Oil is creeping upward. I'm guessing we'll cross the $3 per gallon line and not look back by the end of August. (Yes, I know we passed it in some areas a year ago. I'm speaking nationwide now, where it's seen as a barrier touched but not yet broken.) That's assuming nothing gets 'more special' in an oil-producing region.

Food is, well, if you've been to the grocery store you know. Even if you're a Walmart shopper, the grocery bill's gone up noticeably.

And wages aren't going up to match. Without money and without a way for the majority to reasonably borrow money, businesses aren't going to sell. The 'solutions' are for prices to fall or for wages to climb.

All of these are reaching the critical point - have reached it, as it's beginning to show instead of being "if this goes on." So by my measure, we've entered a recession. And it will last till prices drop or wages climb (or both).

The only questions remaining are how deep and the how long. For what it's worth they're related but not conjoined - it's possible that it can be shallow and long (or deep and short), though that's difficult.

I think "how deep" is going to depend on the bankruptcy and unemployment numbers. My GUESS on that is that it's going to be visible and painful but not catastrophic. Oh - and I have this sneaking suspicion that while a lot of unemployed will go bankrupt, a lot of bankruptcies won't be due to unemployment.

I think we'll see a huge spike in bankruptcies from the 'upper middle/lower rich' classes. These are the folk who had incomes high enough to speculate on housing. They used some alternate mortgages to get second houses or pieces of condo developments with the plan of selling them at a profit to pay for their own houses. What they're not prepared for is the change in the bankruptcy law plus the changes in income tax law. Yep, I'm about to digress, but I'll keep it brief.

Standard mortgages are "non-resourced". That means that if you default on the debt, the only thing the creditor can seize to pay off the debt is what the debt was for - the property. However, a lot of special mortgages are "resourced". In other words, the creditor can place liens on (try to seize) OTHER assets if the primary asset is insufficient to cover the cost.

Say you have a $200,000 mortgage and you've payed zero principle. You default. The bank sells the property for $100,000. Non-resourced, the bank eats the other $100,000. Resourced, and the bank puts you into receivership (seizing just about everything you own PLUS a portion of your wages) till the other $100,000 is recovered.

Taxes - Foreclosure losses are treated as income. Let's take that example just above - the bank foreclosed, and you have $100,000 remaining. This time it's non-resourced so the bank can't touch it. The IRS considers it income - income that's ineligible for capital gains writeoffs. Add it to the wages and tips line, kids.

Here's the way the whole thing will go together for most people. Let's assume they did an 80/20 loan - 100% in two loans - on a $200,000 house. The 80 is almost certainly non-resource, the 20 is resourced. They've paid zero principle, and the bank seizes the house and sells it for $100,000. Let's assume the bank is honorable and applies the recovery at 80/20 - it might even be requiered by law, but as I understand it this is only true in some states. So there's $80,000 on the resourced and $20,000 on the non-resourced still remaining. The bank seizes $20,000 of the owners other goods and income, and the IRS taxes the owners for $80,000 of surprise income this year. The ex-owners aren't paying as MUCH as they were before (yet), but they've incurred a debt they're not getting out of short of bankruptcy. Notice that if the bank has its choice it'll put the foreclosure recovery wholly againnst the non-resource debt. That way instead of $100K + $20K, they get $100K +$40K. Sure, the owners "only" have $60K in surprise income to be taxed, but losing $40K of other property is unlikely to be a pleasant experience.

The thing is, it's the wealthier households who are able to do this. But if they're wealthy ENOUGH they're going to be able to weather the losses or hold the properties through the decline - unless they got greedy. Oh, there'll be families earning $50,000 who scraped together the gamble, but they'll be exceptions. No, you'll see a wave of upper middle/lower rich getting the shaft this time.

And that's going to play hob with businesses and with unemployment. And in the long run with politics as well. (If a conservative [R] is a liberal who got mugged, a liberal [D] is equally a conservative who lost his job in a recession.) So much for the digression.

I expect unemployment to exceed 6%. I think the nation's resilient enough that it'll not break double digits, but if it reaches 8% I'm going to get worried about complications.

I think I'll ponder more, but that's my first thoughts.


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