Farrell: A Muted Recovery Ahead

Yeah, but all at once!

The Wall Street Journal had a short article Tuesday that mentioned consumer debt is still at 124% of disposable income. I don't know what the right number for this would be but it was 61% of disposable income in 1984. While down a good 10% from the recent peak, it appears to still have a long way to go. But I didn't think it would try to get there all at once! Consumer credit for last month was announced, and the estimates around the Street were for a decline in credit outstanding of $4 billion. It declined $21.6 billion (that is for July) and last month's number was revised from a decline of $10.3 billion to -$15.5 billion.

So much for expert estimates.

I think this is a record decline and I am very glad the stock market took it in stride. At the end of the day, we know the consumers were way over their heads and had to pull back. We might as well get it underway and recognize that any recovery in the US economy will not in any way be led by the consumer.

The Crisis: 1 Year Later - A CNBC Special Report - See Complete Coverage
The Crisis: 1 Year Later - A CNBC Special Report - See Complete Coverage

Lyle Gramley, our chief economist, wrote a short while ago that he expected a modest economic recovery.

The average GDP move in the first year after a recession has been 5.8%. When the recession has been deeper than average, the bounce-back was 7.1% in the first year.

The recession just ended (or ending) was the deepest since the Depression, so if history were to serve as a guide, we could expect a fairly robust recovery. But with the consumer in lock-down mode, we are likely to see a muted recovery.

A lot of questions revolve on what letter shape we can expect in the months ahead.

A "V"-shaped move, a "W" implying a double-dip recession, or a "U" for a very sluggish turn. I favor the square root symbol, meaning a smart enough recovery of say 3-4 % (my guess; Lyle has figured the average recovery off those recessions that were less severe than average has been 4.1% and he figures a 3% or so Q3 GDP) followed by a sluggish upward tilt as the consumer struggles to regain some financial footing.

Alternative Investing - A CNBC Special Report - See Complete Coverage
Alternative Investing - A CNBC Special Report - See Complete Coverage

While this is going on, we can expect the bond market to continue to finance our deficit.

The worries about inflation seem to be more spoken than real, and our very frequent auctions of Treasury bonds continue to attract buyers.

Tuesday's 3-year sale was well received, with a bid-to-cover of 3.02 (4-auction average of 2.53) and going-away buying of 54.2% (4-auction average of 50.5%.) At the same time, the price of gold is soaring, so is there a battle about different views regarding inflation? I don't think so. Treat gold like a currency for a second, and the weakness in the dollar kind of naturally leads to strength in gold. With interest rates so low, the opportunity cost of owning gold is negligible. The bond market is also a much bigger voting booth, and it is voting that inflation will be contained for the foreseeable future. The consumer is in full retreat, and large scale deleveraging is taking place. Hours worked are down 7% from a year ago, and the reason consumer incomes are flat is that there have been tax cuts and benefit extensions from the government, but they won't go on forever.

Savings rates are headed higher, residential real estate is still troublesome, the problems in commercial real estate are probably more ahead of us than not, and local governments are cutting back aggressively.

It's hard to make a case for inflation, so I would opt for a trading explanation for the move in gold.

I did a quick bit for CNBC Tuesday on the new "reverse" sort of life insurance products securitized by Wall Street.

Life policies are bought, bundled, and sold like the old subprime stuff.

I don't know what will go wrong with this just as I didn't know what would go wrong with subprime products.

But be leery of geeky Wall Streeters bearing complicated formulas. Maybe it's all good stuff, but if it is, I think the investment bankers that dreamed it up should take their bonuses in the paper they are creating. Attention would then be paid to the long-term value of the product!

I know I touched a nerve because I got an irate phone call from some life insurance securitizer wanting to discuss the advantages of the product. What could he possibly know about the risk of this product five years out? Wall Street will be Wall Street, and money-making dreams will always be conjured up.

Let the buyer beware.

Have we not learned that?

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