Economic Recovery Looms in the Distance: But is It Still Out of Reach?

The market has struggled for nearly three weeks to maintain its gains since March of this year, and then bang the DOW rises 256 points because Intel reports better than expect earnings. While there continues to be glimmers of hope that investors latch onto; the market, oil, and housing pull back against all efforts. It was a surprise to see the Dow drop to 7500 in the early part of 2009, and watch as it slipped another thousand points. I would preach to friends that the recovery would not happen until certain conditions were overcome in the economy.

The economy was in the perfect position to suffer a collapse when three factors united to create an economic implosion. Each factor provided its own contribution to the collapse while providing fuel to the others. Markets might have survived one onslaught but the convergence of the three was too much in an economy that had reached an imbalance at its peak.

• Inflated housing prices were jumping after 2000 at a rate greater than the normal rate of inflation. This fueled a housing boom that benefited developers, allowing above normal profits. Consumers were finding housing prices escalating at rates that encouraged speculation. Additionally, to keep the demand high and keep prices going up it was necessary to bring more buyers to the market. This was done with Adjustable Rate Mortgages (ARM’s). The problem here was that these were best for speculators who would buy and resell a house. They were trouble for the individual who bought their home in hopes their income would increase and they would be able to refinance or afford the increase in payments.
• The derivatives market represented an estimated $516 trillion bubble that was based on paper contracts that would have to be met at some point in time. While an article written back in March of 2008, by Paul Farrell for Market Watch, warned of the dangers of this bubble and the cost of unraveling derivative instruments, investors got to see first hand the consequences of lost wealth as the underlying prices (of whatever supported the derivative) began to fall. For those who had derivatives based on the mortgage market there might be no value in the asset for which the buyer has contracted if the loan goes into default (the property belonged to the bank). The value of these contracts, whether hedges or speculations, were lost almost instantly.
• Oil prices: were driven up by speculators, OPEC, and countries who budgeted for higher prices per barrel of crude. One report had Venezuela budgeting for $120 per barrel. As the world economy tried developing and the need for oil products increased the price was continuing to rise but it exceeded the consumers’ willingness and ability to pay. As ARM’s began demanding higher payments the price of gas was also escalating, reducing the amount of disposable income the consumer had to spend. Slowly but surely household reserves were falling and the choice began to be made between gas for work, food for the family, and the house payment.

Housing and fuel prices shifted and at these new prices consumers were unable to find a balance that fit within their income. Basic economics requires that a new equilibrium be found and that must be found within the constraints of consumers’ earning power.