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I had occasion earlier today to attend a session on the recently enacted American Recovery and Reinvestment Act of 2009 – more commonly referred to as the “economic stimulus bill” – hosted by the Main Line Chamber of Commerce (www.mlcc.org), with Pennsylvania 7th District Congressman Joe Sestak (D) as its only speaker.

Congressman Sestak, a retired Navy Vice Admiral serving in his second term in Washington, spoke at length, and then fielded about 10 questions submitted by the audience.  The Congressman serves as vice-chairman of the House Small Business Committee, and holds post-graduate degrees in Public Administration and Political Economy from Harvard University.

The most striking part of the presentation was the admission by Congressman Sestak, that this Act is really a job-saving measure, designed primarily to avoid the loss of 3 million jobs, and to hopefully see the US unemployment rate crest at 9%, rather than 11.5%.  Doing the math, that amounts to over $260,000 paid out by the Federal Government for every job saved.  A multitude of questions arise – starting with “will this level of investment permanently save jobs, or only do so temporarily?”  “Where is the incentive for businesses to stay profitable and cut costs (including labor costs) if that’s what sound business practices call for?”  Conversely, “where is the incentive for individuals and businesses to invest in new product lines or in delivery of goods and services which are perceived to be in demand?”

As the TARP bailout proved, you can’t always get people to do things you want them to do by handing out money.  Banks were presented with capital – and used it to boost their reserves or acquire other banks.  The desired effect of unfreezing credit markets has not yet materialized.

The Congressman quoted statistics, such as 18.5 million mortgages are for properties which are now worth less than the mortgage amount.  He then went on to state that these are for “prime” mortgages, as opposed to “subprime ARMs.”  Moody’s puts this figure at 13.8 million (and includes both prime and subprime in its calculation), which is still 27% of all U.S. home mortgages. (www.economy.com).

As you may well know, not all ARM’s are subprime and not all fixed rate lending is prime.  The bottom line is that mortgages where little down money was paid are the ones in the most trouble, regardless of whether they are fixed rate or not.  And with interest rates having plummeted of late, ARMs are not the culprit of foreclosures at this time – rather, the culprit is ability to pay and incentive to pay, which has its roots in lack of fundamental underwriting standards for mortgages and the existence of a market to buy and hold such mortgages from 2002- August 2007.

I can’t help but think that I’m hearing a litany of “solutions” for the wrong problems.  Last I checked, the Bankruptcy Code was still in force.  Could it use some tweaking, perhaps by allowing a “cramdown” similar to what debtors in bankruptcy get when they only have to pay for what’s their depreciated car is worth in order to keep it, which is a discount from what they owe?   And what of the potential windfall, if/when housing prices climb back up – is that a freebie to the assisted homeowner, at taxpayer expense?  Or should it be recaptured by the Federal Government?

All of these issues are up for debate (or are they being silenced in favor of another massive Federal giveaway program?), as the fashioning of another “pillar” of the revitalization of the US economy – that of the housing sector - is underway.  The stimulus plan grew from an initial plan of about $60 billion less than 6 months ago.  Now we are looking at 13 times that, plus $75 billion for housing (which may or may not come out of the $350 billion remaining in the TARP), plus up to $400 billion in guarantees for losses which might be sustained by Fannie Mae and Freddie Mac.  FDIC Chairman Sheila Bair said “we’ve not attacked the problem at the core; we are woefully behind the curve.”  Treasury Secretary Timothy Geithner said “the cost of inaction has been very severe.”  And, as if to underscore the magnitude what amounts to government-funded mortgage payment relief which benefits borrowers who are “underwater” and their creditors simultaneously, at the expense of the other 73% of homeowners who still have equity, plus those who do not own homes, Housing Secretary Shaun Donovan stressed that homeowners don’t need to be delinquent in order to get help.

In the meantime, the stock markets plummeted another 4% yesterday, approaching 5-year and 11-year lows.

Here’s a sobering thought, quoting Madlen Read, business writer for the Associated Press:  “The biggest fear in the market is not that the stocks of banks and automakers will get wiped out. If all the Dow companies involved in financial services or automaking — American Express Co., Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co., General Electric Co. and General Motors Corp. — saw their shares sink to zero right now, the Dow would only lose about 400 points, or 5 percent.  Rather, the concern is that these ailing industries will keep hobbling the broader financial system and the economy.”

It sure sounds like we’ve just about reached bottom – at least in the Dow Jones Industrial Average.  How soon we get back on the road to recovering the lost $13 trillion of wealth and getting people back to work remains to be seen.

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The ringing in of a new year has economic experts chiming in, too - about the state of the economy, and, as is also fashionable at this time of year - a forecast for 2009.

I have been privileged to attend three recent presentations, featuring three well-regarded area economists.  The first was a symposium presented by PhillyCarShare on 12/9/08 entitled “Sustaining a NonProfit in tough economic times.  The economist featured was Steven Wray, Executive Director of the Economy League of Greater Philadelphia, http://economyleague.org.

Next was a panel discussion sponsored by the Philadelphia Business Journal, philadelphia.bizjournals.com/philadelphia/, on 12/10/08, entitled “Election Aftermath:  A Community Conversation.”  The economist featured was Professor Bill Dunkelberg, of Temple University’s Fox School of Business, and Chief Economist to the National Federation of Independent Business.

The most recent was the Main Line Chamber of Commerce’s, www.mlcc.org, Economic Forecast Breakfast on 1/15/09, featuring The Vanguard Group’s Chief Investment Officer, George U. “Gus” Sauter.

Each of these esteemed economists introduced the set of triggering events that led the U.S. and Global economies into recession.  The clear consensus is that the subprime credit crisis plunged the economy into recession, and that major players were caught somewhat off-guard by the depth of the crisis, in terms how much exposure “mainstream” financial institutions actually had.  Mr. Sauter’s analysis was based more on a convergence of factors that created a very significant marketplace for subprime loans from 2002-2006 (about $200 billion in 2002, $300 billion in 2003, and moving from $400 billion to a peak of about $600 billion in 2006, before the market for these loans crashed in August 2007).  In other words, it took the combination of willing borrowers, low interest rates, sellers of individual loans, low or non-existent underwriting standards, failure to share in the risk at the micro level, a mechanism to package loans from the micro level into highly-rated securities at the macro level, and failure to acknowledge or comprehend the risk at the macro level by those who chose to invest in those securities, because they were offering a slightly higher (.5% on average) rate of return.

We in the collection industry had a front-row seat for the ascendance of sub-prime lending/borrowing.  It seemingly wiped out a lot of bad credit history with a stroke of a pen and an overleveraged house as collateral.  Which worked reasonably well, as long as the borrowers had jobs and were motivated to pay.  Part of that motivation is that their home value has to be an asset, and not decline to the point where the loan exceeds the value.  Another part is their overall, lifelong pattern of how they deal with paying back loans.  The convergence of declining home values and a population of less-than-stellar credit risks started a snowball rolling downhill.  Add to that the momentum of job losses, the rise in household costs from the re-set of adjustable rate mortgages upward coupled with rising fuel costs (both prevalent during the time frame from Q3 2007 to Q3 2008), and we have the recipe for an economic crisis.

Looking ahead, Mr. Wray, in his presentation, focused on the fact that the Philadelphia region does not boom as high nor bust as low.  The Philadelphia economy is heavily tied to colleges, universities, health care facilities and pharmaceutical companies (often referred to locally as “eds and meds”).  So, the prevailing wisdom is that the Philadelphia area, while not immune, never saw the spikes in real estate prices and speculation, and thus won’t have the vacancy and foreclosure levels that other regions are experiencing and may continue to experience for some time.

Mr. Wray also cited other economists who felt that the unemployment rate might spike as high as 10%.  We are already at 7.2% and climbing.  Mr. Sauter felt that unemployment would likely level off around 9% before trending downward no sooner that Q4 2009 if not sometime in 2010.  To put those figures into a historical context, we have not seen rates like that in over 25 years.

Dr. Dunkelberg, due to the topic, focused more on policy.  The concept of Federal government ownership of portions of private industry (primarily in the financial and automobile sectors) might have been unthinkable not long ago, and is less than ideal.  It’s more of a necessity, nearly everyone agrees.  A good place to get in-depth on Dr. Dunkelberg’s observations is at http://wynnewood.org/research/economics/nfib_report_Jan_2009.

The words “bailout” and “too big to fail” dominated the discussion.  Dr. Dunkelberg has also long-observed that U.S. citizens are big spenders and poor savers.  This printing of new money by the Fed, first in the Troubled Asset Recovery Program (TARP) to the tune of $350 billion to date, and authorized up to another $350 billion, plus the expected economic stimulus package to be passed after the Obama inauguration - to the tune of about $850 billion, means that the Fed will circulate over $1.5 trillion of new money.  Whether foreign investors soak it up, U.S. citizens start saving (there are signs that debt is beginning to be paid down for the first time in a long time - “deleveraging” as economists call it), or whether we will all pay for this with higher inflation and interest rates upon the dawning of the next recovery, all remain to be seen.  We are already paying for this by way of the very large spread between what fixed-rate investors receive (around 0-2%) and fixed-rate borrowers pay (around 5-7%), because of all of the uncertainty and illiquidity.

My belief is that a recovery will take hold in the latter part of 2009.  It will be a weaker recovery than what many hope for.  Some sectors will recover much more quickly than others.  We have been used to a good thing.  Even our recessions since 1980-82 have been short.  We have not seen 7+% unemployment since 1992-94.  On the other hand, while there are some numbers that have not been seen since the Great Depression of 1929-1933 - most notably in terms of stock market declines in 2008 - the prior creation of wealth, the existing social safety nets and the Federal government’s intervention make it, in my view, irresponsible to draw comparisons to that time period, as though what we are experience or will experience will come close to 25% unemployment and rampant homelessness and loss of hope which was prevalent in that era.  In fact, in an informal poll by Mr. Sauter, nearly everyone in the room of about 300 businesspeople agreed that the stock market highs of 10/07 would be seen again sometime in the next 10 years - which would necessitate an average annual return of at least 7-8%.

Call me an optimist - in fact, call me!  Your feedback is appreciated.

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