Economic crisis is far from over

April 11, 2009|By JAY HANCOCK

Every horror movie comes with interludes in which the stalker appears to be dead, the demon exorcised, the vampire staked.

"Our business momentum is strong," Wells Fargo CEO John Stumpf said Thursday after the big banking company released an unexpectedly brilliant profit report.

"We're starting to see progress," President Barack Obama said Friday.

"U.S. Economy Could Recover Much Sooner Than Expected," said the headline from CNBC.com.

Slasher-film auteurs know exactly how to write the next scene. (Picture Treasury Secretary Timothy Geithner as the ingenue in Sorority Sister Slaughter.)

Not only isn't the recession over; neither is the financial crisis that caused it. A nation in which one out of five mortgages is "under water" - the debt is greater than the value of the house - will not get off this easy.

We'll emerge eventually. The hangdogs predicting a depression - another 30 percent drop in home prices and 15 percent unemployment - are mistaken. But a broad recovery will not come until late this year at the soonest. Meanwhile, expect new shocks and screechy music.

The report on underwater mortgages, published last month by California-based First American CoreLogic, is perhaps the best single X-ray into the core of the financial meltdown.

Not only were 20 percent of U.S. mortgages "upside down" in December; an additional 5 percent were on the verge of tipping over, the research firm said. That means it'll take only a further 5 percent decline in market values to wipe out the equity in 2 million more homes. (In Maryland, 13.1 percent of all mortgages were under water and 4.4 percent are on the edge.)

Not every upside-down homeowner will default and add to the enormous pile of losses. But many will, especially as unemployment rises.

No wonder the International Monetary Fund is about to bump up its estimate of the total cost of the crisis. In January, it said losses from bad mortgages and other toxic U.S. assets would equal a flabbergasting $2 trillion by the end of next year. Now it will increase the forecast of U.S. losses to $3 trillion and peg worldwide damage, including the United States, at $4 trillion, The Times of London reported this week.

So far, financial companies have acknowledged losses of not much more than $1 trillion.

That's far too low not just because banking companies will be forced to reveal bad paper they already have. As the economy struggles, new defaults occur every day even in prime-grade mortgages. House prices are still falling. Losses are soaring on credit-card debt and commercial real estate loans.

The critical question - for investors, consumers, workers, employers and policymakers - is how prepared banks are to absorb the next blows.

Switch genres to a disaster movie. We're in the flooding Red River Valley, piling up sandbags in the form of government capital injections for banks, ultra-low interest rates, relaxed accounting rules and public-private pools to buy toxic assets.

Is the levee high enough to handle a crest of $4 trillion, or whatever it turns out to be?

That's what the Federal Reserve's "stress test" for big banking companies is supposed to answer. But what officials have said hardly suggests that the examinations, expected to be finished by May 1, are rigorous or honest.

They're behind closed doors. The Fed has ordered banks not to disclose results, according to Bloomberg News. This week The New York Times reported: "Regulators say all 19 banks undergoing the exams will pass them."

So what's the point, except to continue the kind of dangerous puffery that began a decade ago with the analysts who rated Enron a "buy"?

Recent optimism, fueled in part by less-than-totally terrible reports from retailers and other sectors, got started with selective disclosures indicating bank losses were declining. Wells Fargo said it earned $3 billion in the first quarter even after writing off $3.3 billion more in bad paper.

But we haven't seen the whole picture from Wells Fargo or anybody else. Full reports won't arrive until later, and they'll be murky thanks to latitude in how banks value financial assets.

Optimists seem to believe Congress and the Fed are ready to deliver even more aid if banks need it. That's a risky assumption, given public anger over bailouts and the fact that the Fed itself is starting to look as overextended as the banks it's trying to rescue.

Even the Obama administration, the biggest optimist of all, admits banks will require more infusions. That alone says this flick ain't over.

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