In response to a reader comment on my prediction of financial Armageddon for 2008, I have another, more optimistic prediction. As I said before, I am not a fan of predictions per se. It is, however, useful to outline possibilities. This possibility is more likely than financial Armageddon. As you can surmise from my title, I do not believe the economy will be all roses and sunshine this year.
What everyone seems to ignore is that recession is necessary from time to time. Mal-investment must be corrected. Profligate spenders must be chastened. The economy has invested too much capital into housing and it needs to reinvest that capital into other sectors. Unfortunately, that will cause pain. But to try like the Fed to avoid the pain will only delay it and worsen it. That is exactly what happened in 2001 as the Fed cut rates drastically to avoid pain from the stock market crash. The easy money went into housing and caused the current problems.
February: Lenders and counterparties give up on ACA Capital Holdings, the smallest and weakest monoline bond insurer. It declares bankruptcy. The bailout of the other bond insurers succeeds, barely. Ambac [[abk]], and MBIA [[mbi]] survive in run-off mode. New competitors such as Berkshire Hathaway’s [[brka]] subsidiary take over 100% of the municipal-bond insurance market. Harry Macklowe loses much of his real estate empire when he fails to refinance his short term debt. Rents decrease in Manhattan for the first time in years.
March: The stock market continues to stagnate.
April: Towards the end of the month, the homebuilders report more huge writedowns. Several see their stocks drop another 80%. One or two small public builders declare bankruptcy. The largest all survive. On a personal note, the author of this blog sells his house, which he had owned for almost four years, for a 20% loss.
May: Losses to banks from the failure of ACA alone top $20 billion. Bank stocks continue going down, but losses look like they won’t increase further. House prices in St. Louis are down 25% from their peak. In parts of California, house prices are down over 30%.
June: No bank runs, surprisingly.
July: Numerous small companies declare bankruptcy. The default rate on junk bonds approaches an annualized 7% for the year.
August: By this time house prices have fallen over 40% in California from their peak prices. The worst seems over, although house prices will stagnate for the next four years at least.
September: Mortgage insurers Radian [[rdn]] and PMI Group [[pmi]] are bailed out by banks and vulture investors, and none of the mortgage insurers declare bankruptcy. The carnage in the financial sector appears to be over.
October: Google’s profit increases 80%. Citigroup continues to flounder after losing several more top executives.
November: Barack Obama or John McCain wins the election. His (and Congress’) plans to help the economy do nothing for the economy while wasting taxpayers’ money.
December: The unemployment rate hits 5% in the US and the country enters a recession.
Disclosure: I am long BRK-A. I think Barack Obama is naive at best (and a corrupt scoundrel at worst; see his land dealings in Chicago) and John McCain is a fool who has no regard for free speech (as shown by McCain-Feingold).