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No Economic Depression on the Horizon ...

Economics / US Economy Apr 03, 2008 - 08:40 AM GMT

By: Money_and_Markets


Best Financial Markets Analysis ArticleLarry Edelson writes: Last week I told you that the mortgage crisis is not over. This week, the message I want you to come away with is that the mortgage and credit crisis do not present a doomsday scenario.

Don't misunderstand — I am not cavalier about the financial crisis the U.S. is going through. It is scary stuff. Probably the worst crisis this country has seen since the Great Depression.

However, it is not the end of the U.S. nor is it the end of the world.

And I do not believe that it is going to lead to another depression. Quite the contrary, it's going to lead — as you well know from reading my column — to much higher inflation.

I see seven reasons why the mortgage and credit crisis is not as bad as some seem to believe ...

Reason #1: Only 0.83 percent of U.S. mortgages are currently in foreclosure.

True, that's a record high. But let's put it into perspective.

There are 44 million mortgages in the U.S. with an average balance of about $200,000. That's a total mortgage market of $8.8 trillion. At a default rate of .83%, you're talking about $73.4 billion in losses.

Even if the default rate were to explode to 10% — you're talking about $734 billion in losses, less than the damage inflicted by the tech wreck of 2000-2001.

And keep in mind — the value of the collateral, the real estate underlying mortgages — does not fall in value to zero . The above assumptions assume it does.

That's important to understand. Because it means that even in foreclosure, a mortgage in default is not a total loss to the creditors.

While foreclosures are a real problem, they will not break the back of the U.S. financial system.
While foreclosures are a real problem, they will not break the back of the U.S. financial system.

Using the above example and assuming a 50% decline in real estate values and a 10% default rate, instead of looking at $734 billion in losses, you're looking at about $367 billion in real losses.

What about the current delinquency rate, also at a record high of 5.82%?

First, mortgage delinquency is not a guarantee of default.

Second, even if it was, and every single mortgage in delinquency ended up in default, the same rule above applies: The underlying collateral is not worthless.

Yes, that is a somewhat simplistic analysis that does not account for a lot of variables ... like loans stacked on top of loans, leverage ... derivatives and other things that can go wrong.

But it does shed some positive light on the crisis. And it's worth repeating, after all, the collateral underlying all the credit laid on the real estate markets is not completely worthless.

Reason #2: Mortgage markets have tightened, but they are still more liquid than they were in previous real estate declines.

Much is being made about how no one knows who owns what these days when it comes to the mortgage companies and banks. This is chiefly because most mortgages are now underwritten by agencies rather than your local bank. They are then sold off to servicing agents ... pooled in collateralized debt obligation (CDOs) ... and all that other scary stuff you're hearing about.

But look at all of this another way, with the glass half full rather than half empty: Imagine if the mortgages that are going bad today were owned and serviced by local banks in every town and city across America, and that the lending risks were not spread out via millions of mortgage investors, both domestic and foreign?

The banking problems you're seeing now would be absolutely devastating. Local banks all over the country would be collapsing, going bust. They would all be stuck with their own bad loan portfolios in local real estate markets and none of the risk would be spread through the system.

In my opinion, that would be a dramatically worse and far more illiquid crisis than we have today! There would be no hedge funds providing liquidity ... no major investment banks ... and no foreign investors putting money in our mortgage and property markets.

The same can be said about the derivatives markets. The downside of derivatives is counterparty risk. But the positive side of the derivatives markets is that they help spread out — and hence reduce — overall risk and increase liquidity.

Reason #3: Big bankers have cash and strength to endure.

What? Am I crazy? Citibank has already needed a cash infusion. Bear Stearns had to be bailed out. Merrill Lynch needed $11 billion.

Foreign investment and government intervention will help U.S. financial companies.
Foreign investment and government intervention will help U.S. financial companies.

To be sure, some banks will fail in the weeks and month ahead. Perhaps even more investment bankers will collapse.

But the banking industry is just coming off of four years of record earnings ... and is flush with cash ... a record $1.35 trillion as of the end of 2007, according to the FDIC. And the banks are sitting on over $12.2 trillion in total assets.

Moreover, the U.S. banking system is more international than ever. That has helped it weather the storm by diversifying bank earnings to overseas economies, and at the same time, opened our economy to more foreign investment. And like it or not, foreign investment in the U.S. is helping to keep the economy going.

Reason #4: The Federal Reserve has unlimited resources.

The Fed's just-announced new regulatory push will help, long-term. But short-term, over the next few years, the Fed will continue to behave exactly as I have predicted all along for years now — pumping in liquidity and printing money like there's no tomorrow.

Keep in mind the Fed has unlimited resources. It can and will do everything to prevent the financial crisis from turning into a great depression.

If Lehman Brothers, for instance, is looking like it will fail, you will see another bailout like the Bear Stearns deal. If JP Morgan goes down, the Fed will bail it out, too.

The Federal Reserve will stop at nothing to save the U.S. economy!

That will create its own problems down the road — namely a continued long-term plunge in the dollar and much, much more inflation, maybe even hyperinflation.

Indeed, according to John Williams of Shadow Government Statistics, for the two weeks ended March 26, the seasonally-adjusted monetary base rose at an annualized rate of 20.1% from the prior two weeks. And a broader measure of the money supply is increasing at a record annual rate of over 17%!

Reason #5: Overseas exposure to U.S. subprime risk is limited.

Investors, bankers, and governments around the globe have been obsessing that America's crisis will cause the world to collapse as well. And to be sure, there is some fallout.

But I've done loads of research on this and I've found no indication that the U.S. credit contagion will seriously infect the global economy.

Of course, not all areas have complete immunity. Here's a breakdown of known foreign exposure to U.S. mortgage debt:

China: Holds more U.S. mortgage debt than any other country, but due to capital controls in China, their domestic economy is at minimal risk to the U.S. turmoil.

Japan: The world's second biggest holder of U.S. mortgage debt, totaling as much as $200 billion. But the majority of banks in Japan report only 2% to 4% of their investments are at risk.

Taiwan: Only about $50 billion in total exposure. Minimal risk.

Korea: Same, only about $50 billion at risk in U.S. mortgage debt.

Singapore: Minimal risk, only about 2% of its investments at risk in U.S. mortgage debt.

Hong Kong: According to Fitch Ratings, none of the banks surveyed had direct exposure to U.S. mortgages through CDOs or asset-backed paper.

Thailand: No threat of insolvency at any of Thailand's banks due to the U.S. mortgage crisis.

Malaysia: No direct exposure and only modest indirect exposure ($60 million, 1% of total equity) to U.S. subprime debt.

Indonesia: No significant exposure to risky U.S. mortgage debt.

Eurozone: Worst case estimates put the exposure at about $280 billion.

Australia and the United Kingdom have the most total exposure, but even if all their U.S. mortgage investments and the Eurozone were to go bad — an estimated total of $60 billion — it would hardly put a dent in the $65 trillion global economy.

Reason #6: Cheap dollar boosting overseas investment in the U.S.

I alluded to this above. The cheap dollar — worth a third less than it was five years ago — makes it possible for overseas investors to buy more with their euros and yen and pounds and Australian dollars.

In fact, practically all currencies buy more in dollar terms these days. And the greenback will only get cheaper as the Fed keeps the printing presses running overtime and, possibly, cuts rates further.

With so many cheapening dollars flowing to Asia to pay for Americans' insatiable appetite for inexpensive imported goods, Asian consumers have more buying power than ever before.

That's why you're already starting to see some Asian and other foreign money buy up Manhattan real estate.

For example, in through the first quarter of this year one-third of all commercial properties being bought in Manhattan are from foreign buyers, almost triple the amount for all of 2007.

Reason #7: Asian demand offsets U.S. economic softness.

On paper, the United States has the world's largest economy. But it has become essentially static. Instead, the real powerhouses of expansion are China and India, the globe's two fastest-growing economies.

Rising consumption in Asia can help power the global economy.
Rising consumption in Asia can help power the global economy.

There's simply no stopping the tidal wave of demand coming from 2.4 billion people in China and India (nearly 40% of the world's population) as they race to modernize and catch up with the developed world.

Other parts of Asia — Singapore, Vietnam, Thailand, Malaysia, Indonesia — have caught the boom fever and are coming into their own. Even Japan is awakening from its long coma to show signs of renewed economic vigor.

Without this demand and the rising economies of Asia, the global economy — and the U.S. — would be particularly vulnerable. But that's not the case. The world has changed dramatically in the last 10 years. And there is no question in my mind that the economic growth being seen in Asia is a positive for the U.S.

So What Should You Be Doing Right Now?

I suggest staying the course with the investment philosophy I've laid out in previous issues.

In my opinion, gold is still your best hedge against a falling dollar and rising inflation.

And natural resource stocks will continue to benefit from demand by more people than ever before in the history of this planet.

Best wishes,


P.S. I want to clarify one other point I made in last week's column. When I warned you about Treasuries, I was talking about bonds with longer-term maturities. I continue to believe that short-term Treasury bills are a good place for your keep-safe funds.

This investment news is brought to you by Money and Markets . Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit .

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