Status Quo of Economics as of 09 12 2008

Credit crunch is no longer limited to housing market. It originated in housing market but has spreaded to commercial real estate, and consumer loans. It has weakend the economy fundamentals and tipped economy into the brink of recession. The keystones underpinning US economy are credit and employments. The indicators of the two elements showed no improvement and even deterioration. The Libor spread stays high, indicating the scarcity of credits. Three month Libor spread has been hovering around 81 bps for at least 2 months. The high cost of credit and weakening profits forced many corporates to file for bankruptcies. The Corporate defaults is on the rise to 2% and it is projected to exceed 5% by next year. Unemployment surged to 6.1% in August, rivalling the peak in the previous recession. The overall economy indocator, GDP, had a surprising surge in Q2 08, but the major driver was from trade deficit due to weak dollar. As global recession is looming, demand from overseas will fade, widening US trades deficit. The GDP might be flat or negative in Q2 08. This might lend NBER proof to declare a recession. Treasury's bailout of GSEs did prevent the credit crisis from spilling over into agency housing market. The 30 year prime mortgage rate has declined from 6.2% to 5.7% in two days. This will support the availability of US mortgage financing and help stablize and recover the housing market. But effect will not play out overnight. It might take at least a couple of months to see the improvement in housing market: the bounce in the housing prices and the decline in hangover inventory. Additionally, the bailout is not a panacea to all issues. Treasury need to act more to recovery the economy. Traditionally, there are two ways to stimulate economy: fiscal and monetary policy. Although Fed has cut the overnight interest to 2%, the effect of the monetary policy has been hamstrung by the weakness of banks. Many Banks are still sitting on top of risky and illiquid assets, hampering their ability to lend out money. This also slow their deleveraging process because investors are less willing to invest in the banks holding the assets. The uncertainty of government bailout further deter capital infusion into the companies. They are afraid that government bailout will wipe their investment as it did for GSEs. To solve this issue, Treasury had better build a RTC (Reconstrution Trust Corp) like facility to ringfence all risky assets and make the clean banks more appealing to investors. On the fiscal front, Treasury is stuck with large budge deficit, around $600 bil. Now it is on the hook for GSEs, around $200 bil, and Bear Stearn, $29 bil. US government is heavily indeted. This might concern the administration and weaken investors confidence as we note than CDS of riskless Treaury has reached 20 bps, unpreceded high. Though the effect of fiscal policy is questioned, I would say the first sitmulus package, $150 bil, had helped shore up GDP. In the second quarter, the consumer spending, which accounts of two thirds of GDP, was higher than usual. This might be due to the stimulus package. In my opinion, the second package is still needed, but should focus focus on sitimulate corporations, such as cutting tax or infastrucuture investment.