Expect Subpar Growth Well into 2009
 The subprime-fueled credit crisis combined
with record high oil and falling home prices
has ignited the recession debate. In an
attempt to combat the fallout, the Fed has
finally taken aggressive rate cut measures.
While these and expected cuts will help
prevent an outright recession, they will be
unable to fully unfreeze the credit market,
which is where the nation’s biggest problem
lies. As a consequence, subpar GDP growth
is expected until mid-2009, with normalcy
returning only by 2010.
The Fed has done what it can, and now
the ball is in the lenders’ court, more
precisely their mindset. That mindset is
directly a function of a deteriorated balance
sheet and the expectation of what’s to
come. This expectation is the key to the
whole credit problem. At present, lenders
are more worried about potential future
losses, not just what they have written off.
Consequently, they will be super-cautious
in their new lending decisions, affecting
growth prospects longer than expected.
Meanwhile, the outstanding debt in the
asset-backed commercial paper market is
down by almost 40 percent since the credit
crisis began last August. In addition, the
spread between AA and A2 bonds in this
market has risen sharply. Since then, each
time the spread appears to shrink back
to normalcy following Fed cuts, it shoots
back up on the announcement of bad
financial news, especially the write-downs
at major Wall Street banks.
This spread is my best indicator for how
much stress exists in the credit markets.
I need this spread below 10 basis points
for a sustained period of time before I can
pronounce this problem to be over for good.
But even after the credit crisis subsides,
there are other potential pitfalls.
Consumer confidence has been holding
up better than expected despite falling
home and rising gas prices. However, as
it falls further it will affect an already
weakening CEO confidence, resulting in
a pull back on investment growth and job
creation in the economy.
But despite the gloom, I remain cautiously
optimistic that the nation will begin to
see the light at the end of the tunnel by
mid-2009.
Bad debt will get written down and work
its way through the balance sheet of the
system, and Fed rate cuts will help in this
process by providing liquidity to undertake
the write-downs. For now, the only
solution is time.
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