Monday, February 12, 2007


GDP minus Mortgage Equity Withdrawal

Cashing in home equity has been the story of the decade. Home equity has been the driving force behind economic grow since the recession of 2001. Here is a graph illustrating how anemic growth would be without HELOCs (Home equity lines of credit). We are literally spending our savings to finance our lifestyles. The big question is why has economic growth been so weak? Undoubtedly the wealth effect of the Nasdaq bubble bust has been huge. With the stock market rallying strongly, however, you would think that we would begin to see the economy stand on its own two feet without the need of home equity steroids.

We will have to see what happens in 2007. As I have pointed out in the past, deflation is a contraction of credit. Borrowers simply stop borrowing to finance out the expectation that prices will continue falling and the central bank can continue to lower the price of credit but that will do no good as long as the public expects falling prices. So you can call this the Sammy Sosa economy. With the steroids gone it seems all but certain that the economy will deflate and retire.

P.S. One more thing. This year and next will see trillions of dollars in adjustable rate mortgages, which were originated in 2002-2005, adjust to higher interest rates. Already record rates of mortgage defaults will continue to increase barring a stupendous fall in interest rates. A fall that could only come from a very significant recession. So heads is recession and tails is depression.


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