Will there be at some time in the next 10 or 20 years another big bubble and collapse? Absolutely

TO BE NOTED: From Bloomberg:

"New Normal of 2% GDP Growth Coincides With Biggs (Update2)

By Matthew Benjamin

May 26 (Bloomberg) -- Americans may have to get used to unemployment greater than 8 percent for the first time since 1983 and an economy that won’t grow much beyond 2 percent as a consequence of the lost confidence in consumer credit that shattered financial markets.

By this time next year, “the market will realize that potential growth for the U.S. is no longer 3 percent, but is 2 percent or under,” Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., said in an interview with Bloomberg Radio.

“We are transitioning to what we call at Pimco a new normal,” El-Erian said. Pimco, in Newport Beach, California, is the biggest bond fund manager with about $756 billion in assets.

The Standard & Poor’s 500 Index must rise 41 percent to reach its last closing price before Sept. 15, when Lehman Brothers Holdings Inc. filed for bankruptcy, freezing credit markets. Since then, 10-year Treasury notes have climbed 4.6 percent. The disparity shows that stock investors aren’t convinced the economy and profits will grow fast enough to sustain a bigger advance.

The U.S. financial crisis and recession have produced lasting shifts in consumer spending and savings reminiscent of the 1950s that may crimp profits and productivity, said David Rosenberg, chief economist at Gluskin Sheff & Associates Inc. in Toronto and former chief North American economist at Bank of America Corp.

‘New Era’

“This is going to be a new era of frugality,” Rosenberg said. “This isn’t some flashy two- or three-quarter deal. This is a secular change in household attitudes.”

The last time U.S. gross domestic product grew at an annual rate of under 2 percent over a decade was the 1930s, when it expanded at an average 1.3 percent. In the 30 years before the recession that began in December 2007, the average was 2.9 percent. Over the past 15 years, it was 3 percent.

In the first quarter, after contracting at a 6.3 percent annual rate in the previous three months, the economy shrank by 6.1 percent. It was the weakest six-month performance since the last quarter of 1957 and first quarter of 1958.

The coming decade may, in some ways, remind people of those years during President Dwight D. Eisenhower’s administration, Rosenberg said.

The Cleavers

“Life wasn’t so bad for the Cleavers,” he said, referring to the family depicted in “Leave It to Beaver,” the television show that ran from 1957 through 1963. “They weren’t up to their eyeballs in debt and they weren’t a three-car family with a 5,000-square-foot McMansion.”

Behavior by newly ascetic U.S. consumers, whose spending drives more than two-thirds of the economy, will translate into “less return to capital and less-remarkable equity returns,” said Milton Ezrati, senior economist at Jersey City, New Jersey- based Lord Abbett & Co., which manages $70 billion. “The whole picture is muted.”

Barton Biggs, former chief global strategist for Morgan Stanley, sees the near future as brighter with a “powerful” comeback in equities because of government stimulus packages around the world, he said in an interview with Bloomberg Radio.

“The system has had an incredible adrenaline shot, so I think we’re going to have a pretty strong recovery,” said Biggs, who runs New York-based hedge fund Traxis Partners LP.

New Market

U.S. stocks are at the start of a new market that may spur an 88 percent advance in the Standard & Poor’s 500 Index in the next two or three years, said Laszlo Birinyi, founder of Westport, Connecticut-based research and money-management firm Birinyi Associates Inc.

“We’re confident we are in a bull market,” Birinyi said in an interview with Bloomberg Television.

The S&P 500 has rebounded 31 percent since hitting a 12- year low in March. It remains about 43 percent below its October 2007 high, ending at 887 on May 22. Markets in the U.S. were closed yesterday for the Memorial Day holiday.

At Pimco, El-Erian expects that “markets will revert to a mean, but it will not look anything like that of recent years,” he wrote in his May Secular Outlook report. “The financial system will be de-levered, de-globalized and re-regulated.”

Worldwide, “there are insufficient demand buffers and fast-acting structural reforms to provide for a spontaneous and sustainable recovery in the global economy,” he wrote. “It will be a major shock to those that are trapped by an overly dominant ‘business-as-usual’ mentality.”

‘Very Low Growth’

Hewlett-Packard Co., the world’s largest personal-computer maker, is expecting growth in the U.S. to be slow, said Todd Bradley, head of the company’s PC unit.

“We will plan our cost model for very low growth,” he said.

Investors will have to get used to “a 5- to 7-percent return game, not a 15- to 20-percent return game,” said Mark MacQueen, partner and portfolio manager at Sage Advisory Services Ltd. in Austin, Texas, which oversees $7.5 billion.

“Things have changed,” MacQueen said. “Wall Street has changed; confidence in the United States has changed.”

A lasting effect of the recession may be a “markedly higher” natural rate of unemployment, said Edmund Phelps, a professor at Columbia University in New York and winner of the 2006 Nobel Prize in economics. The natural rate is one that neither accelerates nor decelerates inflation.

“It was 5.5 percent,” Phelps said. “Maybe it will be 6.5 percent -- maybe 7 percent.”

Jobless Rate

The U.S. may report on June 5 that the jobless rate moved to 9.2 percent in May, the highest since 1983, from 8.9 percent in April, according to economists surveyed by Bloomberg. In the recession of 1981-1982, unemployment remained at 8.5 percent or higher for two years, beginning in December 1981. It didn’t move below 7 percent until 1986.

Now the rate may not go back under 8 percent until 2013, according to John Ryding, chief economist at RDQ Economics LLC in New York, and Conrad DeQuadros, the firm’s senior economist.

“This unemployment outlook is troubling for the ability of the banking system to make money on consumer loans and credit cards,” they wrote in a report on May 15.

The economy has shed 5.7 million jobs since January 2008, marking the biggest employment loss of any economic slump since the Great Depression.

Highest Debt on Record

Consumers are saddled with debt built up during the boom years. The total amount of U.S. consumer credit rose by an average of 4.9 percent a month at an annual rate from December 2006 to July 2008, according to data compiled by Bloomberg.

Yet it has declined in six of eight months since August 2008, according to data compiled by Bloomberg.

As a percentage of net worth, household debt -- including mortgages -- is at 27 percent, the highest on record, according Federal Reserve figures.

The personal savings rate, which averaged 0.9 percent from 2004 through 2007, has climbed to 4.2 percent. People are responding in part to a drop in their wealth, with house values down 27 percent since June 2006 after rising 63 percent the previous four years, according to national Case-Shiller data.

“That in itself will be a big slowdown in the economy if people are saving instead of consuming,” said Kenneth Volpert, who oversees $180 billion in taxable bonds for Vanguard Group in Malvern, Pennsylvania. The national savings rate could peak at 9 percent, he said.

Debt, Savings

Household debt was 11 percent of net worth at the end of 1959 and the savings rate was about 8 percent, according to Fed and Commerce Department data. The average size of a home built in 1960 was 1,200 square feet, according to Census figures. That grew to 2,521 square feet by 2007, with 24 percent of new homes larger than 3,000 square feet.

Now, smaller may be back as people seek to devote less of their incomes to mortgage payments, said Ara Hovnanian, CEO of Hovnanian Enterprises Inc., New Jersey’s largest homebuilder.

“For some number of years certainly after this correction you will see that conservatism translate into both the size of the homes and the finishes customers want,” Hovnanian said. That means “fewer European cabinets and appliances and fewer granite countertops.”

$200 Handbags

Shoppers will be restrained, which will result in the number of U.S. malls falling by at least a fifth and weak chains succumbing to bankruptcy, said retail analyst Patricia Edwards, founder of Storehouse Partners LLC in Bellevue, Washington.

In preparation, Coach Inc. has begun to “engineer” its collections so at least half its handbags fall into the $200 to $300 range, compared with 30 percent previously, meaning an average reduction in price of 10 percent to 15 percent, CEO Lew Frankfort said.

Long after the economic contraction has ended, “consumers will spend less on luxury goods than they did before the recession began,” Frankfort said at an April 28 investors’ conference. “We are adapting to what will be a new normal.”

Abercrombie & Fitch Co., a teen-apparel retailer that had avoided offering discounts and promotions, said May 15 it will begin reducing what it charges at its Hollister stores. Brinker International Inc., the owner of the Chili’s Grill & Bar chain, said April 21 that it updated its menus to reflect a focus on “lower price points.”

That’s not to say that debt-fueled shopping sprees, expensive restaurants and run-ups in house values and stock prices won’t ever make a comeback, said Ethan Harris, co-head of U.S. economics research at Barclays Capital in New York.

“Will there be at some time in the next 10 or 20 years another big bubble and collapse? Absolutely,” Harris said. “You can’t entirely change human nature.”

To contact the reporter on this story: Matthew Benjamin in Washington at mbenjamin2@bloomberg.net."

percentage of net worth, household debt -- which includes mortgages -- stands at 27 percent, the highest on record

TO BE NOTED: From Bloomberg:

"U.S. Recovery May Start, Then Sputter as Zarnowitz Rule Is Bent

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By Rich Miller and Matthew Benjamin

May 11 (Bloomberg) -- The Zarnowitz rule may live, but not for long.

The current contraction may so far be following the economic law named for Victor Zarnowitz, the late expert on business cycles: Deep recessions are almost always followed by rapid rebounds. Consumer confidence rose by the most in more than two years in April as surging stock prices and falling mortgage rates boosted optimism. A gauge of U.S. manufacturing activity had its biggest bounce since 2005 as companies eased up on efforts to slash inventories. Even the crippled housing market has shown signs of stabilizing.

The risk is that any snapback may end up stunted by structural impediments -- from heavily indebted consumers to a hobbled banking system -- that continue to weigh on the economy and may prevent a sustained run of rapid expansion.

“We could see one or two quarters of 6, 5, 4 percent growth,” says Joel Naroff, president of Naroff Economic Advisors Inc. in Holland, Pennsylvania, who was the top forecaster of the U.S. economy in Bloomberg News surveys last year. “But that doesn’t mean that the economy will be in good shape. We’ll just be going from truly gruesome to bad.”

Bridgewater Associates agrees. The Westport, Connecticut- based financial firm, which says it manages $72 billion in assets, sees a good chance of a big spurt in the economy late in the year, with growth then settling back to a trend line of a shade over 2 percent. That would be well below the postwar rate of 3.3 percent.

Weak Performance

The economy shrank at an annual pace of 6.1 percent in the first quarter after contracting by 6.3 percent in the previous three months, the weakest six-month performance since 1957-58. Inventory cutbacks alone accounted for 2.79 percentage points of last quarter’s decline, as businesses slashed stockpiles at the fastest pace since government records began in 1947.

That has some economists expecting a fillip when companies ramp output back up after reducing unsold supplies to desired levels. If the increase is concentrated in a short period of time, the impact on growth in any given quarter might be significant.

“An important influence on the near-term economic outlook is the extent to which businesses have been able to shed the unwanted inventories,” Federal Reserve Chairman Ben S. Bernanke told lawmakers on May 5. “As stocks move in better alignment with sales, a reduction in the pace of inventory liquidation should provide some support to production.”

Making Toyotas

That may already be happening at some companies. Toyota Motor Corp. is boosting the speed of a Camry assembly line in Georgetown, Kentucky, and is scheduling overtime at a factory building RAV4 sport utility vehicles in Woodstock, Ontario, as stockpiles ran low following previous output cuts.

Housing is another area that may prove to be a surprise source of strength. Homebuilding began to buckle in 2006, chopping 1 percentage point from annual economic growth ever since. As the market stabilizes, that drag will dissipate, giving the economy a short-term boost.

“Housing looks like it has bottomed,” says Allen Sinai, chief economist at Decision Economics in New York.

Confidence among homebuilders rose in April to its highest level since October as record-low mortgage rates below 5 percent started to stir demand. Prices for home resales in March posted their biggest monthly gain since June 2005, with some regions seeing multiple bids on properties.

‘Seeing a Floor’

In southern California, one of the hardest hit areas, prices have begun to stabilize, according to KB Home Chief Executive Officer Jeffrey Mezger. “We’re seeing a floor,” he said in a May 4 call with analysts. That’s giving the Los Angeles-based company an opening to sell newly built homes.

The economy will also get a lift from President Barack Obama’s $787 billion stimulus package of spending increases and tax cuts, which was signed into law in February and is only now starting to kick in. While Federal agencies have allocated $88.1 billion of investment, so far just $28.6 billion has been spent.

Louis Crandall, chief economist at Wrightson ICAP LLC, a Jersey City, New Jersey-based research firm, says consumers will also benefit this month from some $13 billion in extra Social Security payments.

That leads Michael Mussa, a former chief economist of the International Monetary Fund, to argue that the U.S. will enjoy a so-called V-shaped recovery. Mussa, who’s now at the Peterson Institute for International Economics in Washington, invokes Zarnowitz in saying “there is no good reason to presume” that this recovery won’t be a strong one.

Soviet Gulag

Zarnowitz, a native of Poland, fled the Nazis in 1939 only to end up in the Soviet gulag. After making it to the U.S. in 1952, he became a professor of economics at the University of Chicago and a leading expert on business cycles and economic indicators. He joined the National Bureau of Economic Research in 1952, where he was one of the seven economists who date recessions and expansions. He died in February at age 89.

Many economists, including Naroff, disagree with Mussa. David Rosenberg, former chief North American economist at Bank of America and now chief economist at Gluskin Sheff & Associates Inc. in Toronto, says the current contraction isn’t a typical, inventory-driven recession: “This is a deleveraging cycle.”

Consumers are still saddled with hundreds of billions of dollars in debt built up during the boom years when home prices skyrocketed. As a percentage of net worth, household debt -- which includes mortgages -- stands at 27 percent, the highest on record, according to John Lonski, chief economist at Moody’s Capital Markets Group.

Wealth Walloped

Americans have also seen their wealth walloped. U.S. house prices rose 63 percent from 2002 to June 2006 and then fell 27 percent since that peak, according to national Case-Shiller data. The Standard & Poor’s 500 index hit a 12-year low in March and now stands 42 percent below its October 2007 peak.

As a result, households are being forced to save more and spend less. Lyle Gramley, a former Fed governor who is a senior economic adviser for New York-based Soleil Securities Corp., sees the savings rate rising to 7 to 8 percent over the next few years from an average of 1.7 percent during the past decade.

An added reason for restraint: the continued rise in unemployment, which climbed to a 25-year high of 8.9 percent in April from 8.5 percent in March.

Banks have also turned more cautious after piling up close to $1 trillion in lending and investment losses during the last two and a half years. A Fed survey released May 4 found that banks toughened terms on home and credit-card loans in the past three months.

According to stress tests carried out by regulators, the nation’s biggest banks need $74.6 billion in additional capital to be able to weather a further worsening of the economy and keep on lending.

“The biggest financial crisis in 70 years is likely to leave a legacy with consumers, business people and investors,” says Richard Berner, co-head of global economics for Morgan Stanley in New York. That “will have an impact on the kind of economic activity and the kind of rebound we’re likely to get.”

To contact the reporters on this story: Rich Miller in Washington rmiller28@bloomberg.netMatthew Benjamin in Washington at mbenjamin2@bloomberg.net"

"conversion, whereby, for example, all existing mortgage debts could be wholly or partly converted into long-term, low and fixed-interest loans"

Niall Ferguson on FT talks about Leviticus:

"In the Old Testament Book of Leviticus, God commands the children of Israel to observe a jubilee every 50 years. Nowadays we tend to associate the word with celebrations of royal anniversaries such as Queen Elizabeth’s golden jubilee in 2002. But the biblical conception of a jubilee was more precise: that of a general cancellation of debts.

This point is spelt out in Deuteronomy: “Every creditor that lendeth ought unto his neighbour shall release it; he shall not exact it of his neighbour, or of his brother; because it is called the Lord’s release.” ( I BELIEVE THAT THIS WAS ALSO TO ENSURE THE LAND REMAINED IN THE POSSESSION OF EACH TRIBE )

Such injunctions may strike the modern reader as utopian. How could any sophisticated society function if all debts were cancelled twice a century – much less, as Deuteronomy seems to suggest, every seven years? Yet we know that such general cancellations of debt really did happen in the ancient world. In 1788 BC, for example, about 500 years before the time of Moses, King Rim-Sin of Ur issued a royal edict declaring all loans null and void, wiping out some of history’s earliest known moneylenders. ( WHY NOT HAVE SAVER NATIONS LIKE CHINA AND GERMANY CANCEL DEBT, AND THEN THE SPENDER NATIONS CAN START SPENDING AGAIN AND EVERYONE IS HAPPY AND DOING WHAT COMES NATURALLY TO THEM? )

The idea of a generalised debt cancellation is not wholly unknown in modern times. The late Gerald Feldman, the world’s leading authority on the German hyperinflation of 1923, drew a parallel between the ancient Hebrew yovel and the wiping out of all paper mark-denominated debts as a result of the collapse of the German currency (though, as he was quick to point out, those whose savings were wiped out were far from jubilant).

In the hope of avoiding the mark’s meltdown, the economist John Maynard Keynes had repeatedly called for a general cancellation of the war debts and reparations arising from the first world war. Though no such intergovernmental jubilee was ever proclaimed, debt cancellation was effectively what happened after 1931, beginning with President Herbert Hoover’s one-year moratorium on both war debts and reparations.

As 2008 draws to a close, there are many people on both sides of the Atlantic who yearn for such a simple solution to the problem of excessive indebtedness. Parallels with the interwar period are not inappropriate. It is all but inevitable that we shall see serious political and geopolitical upheavals in 2009, as the recession takes its toll on weak governments (Thailand and Greece are already reeling) and raises the stakes in inter-state rivalries (India-Pakistan). In the words of Hank Paulson, the US Treasury secretary: “We are dealing with a historic situation that happens once or twice in 100 years.” The stakes are high indeed. Has the time arrived for a once-in-50-years biblical jubilee?

Excessive debt is the key to this crisis ( BUT WHAT CAUSED IT? ); it is the reason we are confronting no ordinary recession, curable by a simple downward adjustment of interest rates. It is the reason we still have to fear, if not a second Great Depression, then very likely the biggest recession since the 1930s. We are living through the painful end of an age of leverage which saw total private and public debt in the US rise from about 155 per cent of gross domestic product in the early 1980s to something like 342 per cent by the middle of this year.

With average household debt rising from about 75 per cent of annual disposable income in 1990 to very nearly 130 per cent on the eve of the crisis, a large proportion of American families are submerging under the weight of their accumulated borrowings. British households are in even worse shape.

Looking back, we now see just how big a proportion of US growth since 2001 was financed by mortgage equity withdrawals. Without that as a means of financing consumption, the economy would barely have grown at 1 per cent a year under President George W. Bush. Looking forward, we see just how hard it will be to stabilise property prices and the prices of the securities based on them. Already, at the end of September, one in 10 American home owners with a mortgage was either at least a month in arrears or in foreclosure. One in five mortgages exceeds the value of the home it was used to purchase.

The financial sector’s debts grew even faster as banks sought to bolster their returns on equity by “levering up” ( THIS IS TRUE ). According to one recent estimate, the total leverage ratios (on- and off-book assets and exposure divided by tangible equity) for the two biggest US banks were 88:1 for Citibank and 134:1 for Bank of America. The bursting of the property bubble caused such ratios, which were already too high on the eve of the crisis, to explode as off-balance-sheet commitments and pre-arranged credit lines came home to roost. Only by borrowing from the Federal Reserve on an unprecedented scale have the banks been able to stay in business( THE BANKS CONSIDER IT INSURANCE AND WERE COUNTING ON IT ).

With estimates of total losses on risky assets now ranging from $2,800bn (£1,850bn, €1,960bn) to $6,000bn, a chain reaction is under way that will leave no sector of the world economy untouched. The American economy is contracting at an annualised rate of 5 per cent ( WE NEED TO WAIT ON THAT ). Commercial property is following the residential market into freefall. The Standard & Poor’s 500 index is down 43 per cent since its peak in October last year. The market for credit default swaps is pointing to a surge in defaults on corporate bonds( I BELIEVE THIS IS OVERDONE ). The automotive industry is already (against the will of Congress and the original intention of the Treasury) on life support. The US is at the centre of the crisis but Europe and Japan may suffer even larger aftershocks. As for the much feted emerging market “Brics” – Brazil, Russia, India and China – their stock markets have been dropping like, well, bricks.

What makes this crisis of burning interest to financial historians is the knowledge that we are witnessing a real-time experiment with not one but two theories( THEY'RE NOT MUCH HELP ) about the Depression.

On one side, Ben Bernanke, Fed chairman, is applying the lesson of Milton Friedman’s and Anna Schwartz’s A Monetary History of the United States, which argued that the Depression was in large measure the fault of the central bank for failing to inject liquidity into an imploding financial system. Mr Bernanke has not merely slashed the federal funds rate to below 0.25 per cent. He has lent freely to the banks against undisclosed but probably toxic collateral. Now he is buying securities in the open market. ( HE'S DOING WHAT LOOKS LIKE THE LEAST AWFUL ALTERNATIVE )

The result has been an explosion of the Fed’s balance sheet and of the monetary base. With assets approaching $2,263bn and capital of less than $40bn, the Fed increasingly resembles a public hedge fund, leveraged at more than 50:1. ( THE ASSETS OF THE AMERICAN PEOPLE BACK THIS )

On the other side, Mr Paulson has emerged as an unwitting disciple of Keynes, running a huge government deficit in an effort not merely to bail out the financial sector but also to provide a public sector substitute for sharply falling private sector consumption. Even before President-elect Barack Obama launches his promised infrastructure investment programme, estimates of next year’s deficit run as high as 12.5 per cent.

Once, monetarism and Keynesianism were considered mutually exclusive economic theories. So severe is this crisis that governments all over the world are trying both simultaneously ( THAT'S BECAUSE WE'RE NOT SURE WHAT TO DO ).

Although commentators like to draw parallels with Franklin Roosevelt’s New Deal, in truth the measures taken since the crisis began in August 2007 more closely resemble those taken during the world wars ( AND? ). After 1914, and again after 1939, there was massive government intervention in the financial system. Banks and bond markets were reduced to mere channels for the financing of huge public sector deficits. That is what is happening today, but without the stimulus to manufacturing that the world wars provided. We are having war finance without the war itself.( THANK GOD )

Yet the effect of these policies is essentially to add a new layer of public debt to the existing debt mountain. Added together, the loans, investments and guarantees made by the Fed and the Treasury in the past year total about $7,800bn, compared with a pre-crisis federal debt of about $10,000bn. The Treasury may have to issue as much as $2,200bn in new debt in the coming year. ( IT'S A PROBLEM, BUT NOT INSURMOUNTABLE )

For the time being, the distress-driven demand for dollars and risk-free assets is pushing down the cost of all this borrowing. Treasury yields are at historic lows. But it is not without significance that the cost of insuring against a US government default has risen 25-fold in little over a year ( THIS MIGHT WELL BE OVERDONE ). At some point ( WHAT POINT? ), with most big economies adopting the same fiscal policy, global bond markets are going to start choking.

Is it really plausible that the cure for excessive leverage in the private sector is excessive leverage in the public sector ( YES IT IS. IT'S PARADOXICAL, BUT MUCH OF LIFE IS ) Might there not be a simpler way forward? When economists talk about “deleveraging” they usually have in mind a rather slow process whereby companies and households increase their savings in order to pay off debt. But the paradox of thrift means that a concerted effort along these lines will drive an economy such as that of the US deeper into recession, raising debt-to-income ratios.

The alternative must surely be a more radical reduction of debt. Historically, such reductions have been done in one of four ways:( 1 ) outright default,( 2 ) restructuring (for instance, bankruptcy), ( 3 )inflation or ( 4 ) conversion. At the moment, more and more American households are choosing the first as a way of dealing with the problem of negative equity, while more and more companies are being driven towards bankruptcy. But mass foreclosures and bankruptcies are not a pretty prospect.( BUT THEY MIGHT HELP )

Inflation, by contrast, is hard to worry about in the short term, not least because the Fed’s expansion of the monetary base is leading to no commensurate expansion of the broad money supply; the banks would rather shrink than expand their balance sheets.( SO WHY NOT USE IT? )

That leaves conversion, whereby, for example, all existing mortgage debts could be wholly or partly converted into long-term, low and fixed-interest loans, as recently suggested by Harvard’s Martin Feldstein. (In his scheme, the government would offer any homeowner with a mortgage the option to replace 20 per cent of the mortgage with a low-interest loan from the government, subject to a maximum of $80,000. The annual interest rate could be as low as 2 per cent and the loan would be amortised over 30 years ( THEY DO HAVE TO PAY THE MONEY BACK ).

At the very least, this would rescue many homeowners from the nightmare of negative equity. A similar operation might also be contemplated for the debts of those banks that have been partially or wholly recapitalised by the state. This would not add to the federal debt in net terms and would reduce the interest burden, if not the absolute debt burden, of households.

Such radical steps would naturally represent a haircut for creditors ( FINE WITH ME, SINCE THE HOUSES THEY WOULD FORECLOSE ON WOULD BE WORTH LESS ), notably the holders of mortgage-backed securities and bank bonds. Yet they would surely be preferable to the alternatives ( NOT IF THEY FEEL THAT THEY CAN GET A BETTER DEAL FROM THE GOVERNMENT. ALSO, ARE YOU GOING TO MANDATE THIS? ). And they would certainly be a less extreme solution than the general debt cancellation envisaged in the Old Testament.

Financially, 2008 has been an annus horribilis. The answer may be to make 2009 a true jubilee year.

To be honest, I don't think he made a case for any of the four alternatives. It's an interesting plan, but it is dubious that it can be made to work in practice, due to a number of factors leaving lenders and borrowers to prefer other alternatives.

How fallow years led to a golden jubilee

Every seven years, God told Moses, the children of Israel should neither sow their fields nor prune their vineyards – a kind of self-imposed recession. After seven such sabbatical years, the trumpet of jubilee should be sounded: “And ye shall hallow the fiftieth year, and proclaim liberty throughout all the land unto all the inhabitants thereof: it shall be a jubilee unto you; and ye shall return every man unto his possession.”

Land that had been sold was to be redeemed or returned to the original seller and the poor were to be relieved: “If thy brother be waxen poor, and hath sold away some of his possession, and if any of his kin come to redeem it, then shall he redeem that which his brother sold ... If thy brother be waxen poor ... then shalt thou relieve him: yea, though he be a stranger ... Take thou no usury of him ...” In addition, Jews who were slaves were to be set free.

To modern eyes, however, the most striking of these divine injunctions was that debts were to be cancelled as part of “the Lord’s release”.

"people are not going to rush to borrow to buy such big-ticket, long-lasting items anytime soon."

Sudden Debt with an interesting post about where we've been and where we might be going:

"Two of the largest sectors of the US economy are housing and automobiles. Both are reeling (see charts below).

Looking at the charts, we observe that both industries had been on a more or less continuous uptrend since 1990-92 - until they jumped off the cliff in 2007. What happened? It's quite simple, really: houses and autos are the #1 and #2 most significant purchases people make in their lifetimes, usually financing both ( TRUE ). That's where easy-easier-easiest credit came in: in just a few years household debt as a percentage of GDP jumped from 67% to nearly 100% (see chart below).
In other words, between 2000 and 2007 we over-borrowed and over-spent on houses and cars, satisfying future demand for many years to come. No matter how low the Fed takes its rates (a record low 0.0% - 0.25% as of yesterday), people are not going to rush to borrow to buy such big-ticket, long-lasting items anytime soon. They do not need them, because they've already bought them. It follows that household lending - the driving force behind finance in recent years - is also going to be down on its heels for many years ( TRUE ).

Conclusion: don't go bottom-fishing in these sectors just yet ( YOU CAN BUY INDIVIDUAL STOCKS IF YOU CAN DO THE RESEARCH ). Instead, investors will be better off looking for The Next Big Thing. What's that? My bet is on alternative energy and everything that revolves around it, such as smart electricity grids. A wholesale shift from "black" to "green" will necessarily require massive investment and will, also necessarily, lead to a shift from consumption to saving, in order to finance it( IT'S A VERY WIDE AREA, BUT THE GENERAL POINT SEEMS RIGHT ). This will pose significant challenges to the retail and traditional services sectors, too.

I fully expect a long period of massive Creative Destruction to unfold, i.e. OPPORTUNITY. ( I AGREE WITH THIS, AS DOES JIM GRANT )Any and all ideas from readers are welcome.."

One added point. I've said that houses are an investment, so that, theoretically, the money that had been used for buying houses would now be spent on other things. As well, it is important to remember that for the people who remain in their houses after buying in recent years, the house is still an investment which generally pays off better than renting. As for autos, that money should also go towards other purchases. I'm not savvy enough to know where that money is going to go. This is a version of Ricardian Equivalence.

"Everyone is facing a deterioration in wealth – home and equity owners alike – and this time around, consumption is bound to decline…further."

I liked Rebecca Wilder's summation of the numbers that came out from the Fed this week on News N Economics:

"Households debt falls for the first time...ever (at least since 1952)!

The Federal Reserve released its third quarter flow of funds account. I have never been so anxious to get a release as I was today for the flow of funds account. Third quarter highlights GO something like this:

• Household net worth declined 4.7%
• Household debt decreased an annualized 0.8% - a sign of real delevering, given that the 0.8% contraction is in nominal terms and prices rose 1.6% over the same quarter.
• Total business debt decelerated to a 2.94% pace (down from 5.6%).
• Federal debt grew an annualized 39% in the third quarter, which is 33.5% above the average 5.5% quarterly debt growth from q2 2007 to q2 2008. This is the biggest surge since 1952.

But there is also a very troubling effect that may emerge, and that is the wealth effect.

The chart illustrates the ratio of household net worth to disposable personal income spanning 1952:Q1 to 2008:Q3. In the third quarter, the share of net worth fell to 5.3% times current disposable income, driven by falling equity and home values. Consumer wealth is falling, and unless housing and equity markets stabilize and grow SOON, wealth will likely fall for two more quarters…at least.

The continuous decline in net worth is likely to hammer consumption, and with that, GDP. It seems like the wealth effect – which is previously questionable as an empirical determinant of consumption – is now quite strong.

Households are watching their stock of housing wealth fall when they return home from work, when they turn on the TV, and when they sit down for dinner. Everyone is facing a deterioration in wealth – home and equity owners alike – and this time around, consumption is bound to decline…further.

There is some serious slack building in this economy. Go Policymakers~!"

I've questioned the Wealth Effect in the following way:

I believe that there is one, but it's based on perception by individuals. I don't see it correlating exactly with any set of numbers. However, Rebecca makes a good point, that this graph does suggest a general correlation that is much closer than I'd assumed. This goes back to my talking about people's perception of the value of their homes being higher than the market warranted. I'd like to know more about those perceptions before I accept a graphic way to determine the Wealth Effect.

The falling household debt does suggest a general aversion and fear of risk and flight to safety, which will have to be addressed at the level of households.