Is the recovery on?

Well, last night there was a great debate on most of the financial news networks about whether yesterday's lovely stock market gains constitute the start of the recovery. Some said yes. Some said no.

So is the recession over, and is the recovery on-going? I'll give you a short answer and a long answer. The short answer is: No, fuck no. The long answer? Let me tell you about it.

There are two fundamental forces driving this recession.
1. Housing prices
2. De-leveraging

First we have the structural economic problem that the housing in America is vastly overpriced and unaffordable. Go do a housing survey in any region. Go do an income survey in that same region. Just about everywhere in the country, you will find the same relationship. Housing is more than 4 times the total annual income level of the typical family or buyer. In afflicted regions such as Los Angeles, San Diego and San Francisco, it is much worse. A typical family home can be 6 or 7 times the annual income of the typical family.

So what? Old bankers will tell you that (historically) the safe formula for mortgages says write a mortgage for no more than 2.5x the house hold income and ensure that the total cost of housing does not exceed 28% of total income. Insurance, HOA, and Mortgage payment must be less than 28% of household income. We are vastly beyond this safety limit right now, and this is the absolute fundamental reason for this horrible banking calamity we are experiencing. People are defaulting on mortgages because they cannot afford them.

Certain politicians and real estate brokers are attempting to re-cast reality to say that this calamity was brought to us by a bunch of unethical loan sharks who wrote nasty loans. The implication is that housing prices don't need to go down, loan terms just need to be adjusted. What...? As if they could have written a good mortgage for these outrageous amounts? No way. Every mortgage looks predatory if you write it for a party that cannot afford the basic price of sale. The absolute problem is an over-bought, over-speculated, inflated housing market that is fundamentally unaffordable for the people. The variable that must be adjusted is base-price of sale. That figure needs to go way down. All the way down to 2.5x average household income.

This can be accomplished in two ways:
1. You can raise average household income, which is bloody unlikely
2. You can lower the base price of sale through a process of default, foreclosure, auction, and short sale. This process is absolutely in progress right now.

That process of price tatonement must run to completion before the recovery will begin. We are not near the equilibrium point just yet, so forget about recovery. I predict that the equilibrium point will occur when average housing prices = 2.5x average income by region. Once we hit that, recovery will be possible.

The second problem driving this recession is de-leveraging.

When the economy had it's stroke and heart attack on September 15th 2008, the wave of panic that shot through the media was totally unprecedented in my lifetime. The U.S. Presidential election cycle stopped cold for several days and was thrown on the back-burner by the news agencies. Barrak Obama and John McCane suspended their campaigns.

This scared the unholy shit out of the people. At our Thanksgiving Day table, we had not a single conversation about anything other than the economy, job loss, the Great Depression, banking collapse, retirement funds, being under-water, etc. We did not discuse McCane or Obama. Our family was pretty dang terrified. I bet you were too.

The natural response to this new threat was to pay off all debt, store up some savings, and prepare for unemployment, should it strike. Just about all businesses and individuals began throwing all new earnings at debt. Consumption fell off a cliff. Businesses starved for customers and demand. This is about as pro-cyclical a move as the American consumer could have possibly made, but we all made that move together. We did it individually and collectively. The result is a deep, agonizing, downward spiraling recession.

So now we have a problem to solve: When does de-leveraging stop? There are two possible answers:
1. De-leveraging stops when everybody is completely out of debt
2. De-leveraging stops when the American consumer gets tired of austerity and breaks out the credit cards again.

Here, I can sound a bit more optimistic. I have little faith in the fiscal discipline of my people. We Americans like to spend and consume. We don't like zero debt for this reason. I expect our good people to half-step here. They will move their debt loads down considerably, perhaps even to safe levels, and then they will begin consuming again.

But then on the other hand... We should also remember that America's favorite shopping tool is the credit card. Certain credit card firms, most importantly Amex and Chase, are in a lot of trouble with consumer credit. They are playing shutdown defense right now. There are more and more reports of Chase and Amex closing accounts, reducing credit limits, hammering long term customers with massive interest increases.

There are some reports of Citibank doing the same thing. I personally have two Citibank MasterCards and they have done no such thing to me... yet. Let's hope they don't. I like my gasoline cards.

Anyway, presuming that consumer credit largely stays intact. Americans might start spending again by Christmas of 2009.