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Article Excerpt
Commentary
Over the past six months, the economy and capital markets have dominated the news. This attention blossomed in late fall as the economic environment continued to implode and Washington debated what it could do to avoid a complete meltdown and forestall a depression, which has become a plausible, albeit moderate, downside scenario.
Unfortunately, there has been little positive to offset news of the economic devastation that has rippled across the country and globe. In such an environment, everyone is looking for answers or at least for a list of indicators that could be monitored to signal an end is in sight. While this is understandable, the reality is the economy and capital markets are in such unchartered waters that it is impossible to identify the set of indicators that will foretell when we have changed course and can look forward to calmer seas.
Predicting what will happen in these uncertain times, which will continue well into 2009, is complicated by a number of factors. First, the federal government is still debating the course of action to take regarding an economic stimulus package. Thus, to an extent, we have shifted from a market-based economy to a political economy in which all bets are off until the new administration settles into office and the boundaries that will be placed on further interventions become clearer.
Second, due to the lack of data, monitoring, transparency, and regulation, it is impossible to identify the problems that are lingering beneath the surface. For example, the impending credit-driven contraction in the commercial real estate market has not received much attention outside of real estate circles. As such, there is no way to objectively quantify the impact of the easy credit environment of the recent past, which would allow us to determine where the economy is at in the cycle and how it is likely to play out, with or without further stimuli.
Third, the erosion in consumer and business confidence levels has been so dramatic and revolutionary that it has rendered traditional economic models and forecasts invalid. That is, we are now in an environment in which perceptions and market behavior will rule the day rather than rational models driven by economic considerations. Fundamental questions include several dimensions: Who are the key players? What will they do next? What will be the collective impact when it all plays out?
In light of the challenges we face, one response would be to shut down, to ignore the fray. Unfortunately, that is easier to say than to do, especially when personal and corporate wealth and revenue streams are in play. Although the arrival of the Obama administration in Washington, DC, has been much heralded and has worked to get a jump-start on action plans, the reality is there are no obvious solutions for deleveraging the economy without creating further disruptions to collateral values and market activities. This situation will affect both the wealth and income sides of our individual and collective balance sheets and will warrant close attention.
The commercial real estate market in particular is vulnerable to a number of downside risks that are now beginning to surface and are being talked about more openly as industry advocates try to belly up to the bailout bar before the last call is issued. Since this situation is likely to continue to unfold, it is useful to try to focus on where we are at, what is likely to occur, and what to monitor to stay on top of things. Unfortunately, even with perfect foresight, the time for developing proactive or defensive plans is long past. Due to the economic house of cards in which we live, most of us will have to deal with the hands that we have been dealt, and hope not to get caught in the changing rules of the game that will be decided in the political arena.
A Note on Market Interventions and Market Behavior
The current economic collapse can be attributed to the lagged impact of three major, related phenomena: the issuance of easy and cheap credit that created market bubbles; the resultant collapse of confidence as it became clear the market had gotten out of balance; and the actual and anticipated collapse of collateral values that had been artificially bolstered by excess capital flows and the lack of attention to risk. Of the three factors, the confidence issue is the most disconcerting since it is so widespread and ingrained.
At this point, using traditional remedies-such as addressing the credit crisis by stimulating credit flows or supporting collateral values at current levels by driving down interest rates-may provide some respite, but cannot be relied on to rekindle confidence levels. That is, traditional approaches based on the assumption of rational thinking will not work in a situation where one of the major obstacles that must be addressed is more psychological than economic. This is especially true when the negative news and underlying facts are so pervasive and seemingly never ending. In some respects, the situation is analogous to the problems a coach faces in turning around the fortunes of a languishing team that has been infested with negativism--one in which players are waiting for the next bad break. In that situation, as in the current economic situation, the downside can become a serf-fulfilling prophecy. To turn things around, it is necessary to work on the psychological side of the issue as much as on the technical side.
Unfortunately, econometric models and financial theory do not handle such intangibles very well and are unlikely to do so over the near term. This disconnect from the reality of the market is evidenced by the fact that consumers and businesses knew we were in a recession long before the official numbers came out; the market could sense it and was feeling the pain it was causing.
In this environment, one of the key signs that the economy and credit markets are turning the corner will come from improving confidence levels for the key players in the market (i.e., consumers, CEOs, homebuilders, investors). The importance of regaining the market's confidence is one of the major factors behind the attention being placed on the changing of the guard in Washington.
While most realize there will be no quick fix, the bipartisan support for addressing the credit and economic crises has been embraced by most observers. Indeed, the passage of legislation to free up the $300 million in unallocated capital contained in the initial bailout plan prior to the inauguration reflected the objective of allowing the new administration to hit the ground running and gain the momentum necessary to reestablish confidence.
This vote of confidence should buy some much-needed time to allow the administration to get its team assembled and develop a plan of action without proposing more stop-gap measures with questionable prospects for success. A growing cadre of politicians, businesses, and consumers seem to be resigned to the fact that things will get much worse before they get better. This sober but understandable mindset will take some pressure off short-term fixes and open the door to additional debates regarding what steps should be taken.
At the same time, the administration will be under pressure to prevent the situation from eroding further. Because of the staunch criticism triggered by the lack of transparency and accountability embedded in the initial bailout awards, new programs are likely to contain a number of requirements, including disclosure and compensation limits.
A number of initiatives have been discussed regarding the allocation of the initial bailout funds and the key elements of a second stimulus package. While the details are far from being final, the new programs are likely to address a number of key issues including stimulating the flow of credit to the mortgage and commercial industries; providing financial assistance to help key industries...
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