We know that the subprime problems fueled the recent credit crisis. And the recent payroll report was simply disastrous, revealing that the economy contracted by 4,000 jobs versus expectations of a 115,000 job increase in August. We now have proof that the job creation machine ground to a halt during the August market sell-off. It's obvious that the subprime woes and credit crisis have now spread to other areas of the economy, and the situation is getting serious.
The Mortgage Banker's Association (MBA) recently reported that the number of mortgage loans entering foreclosure has reached the highest level in the 55-year history of their survey. The sun-belt states of Arizona, California, Florida and Nevada had the fastest rising rates of foreclosure, although rust-belt like Michigan and Ohio as well as some states in the Deep South continued to post high foreclosure rates as well.
Foreclosure delinquencies rose to 5.12% in the second quarter, and subprime delinquencies rose to 14.82%--the highest level in five years. The big difference between now and five years ago, however, has to do with absolute size. In the second quarter of 2002, there were 1.19 million subprime mortgages outstanding, while now there are about 5.9 million outstanding. Yikes! Now you know why major banks and other financial stocks have been performing so poorly lately.
It's apparent that the housing mess has seeped into other areas of the economy, and analysts suspect the rise in foreclosure delinquencies is due to resetting Adjustable Rate Mortgages (ARMs). If this is the case, the Fed should act fast and cut interest rates. Mortgage delinquency rates could rise even more sharply if new job creation does not resume, and that might not happen without lower interest rates.
This brings us to the "R" word. Eight of the past ten recessions have been preceded by overinvestment and then a slump in housing. While economists have placed about a 35% chance of a recession happening in 2008, I disagree. Since Ben Bernanke is the former head of President Bush's Council of Economic Advisors, and he and every voting member of the Fed is a Republican, I believe the chance of a recession next year is nil.
Even though President Bush isn't running for re-election, Politics 101 states that you need to keep the economy strong going into any election. President Bush's dad (#41) learned that lesson the hard way back in 1992, when the economy was in the dump, and surprise, surprise, he didn't get reelected.
While I don't think we're nearing a recession, I do believe that the Fed should act fast to help stop the housing meltdown and keep the economy afloat. Originally I believed the Fed would cut rates a total of 0.75% (in three 0.25% cuts), but I now expect that by the time the year is out, they will have cut rates by a full percentage point.
A big rate cut may not completely fix the housing troubles, but at least it will give some much-needed relief to the battered housing market. Homeowners will be able to refinance at more attractive mortgages rates, and it will also prevent any more housing fallout from affecting the economy. Don't listen to Jim Cramer when he says that we're facing a recession. The Fed won't let that happen.
