[OPE-L] The Last Letter of Kurt Richebacher

From: glevy@PRATT.EDU
Date: Fri Sep 14 2007 - 13:56:23 EDT

Kurt Richenbacher -- Austrian-school economist, financial commentator, and
author of "The Richenbacher Letter" -- died recently in Cannes at the age
of 88. The following is his last letter.

In solidarity, Jerry

US Economy Headed for Recession as Housing Bubble Bursts
Dr. Kurt Richebacher on Sep 14th, 2007
"America's income-short, consumer-led recovery is the aberration - not the
norm - in this Brave New World. It is all about ever-declining saving
rates, ever-widening current account deficits, mounting debt burdens and
increasingly wealth-dependent consumers. It personifies what I believe is
one of the most precarious macro models that has ever existed for a major
economic power."
- Stephen Roach, Morgan Stanley Economist, April 4, 2005
Private households in the United States have embarked on their greatest
borrowing binge of all time, fostered and facilitated by the rampant house
price inflation and a most aggressive financial system. What has been
developing in the balance sheets of private households, therefore, is a
race between booming "wealth creation" through rising house prices and
soaring indebtedness.
It appears that indebtedness will win this race and wealth creation will
lose. Over the five recovery years since the end of 2001, the overall
indebtedness of private households surged by 66%. Even though overall
indebtedness soared, rising home prices still provided the private
households with the biggest wealth gains of all time. The housing bubble,
therefore, has been the single most important economic event of the last
few years. Homeowners used the sharply rising market values to embark on
their greatest borrowing-and-spending binge of all time, financing higher
consumer spending through soaring equity withdrawals, even though personal
savings were negative in the aggregate.
The bursting housing bubble, therefore, should be the single most
important economic event of the next few years.
In a recent speech in Atlanta, Donald L. Kohn, vice chairman of the
Federal Reserve Board, remarked:
"Our uncertainty about what pushed home prices and sales to those elevated
levels raises questions about how the market will adjust now that
expectations of the rate of house price appreciation are being trimmed."
Please note his explicit remark on "our uncertainty about what pushed home
prices and sales to those elevated levels". The Fed slashed its federal
funds rate with unprecedented speed to 1% and accommodated America's
greatest credit inflation, yet Mr. Bernanke stresses the uncertainties in
the Fed about what truly pushed homes and sales of housing to those
elevated levels.
There never was a secret about what exactly has been fuelling the US
asset-inflation bubbles - above all, equities, bonds and the boom in
housing. First of all, the Federal Reserve - with Messrs. Greenspan and
Bernanke at its helm - played a key role in the late 1990s both with
extremely loose monetary policies and highly encouraging public remarks to
foster the stock market boom.
Nevertheless, the stock market boom went bust in 2000 and the following
years. While the government and the Federal Reserve opened their fiscal
and monetary spigots as never before, the economy started its most anaemic
postwar recovery. The main support for economic growth came from the
developing residential housing bubble, which offset the stock market bust
of 2000 to 2002 and provided homeowners with soaring collateral for
borrowing through home mortgage refinancing.
To quote Stephen Roach of Morgan Stanley: "The Fed, in effect, had become
a serial bubble blower." By the time the equity bubble popped in early
2000, consumers had moved on to a new strain of wealth effects - taking
advantage of possible equity withdrawals from rising housing values to
extract newfound purchasing power. But now that home values are falling,
this purchasing power is moving in reverse.
According to the Fed's Flow of Funds Accounts of the United States, new
mortgage borrowing by private households peaked in the third quarter of
2005 to an annual rate of US$1,223.6 billion. One year later, its growth
sharply slumped to US$672.7 billion, marking a decline by 45% within just
one year. Retrenchment in mortgage borrowing and lending over this brief
period has been dramatic.
Without rising home values, and continuing access to new credit, the
American economy will slide into recession.
The US economy is one of the very cases in the world in which all three
main sectors - government, businesses and private households - keep
borrowing and spending heavily in excess of their current income growth.
In 2005, they together borrowed US$3.35 trillion, of which the
nonfinancial sector borrowed US$2.3 trillion and the financial sector
another US$1 trillion. This compared with a total credit expansion by
US$1.6 trillion in 2000. This coincided with a collapse in national saving
from US$582.7 billion to US$7.2 billion.
Therefore, arguments between bulls and bears about the further prospects
of the economy and the financial markets are focused more than ever before
on one aggregate: excess liquidity and credit growth. Long ago, until the
late 1960s, credit growth was closely tied to economic growth, as measured
by gross national product. But this formerly close relationship between
the two aggregates went completely bust in the 1980s. Ever since, credit
has been expanding in excess of GDP growth.
During 2005, total credit grew in that single year by US$3.35 trillion.
Compared with nominal GDP growth by US$0.74 billion. In other words, it
required US$4.50 of new credit to add US$1 to GDP. Clearly, this is
excessive liquidity and credit growth.
It is a fact that each major economic and financial crisis has been
preceded by "excess" liquidity. Just think of America's New Era during the
1920s and of Japan's famous bubble years in the late 1980s. In both cases,
prior excess liquidity vanished in no time when the existing asset bubbles
began to burst. If growing asset bubbles are the channels to excess
liquidity, bursting asset bubbles are the channels to liquidity
destruction and excess debt.
Therefore, we observe with a very critical eye the balance sheets of
private households. According to the consensus of economists, American
balance sheets are in excellent shape because asset values, mainly equity
and housing, have soared in value for years, altogether by about US$19
trillion - or almost 40% - since recession year 2001.
But the bulk of these gains has been entirely in illiquid assets, mainly
equity and housing. Liquidity, measuring existing cash against overall
liabilities, is at its lowest ratio in postwar history. To us, consumer
balance sheets in the aggregate look more like a house of cards.
The great question is whether there is anything in the pipeline that might
shake this house of cards. Clearly, we do not want to be standing near
this house of cards when the macro-economic trembler finally arrives.

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