Keeping Things in perspective (cont'd)

In which Scott Grannis, Chief Economist at Western Asset Management, continues his thoughts on the current 'crisis'.
-- David M Gordon / The Deipnosophist
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Homeowners who might have been able to get a subprime loan a year ago can no longer do so, given that most banks have shut down subprime lending. The credit markets seem to have seized up, spreads have surged, and there is talk of a liquidity squeeze that could trigger a meltdown scenario. While it is true that some sectors are really hurting, not everyone is. In fact, small businesses and many corporations are enjoying easy access to credit these days, as reflected in strong growth of commercial paper and C&I Loans. According to data compiled by the Fed through the first week of August, there's been almost $138 billion of new money made available through these two conduits so far this year. C&I Loans are up $90.5 billion, for an annualized rate of growth of 13.4%. Commercial paper issuance is up $47.3 billion, a 56.7% annualized rate of increase. Those who leveraged themselves into subprime paper are likely deleveraging as fast as they can, but other sectors of the economy are still releveraging themselves. The average household, meanwhile, has experienced an insignificant increase in the burden of its financial obligations over the past several years.

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And what about the generalized decline in housing prices that is emerging across the country? According to the Fed, as of March 2007 U.S. households owned $22.9 trillion of real estate, out of a total net worth of $56.2 trillion. Let's assume a massive, unprecedented drop in nationwide home prices of 20% over the next two years. That would represent a destruction of wealth on a par with what was lost in the equity market from 2000 to 2002, and that was an earth-shattering event that saw the mildest recession in modern history (and recall that the Crash of 1987 produced only a one-quarter slowdown in growth). Some further perspective: households added $2 trillion to their their non-equity financial assets in the 12 months ending March, enough to offset an almost 10% decline in real estate prices. And even if home prices fell 20% from March '07 levels, they would still be higher than they were three years ago.

As for liquidity in general, M1 is flat over the past year (and for the past 3 years as well), MZM is up an annualized 9.5% year to date, M2 is up an annualized 5.9%, and no measure shows any deterioration over the past two months when the subprime crisis really came to the fore. With the dollar still scraping the bottom of the valuation barrel, there does not appear to be a generalized shortage of liquidity or even a developing shortage of liquidity.

All things considered, this still looks like a problem that is relatively contained, and one that the economy should be able to absorb without major difficulties.