The Economic Recovery Isn't In Trouble -- It Just Never Really Existed

Last Updated Jun 15, 2011 2:51 PM EDT

The news today is filled with concern over leading indicators that the recovery is in trouble, particularly the decline in housing prices and the unemployment rate. Both assumptions are wrong. The recovery isn't at risk and these aren't leading indicators. In fact, what these persistent facts prove is that the recovery was never anything but smoke and mirrors.

The problems that caused the economic meltdown are still there. They have not been addressed. So, let's recap: Financial institutions loaned out a huge amount of money against assets that are no longer worth anything near what they were at the time, and whose value is still falling fast. Somehow, someway, the difference between the outstanding loans and the shrinking value of the collateral assets has to reconciled.
Let's lay it out:
  • Subtract the current value of assets (X)
  • From money loaned against them (Y)
  • And you get the amount of bad debt that needs to be dealt with (Z).
So just do X - Y = Z and you'll know exactly how solvent our economy is.

Working this out would be easy except for one thing. The government and the banks are making it impossible to get the numbers needed to actually solve the problem.

The only thing we can say for certain about the value of the nation's housing stock is that it's falling. Just this week we found out it accounts for an even smaller fraction of the amount loaned than previously thought -- and the previously-thought numbers were already pretty bad.

The S&P/Case-Shiller reports home prices are down 4.2 percent in the first quarter and more than 5 percent over the last year. As my BNET colleague Alain Sherter put it:
What specific factors are pushing down home prices? The same ones that were buffeting the sector last year ... an oversupply of vacant homes, driven in part by the ongoing flood of foreclosures; weak demand for residential real estate; high unemployment; and wage stagnation.
If all that wasn't enough, there's also the robo-signing scandal still hanging around out there. Basically, the banks screwed up original mortgage paperwork so badly they're having major problems proving they have a legal right to the homes they offered mortgage loans on. Short form: The banks effectively gave that money away. Whatever the outcome, the debit side of the banks' ledgers will get a whole lot redder and the amount of money that has to be accounted for a whole lot larger.

Now, the banks were in bad shape even before all of the above. How bad? Bad enough that they and the government have gone out of their way to hide it. My theory is that they believe -- perhaps reasonably -- that honestly disclosing bank finances will cause the world's economy to go into freefall. Unfortunately, hiding it doesn't make it go away.
How to hide bad debt without really trying
Now hiding these numbers isn't easy. It takes accounting legerdemain that seems like a merger of Houdini and Arthur Anderson.

First, the government tried to purchase mortgage debt from the banks. The problem here was that selling this debt would mean declaring its value -- i.e. providing a real number as to how little bank assets are worth. In other words, that would mean admitting what everyone knows -- that a number of banks have debts well in excess of their assets.

Because this didn't work, the government tried to give banks enough funds to be able to weather the disclosure of the value of the assets. Under this plan the equation would be:
  • Add hundreds of billions of dollars to the money the banks still have (X), then
  • Subtract that from the ever declining value of assets (Y)
  • And the amount of debt to be accounted for (Z) will be acceptable.
Given how much money banks are still sitting on even after the toxic asset relief payments (or whatever they're calling it now), it is reasonable to conclude that Y = way more than hundreds of billions.

But wait, you say! Many of these financial institutions have already repaid the bailout money! Yes, that is true. However keep in mind, they repaid it with money borrowed from the government. This is robbing Peter to pay Paul as imagined by M.C. Escher on LSD. Those staircases are never going to meet up, but it allows both the banks and the government to say that they do while hoping no one reads the fine print.

So being unable to either 1) increase bank capital enough to do any good or 2) stop the actual value of homes from declining, the government tried letting financial institutions play let's pretend with the book value of homes. Changes in accounting rules have let institutions set the value of a property at what they think it would go for in an "orderly" sale, as opposed to a forced or distressed one.

Or, to quote the head of the central bank of Wonderland:
"When I use a word," Humpty Dumpty said, in rather a scornful tone, "it means just what I choose it to mean -- neither more nor less."
What all those measures did was to allow the economy to continue to operate as we all pretended the problem would somehow go away. The idea is to put off the day of reckoning until some time in the far distant future. We are hoping our grandkids will be smart enough to figure out a solution that won't hurt. However, this is impossible. The solution will hurt, and it will hurt a lot.

All talk of growing our way out of the recession is absurd. It is based on the belief that we can continue to increase the size of the economy as was done earlier in this decade. Let's make one thing clear: The last decade's worth of growth was funded by loans against assets that were never worth those loans in the first place. Trying to go back to that means continuing to believe in the fiction that it was ever sustainable in the first place.

PS: In case the above didn't ruin your sleep, please consider this from SeekingAlpha: Chinese land prices -- which are down 20 percent this year -- could come under further pressure as some developers, unable to move product fast enough, are forced to unload inventory. "The potential exodus of small developers could be overwhelming," says a Credit Suisse survey. Sound familiar?

Related:
  • Constantine von Hoffman On Twitter»

    Constantine von Hoffman is a freelance writer and writing coach. His work has appeared in outlets such as Harvard Business Review, NPR, Sierra magazine, Brandweek, CIO, The Boston Herald, TheStreet.com, CSO, and Boston Magazine.

Comments

Market Data

Watch CBSN Live

Watch CBS News anytime, anywhere with the new 24/7 digital news network. Stream CBSN live or on demand for FREE on your TV, computer, tablet, or smartphone.

Market News

Stock Watchlist