Bankruptcy & Foreclosures

Of late we’ve been discussing the topsy-turvy state of economic affairs and with good reason. The government has been quite reluctant to use the “r-word” for fear of the ripple effect merely admitting there is a problem can cause. Rather than surrender to the recent slump, Uncle Sam has been actively battling the instability the only way they can: By cutting interest rates and introducing a fiscal stimulus package.

While it looks pretty appealing from afar (after all the stimulus package means more money in the pocket of the individual) experts argue that these measures are counterproductive in terms of actually solving the problem.

According to economists, greater defaults on subprime mortgages and excessive debt could still drive down economic growth and reducing rates further (whereby providing economic incentive risk) stokes inflation, which already is elevated.

Here’s the deal: Rising defaults in the mortgage market have caused lenders to tighten their lending standards. At the same time, these defaults put a flood of homes on a market where sales have slowed (thanks to slumping prices). If the problem was contained within the housing market things would be bad. Since the turbulence have spilled out into other areas of the economy, things are worse.

So just how does a shaky housing market spill outward? Very simply. Once word of market instability spreads (which is apparent in dealing with even local banks) consumers begin to slow their spending out of fear. With supply suddenly outweighing consumer demand, factories cut production of cars, furniture and appliances. Companies begin to cut back jobs and full-blown recession is upon us.

This is further evidenced as news today (according to Bloomberg) is that manufacturing in the US shrank at the fastest pace in almost five years and construction spending fell the most since 1994 as the economy moved closer to a recession.

Experts are already sounding off in suggesting the Fed raise interest rates the moment the market shows signs of stabilization so as to arrest the risk of inflation as soon as possible. One thing is certain; simply slashing down interest rates on lenders who are already getting nailed from all angles isn’t going to stir up the economic pot. Believe it or not, many of today’s problems could be solved by increased spending. Now if only there was some way for the Fed to make consumers confident about doing so.