A good read and very relevant to the above discussion.

From the Economist:

Does America need a recession?

Another “benefit” of a recession is that it purges the excesses of the previous boom, leaving the economy in a healthier state. The Fed’s massive easing after the dotcom bubble burst delayed this cleansing process and simply replaced one bubble with another, leaving America’s imbalances (inadequate saving, excessive debt and a huge current-account deficit) in place. A recession now would reduce America’s trade gap as consumers would at last be forced to trim their spending. Delaying the correction of past excesses by pumping in more money and encouraging more borrowing is likely to make the eventual correction more painful. The policy dilemma facing the Fed may not be a choice of recession or no recession. It may be a choice between a mild recession now and a nastier one later.

This does not mean that the Fed should follow the advice of Andrew Mellon, the treasury secretary, after the 1929 crash: “liquidate labour, liquidate stocks, liquidate the farmers, and liquidate real estate…It will purge the rottenness out of the system.” America’s output fell by 30% as the Fed sat on its hands. As a scholar of the Great Depression, Ben Bernanke, the Fed’s chairman, will not make that mistake. Central banks must stop recessions from turning into deep depressions. But it may be wrong to prevent them altogether.

Recessions, as much as they are painful for millions of households, due purge excesses out of the system. IMHO our nation hasn’t suffered a real recession since the early 1980s when the Fed chair pushed interest rates to the sky to wring the Carter inflation era out of the economy.

Prior to that our nation suffered its worst economic downturn since the Great Depression in 1974 following the first oil shock (among other causes).

This means the economy hasn’t suffered through a major economic set-back in about 25 years. If the Fed isn’t careful now and allows excesses to remain in the system, the next recession may be one that will be remembered for generations.

Inflation IMHO is the cruelest tax of all and if inflation is allowed to find its way back, tens of millions of baby boomers will find themselves ill equipped to fund an extended retirement and too few workers in the economy to support retirees with federally-funded, inflation-adjusted Social Security payments.

A few month ago, this discussion would not have taken place. The psyche of the marketplace has changed. It is this change of thought that I fear more than anything.  The question is do we do something now or what until later to do something? Because if the economy goes into a recession, the Fed will have to eventually do something.

[quote author=“DawnTreader”]Inflation IMHO is the cruelest tax of all and if inflation is allowed to find its way back, tens of millions of baby boomers will find themselves ill equipped to fund an extended retirement and too few workers in the economy to support retirees with federally-funded, inflation-adjusted Social Security payments.

Exactly my concern. Being at the tail end of the boomers - inflation or a severe recession/depression 10 - 20 yrs from now concerns me more than a run of the mill recession next year. I’d also like to think my children will inherit a country/world of sustainable prosperity.

Of course given the average US politician’s (and citizen’s) short term view, I’m not optimistic that the long term effects of short term pain-avoidance strategies will be given much thought.  Let’s hope the Fed shows more wisdom.

I for years have had most of my investments in real estate, which is very sensitive to actions from the Fed. I am currently divesting all of my real estate to cash because of the current conditions of the mortgage industry and the real estate industry. Currently it is nearly impossible for a new first time buyer to purchase anything affordable and that is the reason lenders started to come out with the sub-prime fiascoes which they called mortgages. Another problem is that everyone and their brother are borrowing all of their equity to finance lifestyles that they have not earned. Eventually this had to end and we, I believe, are starting to see this correction in the pricing of homes and other real estate. When the price of homes start to crash we may see the Fed step in more but I believe that this will just feed the same vicious cycle of higher home prices and the stupidity of the public who think that they can use their homes as another credit card. While this may be good for us as stockholders of a company that produces many of these items of desire I think that this may end soon. I am bullish on Apple but worried about the economy.

d

[quote author=“Play Ultimate”]A few month ago, this discussion would not have taken place. The psyche of the marketplace has changed. It is this change of thought that I fear more than anything.  The question is do we do something now or what until later to do something? Because if the economy goes into a recession, the Fed will have to eventually do something.

The Fed cut interest rates and added liquidity to the system aggressively after 911 to stave off the threat of a deflationary spiral. The White House and the Congress aggressively cut taxes and pumped hundreds of billions of dollars into the economy through a series of short-term tax-related measures. These actions had major stimulative effect on the economy.

As the tax cuts and temporary tax credits expired (with some still to expire) it reduces or eliminates stimulative activity. These cuts and credits, while helpful to the economy in the short-term, create gross excesses that have yet to be addressed. Further, reducing the level of stimulus will dampen prospects for economic growth.

The dollars that flooded into the economy led to inflation in stock prices and home values while ultra-low interest rates debased the dollar’s value and stimulated export activity. While this reduced the active trade deficit and increased corporate profits, it has done so on a temporary basis.

The options aren’t good ones moving forward and whoever occupies the White House in January, 2009 has a set of tasks I do not envy.

The excesses from the added liquidity and distorted economic growth from temporary tax credits and cuts have yet to be worked out of the economy. Enterprise which saw hyper growth during the period (home builders, home lenders, etc.) must retool their services for a different economic climate.

Enterprises that have seen significant export growth due to a low dollar will also feel the effects as interest rates eventually move higher. The more rates are cut now, the more they will need to be raised later.

I see a round of significant consolidation coming and muted job growth as acquisitions force layoffs and wage pressures force a reduction in hiring.

Easy access to home equity debt also created massive economic excesses and fueled consumer spending. Consumer capacity for debt is shrinking by the minute and this will result in slowing economic growth.

IMHO the next recession may be a long and nasty one and I see it beginning in the fourth quarter of 2008 or first quarter of 2009.

[quote author=“roontoon”]I for years have had most of my investments in real estate, which is very sensitive to actions from the Fed. I am currently divesting all of my real estate to cash because of the current conditions of the mortgage industry and the real estate industry. Currently it is nearly impossible for a new first time buyer to purchase anything affordable and that is the reason lenders started to come out with the sub-prime fiascoes which they called mortgages. Another problem is that everyone and their brother are borrowing all of their equity to finance lifestyles that they have not earned. Eventually this had to end and we, I believe, are starting to see this correction in the pricing of homes and other real estate. When the price of homes start to crash we may see the Fed step in more but I believe that this will just feed the same vicious cycle of higher home prices and the stupidity of the public who think that they can use their homes as another credit card. While this may be good for us as stockholders of a company that produces many of these items of desire I think that this may end soon. I am bullish on Apple but worried about the economy.

d

I suspect home builders will retool their plans and begin building smaller housing units with less land. This will accommodate the financial realities of first time buyers.

There is significant housing demand but not enough supply in the market where it is needed.

New construction costs will continue to rise (permit costs, community assessments for the costs of home growth - sewers, fire, police, schools, etc.) which will lead to higher construction costs. Builders will need to reduce the amount of land allocated to each unit as well as unit size to match the financial resources of buyers.

Already there is a fast-growing market for smaller, easier to maintain homes and communities for boomers who will have an active lifestyle as seniors for twenty to twenty five years or more.

Eventually the home building market will adjust to the new economic and demographic realities, but the transition takes time.

Property taxes and other constituent costs of home ownership will only continue to rise. Smaller units on less land and the continuing move toward master planned and managed communities will only continue to gain momentum IMHO.

[quote author=“DawnTreader”][quote author=“roontoon”]I for years have had most of my investments in real estate, which is very sensitive to actions from the Fed. I am currently divesting all of my real estate to cash because of the current conditions of the mortgage industry and the real estate industry. Currently it is nearly impossible for a new first time buyer to purchase anything affordable and that is the reason lenders started to come out with the sub-prime fiascoes which they called mortgages. Another problem is that everyone and their brother are borrowing all of their equity to finance lifestyles that they have not earned. Eventually this had to end and we, I believe, are starting to see this correction in the pricing of homes and other real estate. When the price of homes start to crash we may see the Fed step in more but I believe that this will just feed the same vicious cycle of higher home prices and the stupidity of the public who think that they can use their homes as another credit card. While this may be good for us as stockholders of a company that produces many of these items of desire I think that this may end soon. I am bullish on Apple but worried about the economy.

d

I suspect home builders will retool their plans and begin building smaller housing units with less land. This will accommodate the financial realities of first time buyers.

There is significant housing demand but not enough supply in the market where it is needed.

New construction costs will continue to rise (permit costs, community assessments for the costs of home growth - sewers, fire, police, schools, etc.) which will lead to higher construction costs. Builders will need to reduce the amount of land allocated to each unit as well as unit size to match the financial resources of buyers.

Already there is a fast-growing market for smaller, easier to maintain homes and communities for boomers who will have an active lifestyle as seniors for twenty to twenty five years or more.

Eventually the home building market will adjust to the new economic and demographic realities, but the transition takes time.

Property taxes and other constituent costs of home ownership will only continue to rise. Smaller units on less land and the continuing move toward master planned and managed communities will only continue to gain momentum IMHO.

I don’t believe that new buyers can afford the new homes even if builder’s retool with smaller homes. What most people don’t talk about is that salaries are not keeping up with the cost of homes/insurance/taxes. Minimum wages are a joke and it use to be that if you were a hardworking tradesman you could afford a “basic” home. Not anymore. That would require increasing the cost of the items that these workers would be creating. Be it new homes, cars, washing machines or clothing. The fact is that these jobs are leaving the US because our workers need more money to afford their basic needs. Since the companies can’t compete in the world and pay their workers what they need, the companies take their jobs elsewhere.  Until we have deflation this situation will not change and I view it as one of the biggest financial issues that this county has. 

d

[quote author=“roontoon”]I don’t believe that new buyers can afford the new homes even if builder’s retool with smaller homes. What most people don’t talk about is that salaries are not keeping up with the cost of homes/insurance/taxes. Minimum wages are a joke and it use to be that if you were a hardworking tradesman you could afford a “basic” home. Not anymore. That would require increasing the cost of the items that these workers would be creating. Be it new homes, cars, washing machines or clothing. The fact is that these jobs are leaving the US because our workers need more money to afford their basic needs. Since the companies can’t compete in the world and pay their workers what they need, the companies take their jobs elsewhere.  Until we have deflation this situation will not change and I view it as one of the biggest financial issues that this county has. 

d

I’m not going to dispute the costs of housing won’t continue to escalate (both ownership and rental), but the hefty federal subsidy of home ownership through the federal deduction of mortgage interest and state and local property taxes (and even state income deductions of mortgage interest in high income tax states) makes the effort at home ownership an economically rational decision. Anyone making over $40k a year who does not have mortgage interest to deduct is pretty much screwed by the tax system.

Rents will rise proportionally with the costs of home ownership in most areas of the nation. It’s not as if the net costs (after taxes) of owning a home is appreciably higher (and is in many locals lower) than renting a place to live.

While many people are fixated on real estate values, few are tracking the rising costs of rental housing around the nation.

Thanks to the tax code there’s built in demand for housing and opportunities for home ownership. Again, I see builders retooling to meet this demand.