Better times ahead

Economist offers a brighter outlook amid difficult days

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For more information about economist Carl Steidtmann, visit: www.deloitte.com>

Definitions

Assets: All the entries on a balance sheet showing the entire resources of a person or business, tangible and intangible, including accounts and notes receivable, cash, inventory, equipment, real estate, goodwill, etc.

Equity: The value of property beyond the amount that is owed on it. In the context of the securities markets, it refers to the stock-ownership interest of shareholders.

Leverage: The use of borrowed assets by a business to enhance the return of the owner's equity. The expectation is that the interest rate charged will be lower than the earnings made on the money.

Recession: A downturn in economic activity. Informally, the rule of thumb is that a recession begins after two consecutive quarters of decline in a nation's gross domestic product. Formally a U.S. recession is an extended but temporary decline in real gross domestic product during a period in which the GDP has generally been growing. The National Bureau of Economic Research makes the formal declaration.

Subprime mortgage: Generally, a mortgage loan made to a borrower with a weaker credit profile than that of a prime borrower. As a result of the weaker credit profile, subprime borrowers have a higher likelihood of default than prime borrowers.

Sources: Webster's New World Dictionary, Wall Street Journal

Guide to Business Style and Usage, Fannie Mae

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Carl Steidtmann

— Economist Carl Steidtmann analyzed the financial crisis and gave a levelheaded forecast of the U.S. economy Friday morning, predicting a modest recession with a slow recovery that could start late next year.

Steidtmann was called on to deliver what local Vectra Bank President Bob Kuusinen jokingly called "a crystal-clear picture of where we're heading in the months and years ahead." Steidtmann, chief economist for Deloitte Research, spoke to more than 100 people at Vectra's Business for Breakfast event Friday at the Steamboat Grand Resort Hotel - while across the country, Congress debated and passed a $700 billion bailout of the free-falling financial industry. President Bush signed the bill into law later in the day.

The past

The situation, Steidtmann stressed, is surprisingly stable.

"If you'd told me a year ago that banks were going to lose half a trillion dollars and oil prices would be $150 a barrel : I would have told you there would be a very deep recession," Steidtmann said.

The economy has grown a couple of percentage points in recent quarters, he noted. But there are significant challenges.

The crisis arose largely as a result of investment bank balance sheet issues, he said. Large financial institutions were leveraging 30 times the amount of their equity. Much of that money was borrowed in the commercial paper market, he said, which involves notes that typically are used for short-term financing.

The institutions, such as Lehman Brothers and Bear Stearns, spent some of that money on mortgage-backed securities. Those floundered amid subprime mortgage troubles. The government then bailed out - nationalized, Steidtmann said - lenders Fannie Mae and Freddie Mac. Several banks failed.

But Steidtmann framed those collapses as necessary.

"The financial service industry does represent a bloated part of the economy," he said. "It's downsizing and shrinking, which will actually have a positive effect in the long run. The fact of it is the banking system had gotten out of control."

The government's blame, Steidtmann said, falls squarely onto Republicans and Democrats.

"To create a crisis of this magnitude, it really does require bipartisan cooperation," he said, getting a laugh from the crowd.

As contributing factors, he cited moves in the Carter and Clinton administrations making it easier for low-income people to buy homes, an out-of-control Fannie Mae, lax mortgage lending standards, lax rating industry oversight, and the Securities and Exchange Commission's relaxing of leveraging rules during the Bush administration.

Previously, banks could leverage themselves only 12 times, which means the bank could lend $12 for every $1 of equity, Steidtmann said. The relaxing of that rule led to some banks leveraging 30 times their equity.

The future

Wall Street's failures will have an impact nationally and locally, Steidtmann predicted. U.S. institutions are hugely in debt, he said. That will pose a problem in our credit-based society.

"Households are not going to have the amount of credit they had in the past, so we're going to see a reduction in consumer spending," Steidtmann said.

Consumer spending has risen from 64.5 percent to 72 percent of the gross domestic product since 1982, he said. In the $15 trillion U.S. economy, that's substantial. Steidtmann estimated onsumer spending would drop 5 percentage points as a portion of the GDP.

The $700 billion government bailout plan probably will help but not cure the problem, he said. It will help financial institutions remove bad assets from their books but won't necessarily help them build shareholder equity, Steidtmann said.

Those institutions will be back to ask the government for more money, and automakers also will seek federal help, he predicted.

The recession Steidtmann expects will be modest. It probably will hit the Steamboat Springs area after it hits the rest of the country, he said, which is typical of economic trends. That means the recovery would come later, too.

"It will be a relatively mild recession, but it's going to be a long one because it's going to take banks a long time to work through the problems on their balance sheets," Steidtmann said.

Locally, the recession is likely to drive down spending, employment and construction, he said.

Comparisons to the Great Depression are off base, Steidtmann said. That's partly because the government is shoring up the banking industry, which it did not do in the 1920s and '30s. Also, he said, President Hoover's policies worsened the economy after the Depression. Hoover raised taxes and signed a strict trade policy - two bad moves, Steidtmann said.

Restricting trade would be a colossal mistake, he said. Because the dollar is weak, companies are bringing manufacturing back to the United States. That will increase the United States' exports, and trade restrictions would harm that, he said.

Steidtmann also predicted that investment in energy, renewable and otherwise, would increase. That could be a boon for Northwest Colorado.

So, who's the best person to lead the country through recovery? Steidtmann said he expected both top presidential candidates, Sens. John McCain and Barack Obama, to listen to competent advisers.

"I think at the end of the day, you have pretty conservative policies coming out of either campaign," Steidtmann said.

- To reach Blythe Terrell, call 871-4234 or e-mail bterrell@steamboatpilot.com

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