Will US go into recession? Part 2

Now, the last few weeks of hearing all bad news all around financial markets, made me think is the world is going to be destroyed pretty soon. Is this the Apocalypse? I mean, why is there so much of panic when a casual glance at the current situation doesn’t seem to be bad, at all. Notwithstanding the subprime case that we saw in the part 1 of this series, the tide might not be big enough to rock the boat. Here's why:

1. In most subprime hit localities, American households earn average of 75K/year and buy house at an average rate of $300K that is just 4 times the annual income, and in many rich neighborhoods that earn in 6 digits this ratio could be even less. So, is the house price sky-high? Is the ratio change too much in America’s history? Are other countries better? Brits and Europeans whose average house price is like 10 times the annual house-hold salary seem to worry much less even at the back of a 3x price growth in 10 years. In Asian countries like India, this ratio could get even higher. I don’t know about Africa and South America, but think that they wont be any better in owning houses than America.
2. Current America has a very healthy corporate cycle and unemployment rates are almost historically low. The last housing bust was at the back of big unemployment.
3. The subprime mortgages are still a small portion of total value of American housing assets and not all of them are defaulting and not all the defaulted properties have a value of 0.
4. By the very nature of the American economy, the risks are well spread out and markets are pretty deep and matured compared to almost any other country. Agreed that there is a lot of unnecessary froth at the top, but derivatives in essence builds a very strong foundation and links the stakeholders.
5. The world economy never looked so better and not all of it is based on cheap mortgage. There are quite a bit of fallbacks, unlike the previous times. Even taking the factors that are dependent on US consumption, the consumption of many Asian countries have increased sharply and Russia is back on its knees.
6. Most importantly, unlike in most other times of American history, there are a quite of bit of non-market entities that are extremely powerful and they would like to maintain status quo and have the means to do it. The foreign reserves of Japan, China, India and Korea alone are in the range of $3 trillion and each of them is much bigger than any institutional or individual player in the market and they understand the stakes. If US goes into recession or if there is a reduction in interest rates, there could be losses of hundreds of billions here alone. So, would it be stretch to assume that a couple of hundred billion dollars could get diverted by these power central banks into US mortgage and bonds to save American economy from collapsing, while making strategic buys with high yielding interests. For these central banks few billion dollars are pocket change and they have quite a bit of powers in their arms. They are silently watching and if there is a definite case of collapse, there could be a lot of invisible hands at work to clean the mess.

US is so crucial to the world economy that not many of the powerful hands will allow it to drop. And the fundamentals seem to be good – its not like inflation is going into double digits or corporate are throwing out people in mass numbers. Few hedge fund owners and a few greedy subprime buyers are fried, but I don’t understand why the market value should drop by few trillion dollars.

I agree that the Mortgage lenders have tightened up and its hard to get loans now. But, this can’t go on forever. The fundamental money generation engines have not gone away. Asian and European countries are still generating billions of surplus cash that eventually finds its way to US economy. And those sitting on fences now with hoards of treasuries cannot afford to sit there forever. At somepoint those money will get back into bonds and asset backed securities. The lending standards won’t be as lax as last year, but still I don’t think that the complete opposite that is happening now can be there forever. In fact this crisis could become a like a vaccine that has inserts weak pathogens and arouses the immune systems. A lot of countries are happy that the flood of investment has slowed down and began to take a hard look at the economy fundamentals. For example, Indian central bank was so concerned that it gets so much of portfolio investment that has started hurting the export competency by strengthening the currency and China was constantly expressing fears of a stock market bubble. Now they breath relief. A lot of corporations were very concerned by the overarching powers of Private Equity players and now don’t need to spend as much energy in warding of the PE eagles or making synthetic modifications. And prospective home buyers in US who were getting pushed out of the market are now considering a serious comeback. And banks and financial institutions that have been over enthusiastic will be concentrating on their core businesses realistically. If it is going to be just a blip will it make much sense to close up all the investment positions that have been painstakingly made, just to watch from the sidelines that the markets get back to their bull runs?

And slightly OT here… does the periodicity of business cycles and recession cycles for US still valid? I mean, many of those researches were made before 1990 when significant changes occurred in world economy that multiplied market sizes by many times. In just year 1989 Berlin Wall collapsed, USSR pulled out of Afghanistan leading an eventual collapse of the soviet, China had Tianenmen Square massacre that forced it to join market forces, Indian elected a moribund coalition eventually leading to a bankruptcy and opening of economy…. And thus from start of 1990 the recession cycles are way off and even the Asian crisis of 1997 or dot com crash didn’t dent economy too much and house prices didn’t dent.