Default ain’t My Fault

It’s been pointed out by more than one economist that increases in corporate earnings – other than those who are making profits shorting the market (like Goldman Sachs) – have been due primarily to stringent cost-cutting measures enforced across the corporate landscape. As unemployment rises, as jobs are pared from the books, profitability looks better. But since 70% of economic activity in this country comes from consumer activity, if consumers are delaying purchases, squirreling away what monies they can save, reducing discretionary spending and staying out of the home-buying market, without consumers spending money, the illusion of corporate profitability is unsustainable. You can’t make money simply by cutting costs; there have to be revenues as well.

To make matters worse and add pressure to the horrific credit squeeze that has frozen most businesses out of the lending market, the number of commercial real estate failures is skyrocketing, reminiscent of the skyrocketing subprime mortgage failures that swept the nation last year (and continued into 2009). This is the “other shoe” that economists have dreaded, and it has arrived with a vengeance.

The July 27^th theDeal.com: “Things are getting ugly in the commercial mortgage-backed securities arena as delinquencies have gone through the roof over the past year, rising an ‘astounding’ 585%, according to data from Realpoint Research… And in June, Real Estate Econometrics LLC predicted that the default rate on commercial real estate is likely to reach 4.1% by year's end. That projection would imply defaults on about $44.3 billion of commercial mortgages, based on the $1.08 trillion of such loans held by U.S. banks in the first quarter, according to data in the report.”

Since the commercial real estate business is spread across the banking sector at every level and in every community, the harm of such massive defaults is that local banks will have a significant reduced capacity to access Federal Reserve lending (their underlying required capital base will be sufficiently eroded by these defaults), and hence they will be further impaired in their ability to make local loans. Major economic powerhouse states like California , Texas and Florida are particularly hard hit; Los Angeles alone has $4.5 billion in commercial real estate defaults (foreclosure or bankruptcy).

With small businesses being looked at with a skeptical eye by most banks – the jobless rate and consumer-spending-slowdown have tanked small business revenues particularly hard – this added burden of shrinking lending capacity suggest that the “recession” or “managed depression” as I call it, is very likely going to enter a new phase that will simply prolong the agony. Perhaps this is the second part of a rolling succession of recessions, but whatever the label, Americans are going to have to adapt to this elongated economic contraction.

And as the “new” Chrysler and the “new” General Motors enter this consumer-impaired, credit-contracted world, will even their reconstituted, leaner and meaner business plans be able to survive in this environment? What are your contingency plans?

I’m Peter Dekom, and I approve this message.