Lack of Confidence is a Serious Problem

As congressional leaders debate the merits of the historic bailout package, which
many fear could jeopardize its passage, analysts worry that the country’s economic
fundamentals are deteriorating rapidly. Indeed, many are calling this the worst crisis
since the Great Depression.

With the media latching onto every scintilla of bad news, and the presidential campaign,
by its very nature, highlighting and dramatizing the fallout from a decade of financial
gambling, it’s easy to conclude that the country’s economic underpinning—the very
foundation—is in the process of imminent collapse.

While it’s becoming increasingly clear that we will not avoid recession, it is possible
with appropriate fiscal and monetary response to staunch the severity and duration of
the downturn that is threatening both the consumer and corporate America. Moreover,
the global economy is also in the throes of recession, inhibiting the export boom which
markedly helped fuel U.S. growth. The situation has evolved into a crisis of confidence,
as much as the underlying credit crisis that caused the initial financial dislocation.

The Great Depression, which engulfed the nation’s most intrinsic psyche, produced an
unemployment rate of 25 percent, a mortgage foreclosure rate of 50 percent, and three
generations of Americans who were afraid to spend money, so convinced that prices could
only spiral downwards. Confidence was destroyed, and the collective deflationary mindset
kept optimism at bay. Today, the foreclosure rate, while climbing, is less than 3 percent,
and the unemployment rate, while also set to rise, stands at 6.1 percent.

As never before, Wall Street and Main Street are joined at the hip. The financial
engineering that took the $1.3 trillion subprime mortgage market, and leveraged it up to
$31 on the dollar, has imploded and spread to other asset groups dependent on consumer
health. Auto loans, home equity loans, commercial loans, and student loans also became
fodder for Wall Street engineers. As consumers come under pressure, these assets become
part of the “write down/de-leveraging” process, and the collateral damage continues to
spread, eroding balance sheets and confidence. The vicious circle thrives.

Commercial lending, which sits at the very heart of our economy and is used for paychecks and purchasing capital equipment, is seizing up, impeding the most basic functions of business.
Treasury yields are historically low, manifesting the fear of risk. Americans are worried about the health of money market funds, which hold $3.4 trillion. Fear and risk are functions of confidence.

The economy is at a crucial inflection point. With a recession unfolding, we can endure a mild recession, or something much more severe. During the last 60 years, the longest recession was 18 months. Crucial for Wall Street and the consumer is the housing market. Mortgage rates must come down and housing prices must stabilize. How quickly the housing market recovers will determine how severe the downturn is.

That the Wall Street landscape has been fundamentally altered is a given, a consequence of risk-taking gone bad. But now is not the time to test economic theory. Now is the time for pragmatic solutions that alleviate the economic pain lurking around the bend. Economic conditions are vulnerable, but remarkably solid given the circumstances.

The stock market, perhaps the most leading indicator of all, is watching carefully and prepared to give its vote. Sometimes we have to accept the lesser of evils, the less elegant of solutions as the cure to restoring confidence. Wall Street and Main Street alike are waiting, but the clock is ticking.

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