June 29, 2017


Labor Day, 2008


Article 1.21




Now that the enjoyable distractions of summer time and the Olympic Games have passed, we return to a business environment that is hard to predict. This note summarizes some news and personal, best-guess views (which will, no-doubt, shift) that will hopefully be catalysts for readers to keep rethinking their (unspoken?) assumptions that underlie business planning through 2009.  



Some common questions:

1.       Will the U.S. economy “avoid a recession”? Or, is it already in one?

2.       Are the government rebate checks starting to turn around the economy like they have in the past?

3.       Has the housing slump finally hit a bottom like it did in ‘93?

4.       Is the oil bubble run up over and gas prices headed down again like in ‘81?

5.       What’s really going on with financial company stock prices including Fannie and Fred?

6.       Are the write-offs from bad asset-backed debt instruments just about over? Could my bank be eventually caught up in a credit crunch? Would they then tighten lending standards and raise interest rates on us for our next contract?


Some less likely questions:

1.       How badly does the US government air brush the economic data that it reports?

2.       What are best gauges to look at for forecasting a housing market bottom?

3.       Is there a commodity bubble that is deflating? Or, is “peak oil” real? Could industrial metal prices drop more than oil? What are the implications for chronic, high-priced oil?

4.       Are there metrics that would suggest that the US consumer-driven economy is ready to start growing again?

5.       Given what is going on, what is my firm’s: best, worst and likely economic scenarios for 2009? How much company debt is too risky for the economy we envision?


Assuming we don’t have to have instant answers to all tough questions right away, here are some more thoughts to live with that might help improve our planning.



1.       “Americans felt better about the economy in August (’08), as a barometer of sentiment posted the biggest boost in two years amid falling gas prices.” (Conference Board; 8-26-08)

2.       “The rate of single-family home price declines slowed from May to June…sales of new homes rose in July.” (S&P/Case-Shiller Index Report)

3.       “Existing home sales increased by 3.1% in July. This increase put the annualized pace of sales up to 5 million units…inventories (however) hit a record high of 11.2 months”(Nat’l. Assoc. of Realtors)

4.       The GDP grew at 3.3 percent in the April-June quarter, its fastest pace in nearly a year. (US Commerce Department; 8-28-08)



If we read a little deeper, however, we find that:

1.       Personal spending growth slowed to 0.2% in July from 0.6 in June, but adjusted for 4.5% trailing annual inflation – the biggest gain in 17 years – consumer spending dropped the most in four years.

2.       In the revised GDP growth figure of 3.3% up from 1.9% (because “exports were strong”), the Commerce Department used an inflation deflator number of 1.33%. If they had used the same inflation figure that they did for consumer spending, the GDP grew at only a decelerating .2%. If the “durable goods” orders were deflated by the “producer price index”, a 1.3% increase becomes a 9.4% decrease. Prices were higher, not activity. Government fudging on economic data has been, unfortunately, documented to be a 20+ year trend that has accelerated in the past eight years. Where are we going to get reliable data to base decisions besides just looking at the prices we are paying and the business activity around us? (Suggestion: try going to google:blogs and type in any specific economic topic.)  

3.       Sales of new homes rose in July, because vulture investors have started to aggressively buy foreclosed homes, which are being added to inventory faster than new ones are selling. The investors’ inventory isn’t really “sold”, but rather rented and/or temporarily parked until housing turns around, then the inventory will come back to continue to postpone true, new demand.  

4.       Although the rate of home depreciation had one slower declining month, housing is still declining and no one foresees a bottom yet, because: jobs are disappearing; incomes are declining in real terms; mortgage rates are climbing; mortgage availability is declining; many ARMs remain to be reset; and inventory of all types of homes is staying above 11 months supply with accelerated additions from foreclosures and 3-year condo-project additions (now over 17 months supply and climbing). The Case-Shiller housing index for a twenty-city average has dropped more than 20% since the peak in June ’06. The Case-Shiller index futures are currently predicting a bottom in May 2010 down another 15% from the peak for a total decline of 35%. (Want more “housing bottom” forecasts? Type the phrase in at google-blogs.)



1.       The US credit bubble (go to google-images and type in “US credit bubble” to click on some scary charts) went parabolic from ’02-’07 as $3 trillion+ in nothing-down, dodgy loans for – homes, autos, credit card debt, student loans, leverage buyouts, etc. – were all securitized into bond-like, credit derivatives which are now not performing as promised, making their fair market values plummet..

2.       The financial-system, credit-meltdown crisis that started in the US in July ’07 isn’t over. Like a slow-motion train crash that crumbles one car at a time, we have seen the sub-prime mortgage problem push into alt-prime and now prime mortgages. The percentage of non-performing loans is now climbing in all categories: commercial real estate; home equity lines; credit cards; auto loans and leases; student loans; leverage buyouts; etc. 

3.       So far, working capital loans for distributors backed by inventory and receivables that are still within their covenant restrictions seem fine. What if: interest rates stay high; business profits fade enough to trip covenant standards over the next 6 to 12 months; and our bank has to reduce lending to meet its own debt to equity ratio requirements due to lots of carry-trade securities write offs?

4.       On another front, “Peak Oil” which has been forecasted for years is here, causing inflation in every step of business supply chains and transferring wealth from consumers to oil exporters. To better understand the “future shock” of chronically higher oil prices from global demand growing right past global production and ready reserves watch the video at this link: http://www.chrismartenson.com/peak_oil. 



1.       Fannie and Fred have to be stabilized. They are currently insolvent and if housing values continue to drop in line with Case-Shiller forecasts, the federal government will have in excess of a $1 trillion dollar+, bail-out check to write. More immediately, the twins have to roll over about $270B in debt by September 30th. Do you think the Feds can find some foreign government buyers for this debt and stall writing any big, bailout checks until after the elections?

2.       The inter-bank lending rates will have to return to normal. They have remained “elevated” since the credit squeeze began in July ’07, because - due to write-offs and regulatory capital ratios - banks don’t have money to lend and don’t know if other bank borrowers are solvent net of toxic securities they may own. When the squeeze is finally over, the “Libor-OIS spread” should drop back to normal levels. But, before that happens, US banks have two big hurdles. First, they must roll over almost $800 billion in debt in the next 16 months that was originally borrowed two years ago at around 4%, but now must pay 7-12%, if they can borrow at all. With the prime rate at 5% and many outstanding loan contracts to customers at 6-8%, they won’t make money on their existing loans. Even if banks don’t have more derivative bonds to write down (and many do), they will have to sell assets, raise expensive equity capital, raise loan terms and/or call any marginal loans to customers that they can. And second, many banks will have to pay back temporary loans from the Fed’s emergency “auction facility”.

3.       The European Central Bank and the Fed will have to figure out how to forgive the emergency loans that they have given to commercial and investment banks since August ’07. The trends for these “temporary” schemes are not good. The Fed has continued to lend more money, for longer periods to more borrowers, who remain anonymous to the public, in exchange for lousier quality securities for collateral that has continued to drop in value.

4.       All types of housing for sale – new, resale, condo-supply, foreclosures, and vulture-investor units – must get below eight months supply.

5.       For consumers with debt, their debt service to income ratio has to get from its current, record level of 14.1% back to the 10.5% level that was reached at the end of the ’82 recession. This will require a reduction in $2 trillion in consumer debt from its current level, which – not coincidentally – is the high end of the estimate for total financial system write-offs that needs to be taken (roughly $500B has been taken so far).

6.       Once consumer debt has been paid down and/or written off by the lenders, the savings rate for consumers needs to get back to an historical 8% level. There were several years during the housing bubble when the savings rate was negative as people did home equity extraction spending. In a consumer economy in which boomers haven’t saved for retirement and their asset wealth is eroding, I can’t imagine people buying stuff until they have free cash flow above a minimum savings rate.  



1.       Continue studying this not-in-our-lifetime-economy news stream to continuously rethink our – best, worst, likely – business plan scenarios for which I’d be happy to help with starting with a simple phone call introduction.  

2.       If we have – on second thought – a bit too much debt, remember that: volume is vanity; profit is sanity; and positive cash-flow to pay down debt is best of all. Set a goal to lower debt to a level that is consistent with how much economic risk we may (re)perceive to be in our economic environment over the next 12 to 18 months. Think also about what our banks may request if and when our current loan agreement needs to be rolled over.

3.       Rededicate ourselves to running a better, more strategically focused and profitable business. If any distributor needs some how-to articles for doing this, please feel free to click around www.merrifield.com.





©Merrifield Consulting Group, Inc. Article 1.21, September 1, 2008


bruce@merrifield.com / 919/933-7474