Given the recent positive reading for GDP, some are now doubting that we will even face a recession. This of course is a misnomer and most average Americans realize that our country finds itself in a very tenuous situation. It is very easy to brush off the current talk of economic malaise as simply another business cycle unwinding yet this time there are many fundamental circumstances that simply make this situation a very unique beast.

As baby boomers reach retirement age it could not have happened at a worse time. The economy is on the brink of recession and we are going to face the largest entitlement program drain on our system ever. Social Security was never devised as a retirement or pension program but a large portion of our elderly depend on this income. There is a baby-boomer age-wave theory proposed by economist Harry Dent that views a peak in the US stock market at 2007 and 2009. His prediction is based on observations that consumer spending peaks at or near age 50. With many boomers starting to retire in the upcoming years the age-wave theory predicts a slow down in the economy.

Generally speaking there are 76 million people that were born between 1946 and 1964. With that said, 2011 will be the first year that the first baby boomers will hit the 65 year age mark and the beginning of a long-term trend that will become more reliant on entitlement programs. This is happening just as the largest United States housing bubble is popping. With residential housing prices peaking at nearly $24 trillion only to see about $5 trillion of that disappear in a few short years , the economy is facing constraints at the worst possible times. We are also seeing consumer inflation pick up in gas, groceries, and healthcare at a time when many boomers are going to be stuck on a fixed income. While prices go up, their monthly payment is fixed.

In this article, we are going to examine 10 very crucial areas in our economy that practically guarantee that for the next decade, we are going to see slow to negative growth in our economy. We’ll examine housing, entitlement programs, and income to try to arrive at a forecast for the next decade.

Factor 1 – New Homes Sold

Examine the above chart for a minute. Never in our nation’s history have we seen such an epic boom in new homes being sold. For the past decade, much of our economic prosperity was intertwined with the fate of housing. In fact, there have been recent estimates that housing related industries accounted for 30 to 40 percent of job growth since 2000 .The peak was reached in the second half of 2005. At this time homes were flying off of the shelves like the latest hit album and financing was ample to fuel this flame. Keep in mind the above chart is for new homes. Thus we can assume that builders were keen to this information and started an epic housing construction boom to meet this new home demand. Much of the creative financing including the $500 billion in currently outstanding option ARM mortgages helped fuel this run up.

This pace was simply unrealistic since the growth in population was not keeping up. In fact, demographic trends would have pointed to an otherwise conclusion. That is, many baby boomers now with empty nests would be selling their homes and downsizing and organically there would be a natural jump in housing inventory on the market. Instead, we had a decade long boom in new home construction that will now contend with the onslaught of baby boomer homes that will hit the market in the next decade.

Factor 2 – New Housing Units Started

Given the above, builders were quick to catch onto this once in a lifetime trend. Yet what you’ll notice is that new home sales peaked in the second half of 2005 while new housing starts peaked in the summer of 2006. This lag of course was many builders came late to the game and over estimated the actual demand in the market. What they failed to grasp was much if not most of the market was a Ponzi scheme based on pure speculation. This was similar to 1920s Florida real estate except this engulfed numerous metropolitan areas across the nation. States like California, Florida, Nevada, and Arizona are feeling the brunt of this correction.

The new housing starts and new homes that have been built assure us that we will have plenty of housing for the next decade. Even though many are now pointing to the decline in housing construction as a sign that we will move inventory off the market in the next few years, they fail to examine the baby-boomer age-wave theory and fail to realize that many boomers will be selling their homes in the upcoming years which will once again push inventory up.

The birth rate has also massively declined since the time of the baby boomers. Take a look at the below chart:

*Source: Profutures.com

So the trend is unmistakably for smaller families which of course means that many people do not need bigger places which is ironic given the average size of a home has increased over this time not for necessity, but for other reasons.

Factor 3 – Construction Spending

It would logically follow that construction spending has now declined as well. Construction spending peaked with new housing starts in 2006. Since then, it has been steadily declining. Given the nature of construction, much of the unemployment in this industry has hurt many other areas. These are generally high paying jobs but also include much of the shadow economy of employment. Recent data on remittances to Latin America show a major decrease in money being sent back home that nearly parallels the peak in construction spending and contraction. In addition, trucks are a big part of the industry. Construction bodes well for this industry but it has been hit with a one-two punch. First, the industry has contracted but then high fuel costs have also hurt the recreational truck buyer. That is, those that buy not because they need a truck but because they want a truck.

Construction employs a large number of people and this pull back is only going to fuel even higher unemployment which we are already seeing. The idea being postulated that we’ll see this pick up soon is somewhat unfounded. Just as we start clearing the current glut of new housing, which is 2 to 4 years away, we should be seeing a natural organic selling of baby boomer homes. Not to be macabre but James Love of BoomerDeathCounter.com states that a Baby Boomer will die every 49.5 seconds in the USA during the year 2008. This number will increase simply because of aging and the natural life process and this will add more inventory to the overall housing market. In this same vein, most boomers will also start relying much heavier on an already over burdened healthcare system.

These reasons practically ensure that we will see a decade long contraction in construction as it pertains to residential housing.

Factor 4 – Household Debt and Liabilities

It is hard to believe that there is nearly $14 trillion in household debt in the United States . This trumps our nationwide GDP. As I discussed in a previous article as to why the United States will not see a second half recovery, this amount of debt is putting a pinch on the bottom line of many households. A large amount of this debt, approximately $11 trillion is mortgage debt. As the price of housing continues to fall, the amount of debt does not move. That is the challenge that we are facing. Much of the foreclosures that we are seeing are a vicious way economically speaking of reconciling the balance sheet of America. That is, lenders are not going to willfully modify a long by $200,000 but if a owner cannot make the payment due to the larger economic forces, the lender will get the property back and will have to contend in the open market which will clear the house out at a much lower price.

The amount of debt is simply staggering. Debt in itself is not bad but when you have this much on the balance sheets of American households, what has occurred is many have spent for today with the next decade of earnings. In a consumerist economy where nearly 70 percent of our economy is based on spending, people are going to be forced to pay off debt instead of consuming. And this can be seen in the following chart.

Factor 5 – Household debt as a Percent of Disposable Income

Since 1980 even with ups and downs in our economy, the percent of a household’s disposal income toward debt payments has steadily increased. Money that can be used to go out and have a nice dinner is now diverted to paying the monthly minimum on your American Express card. This is a serious problem. This can only go on for so long and given that the household debt has gone from $5 trillion in the mid 90s to the current $14 trillion is simply amazing. Yet much of this debt increase was due to the epic housing bubble. Never in the history of this country has household debt surpassed GDP until now.

You may be asking, if approximately $11 of the $14 trillion is mortgage debt, what is the rest? The bulk of the remaining $3 trillion is consumer debt. In fact, credit card companies and auto lenders are now starting to see a large increase in defaults and late payments on these items. Why? Well the economy is grinding to a halt and if you lose your job or have a pay cut, all of a sudden more of your disposable income is going to service current debt that hasn’t changed. It becomes a vicious cycle and that is why the debt trap is such a bad precedent to set.

Factor 6 – U.S. Banking Facing Major Issues

I remember seeing the above chart at the FDIC a few months ago. It had one bank. Yet I had to wonder, why in the world would you put a drop down menu if you only have one bank on the list? Clearly the FDIC knew that the United States banking system was going to be facing long term problems. With the failure of Indymac bank the FDIC initially estimated that the cost would be from $4 to $8 billion. There initial insurance fund is at $53 billion. Now, recent revisions tell us that the cost will be more like $8.9 billion. With this one bank failure, the FDIC will eat through 16.7 percent of their fund.

They have come out with a recent report that revised the March 2008 number of troubled banks from 90 to 117, an increase of 30 percent in one quarter . In fact, FDIC Chairwoman Shelia Bair is now mentioning that the FDIC may need to seek assistance from the U.S. Treasury (aka the bank of you and me). Given that U.S. banks have over $6 trillion in deposits you would think that $53 billion (much of it eaten up at Indymac) would do nothing to cover even a slight amount of the overall funds. If as we are expecting systemic problems to arise, we can expect this number to balloon.

Yet why is this going to put the breaks on the economy for the next decade? Banks are now becoming more prudent since much of the money being lent is now their own which puts them on the hook. The “give money to anyone with a pulse model” is finished. I used to get about 20 pieces of mail a week for new credit cards. Now it has dwindled down to about 4 or 5 a week. Now that banks actually have to verify income and ability to pay, it turns out that many Americans do not qualify for loans. Many areas now require 10, 15, or even 20 percent down to purchase a home. One reader sent me an article from Florida where in some heavily hit areas, lenders are requiring 40 percent down. In California where the median home price is $318,000, that means buyers would need to put down $31,800 or $63,600 plus closing costs. As we are quickly finding out, not many people have this amount of money. Even with a 5 percent down payment we have seen what it will do to the market. No money down was a large part of the market.

Given the problems in U.S. banks many are tightening lending at a time when most people actually need money. Banks do not stay in business doling out charity. As the adage goes, a good borrower is someone who does not need the money. Unfortunately, many people now need the money yet banks are afraid to play with their own money.

Factor 7 – Income Inequality

*Source: Wikipedia



Even given our decade long housing and credit boom where homeownership soared to record highs, the inequality in wealth in our country has never been so pronounced. People have just learned a quick lesson that debt does not equal wealth. Having items that make you appear wealthy does not mean that you actually have a healthy balance sheet. Look at the above chart. Only 17.8 percent of United States households make over $100,000 per yea r. We’ve already highlighted before in a detailed budget that $100,000 does not get you that far anymore especially in areas like California. Some politicians would have you believe that $5 million is the threshold for middle class yet only 0.12 percent of American households make over $1.6 million a year.

In fact, I have the actual number for that. In the United States only 146,000 households have incomes over $1,500,000 while there are only 11,000 households that make more than $5,500,000. 82.2 percent of all households make under $100,000 per year. Can any politician point this out? Maybe they are betting that you will acquiesce on the tired old line of “no new taxes” instead of looking at who would get the real tax break. I think given how divergent this is, let us look at both McCain’s and Obama’s tax proposals:

*Source: Washington Post

Things are rarely so clear cut. When you have many of the hedge fund managers and heads of financial institutions making $10 million a year providing products that have harmed our economy, there is something seriously wrong. Financial innovation which once sounded like the new panacea now has echoes of snake oil in the streets of America. Just like during the Great Depression, Wall Street and bankers were seen as the new captains of industry only to be paraded on Capitol Hill in the 1930s to be reviled for the damage they had caused the country. Things have gotten so out of control and this Ponzi scheme is now coming to a painful close. Keep in mind that if we are to punish this decade long bubble and implement regulations and enforce these regulations, we are going to have to pay the piper. This means living within our means. Can Americans do that for a decade to retool their economy for the long future? Sadly when we hear gimmicks about fixing bucket issues it goes to tell us that many Americans only care about the one step that is in front of them instead of the larger and more broader picture. It is time to dig into the data and see the facts for what they are. Even Arnold is quickly realizing that “no new taxes” is a tired line and has backed off his no tax promise. Do you really think those at the top of the criminal crony ladder really deserve major tax breaks?

Factor 8 – Government Spending

*Source: Perotcharts.com

Now we need to come full circle and look at the entitlement programs. For years we have talked about fixing Social Security and Medicare but haven’t done a single thing about it. Guess what? That day has now come. Whether people want to deal with this or not we now have no choice. We spent $1.45 trillion in mandatory spending items including Social Security, Medicare, and Medicaid in 2007. 53% of the $2.73 trillion Federal Budget is based on these fixed items . Another troubling line item is the $237 billion in interest that we pay each year on debt. The U.S. is simply reflecting the poor management of budgets like U.S. households.

Discretionary spending is somewhat of a misleading label. Many items such as the military and defense really are not discretionary since these will not go anywhere. When it comes down to it, a small amount is actually debatable here. The rest is never even touched by politicians since it is like a third rail in politics. For many of the younger generations, we look at these items and wonder if we will ever even see one Social Security check even though we are putting in more and more money into this fund. Take a look at this chart:

You can see how quickly payroll tax rates have increased over the last few decades. Yet you need to remember that there is currently a cap on this at $102,000. Remember the inequality charts above? What this means is those with the highest incomes pay the least in percentage terms into this fund. 82.2 percent of the population pay every nickel on the above rates into this fund.

Now to be upfront I don’t think simply lifting the cap is going to solve the stunning amount we have to confront. There has to be a shift in how this will work. When Social Security was created, the life expectancy of people wasn’t as high as it is now. It was never crafted as a retirement or pension system yet many Americans now rely on Social Security as a primary source of their retirement income. We are going to have to make some hard choices here. What will that be? Either raise the tax rate or let many folks go without these funds. That is the flipside of the political equation. Many “no tax” folks are quick to say don’t ever raise taxes yet fail to follow their logical conclusion. Then what then of the 76 million baby boomers that will be retiring in the next few years? That of course is the harder question. In addition, bad fiscal policy by government causing consumer inflation is a hidden tax but many people don’t understand how inflation even works so this is a good way to tax the public.

There is a great book by Christopher Buckley called Boomsday that examines this exact issue. It is a humorous look at this impending entitlement debacle and explores the possibility of generational politics emerging as a major issue. Currently everyone is for Social Security. But how is that going to play out in the future for younger generations if they realize they won’t see any of that money and become a bigger and more powerful voting bloc? This is going to be a major issue and we need to get ready for this.

And what of the 401(k) idea? Well given how the stock market is currently going, you may be happy with a 5 percent return on a guaranteed investment. If the above trends hold, how horrible of a crosswind to see both a sinking stock market when baby boomers will start drawing on their accounts.

Factor 9 – The Explosion of Entitlement Programs

*Source: Perotcharts.com

Here is how this oncoming tsunami looks. Currently we spend about 8 percent on Social Security, Medicare, and Medicaid. This is going to explode and if we hit a severe recession, these estimates are going to go higher since we’ll have a lower GDP. In addition, the $9.6 trillion in national debt (which will now go over $10 trillion with Fannie Mae and Freddie Mac and the FDIC) has a large portion of entitlement IOUs given by the United States government. That is, the money that people currently pay into the tax system are being used right now for other government spending including current entitlement outflows. Remember that lock box talk? Now you know why it was so important but people rather make fun of things they don’t understand. Now it is time to pay up.

Keep in mind that these tax receipts are viewed by the government as an income stream only second to the actual income taxes paid. At this rate, there is going to be some serious negotiations for the next decade and either way, this is going to put a clamp on our economic growth for the next decade.

Factor 10 – Booming Foreclosures

The immediate problems of course are with the housing market. Long viewed as the most stable of all investments, housing is no longer a solid rock. This long held belief is being shattered and if housing isn’t safe then what is? Stocks? No. Commodities? Not always. So where do people put their money? Aside from all the bottom callers trying to look for the proverbial housing bottom we are really very far away from seeing a bottom in housing.

They are like a dog chasing its own tail. Once we reach the bottom then what? That is the ultimate reality check. Do they somehow think that we are going to hit the bottom and rebound like this past bubble we just had? No chance. If anything, we’ll be back to seeing housing as a boring and dry investment as it should be seen.

If you look at the above chart monthly foreclosure filings are still at record levels. Before we can acknowledge a bottom we first have to define what a bottom is. If we are looking at prices, nationwide it looks like we will hit a bottom in the second half of 2009 or early 2010 . If we look at states like California, we won’t see a bottom in price until May of 2011. If we are defining a bottom as a low in sales, we may be reaching that point yet most people associate a bottom with price so given that definition, we are not even close to a bottom as highlighted by the above foreclosure trend.

Keep in mind, that in California nearly half of all sales were foreclosures. These sales by definition are problematic and are thus pushing prices lower. Nationwide foreclosures are making up a large portion of all sales. This will keep prices low. Until the above chart starts declining, then we can realistically talk about a bottom. Until then, it is merely mincing data with sales numbers and minor bumps in the larger trend.

By looking at multiple facets of the economy it is very likely that we will see a L shape recession like Japan did in the 1990s which it is still battling with. I know many people will argue that we are very different yet given the housing bubble, our boomer population, and credit contraction I just don’t see how we avoid this. People partied this decade on the back of the next decade’s prosperity. It is now going to be time to pay the check.

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