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IR - Consider this. If the Fed lowers the Fed funds rate, and they find takers at the new rate, the money has to flow someplace. Where would it most likely go?

I am not setting you up? This is a real question and I have only conjecture myself. I am guessing it will flow into the general equity and bond markets, but ...
 
I too would guess the equities and bond markets. Real estate and real estate mortgages are toxic and will be for quite some time.

Again, this would only be a short-term phenomenon. Equities are close to the historic (bloated) valuations, so an infusion of cheap capital would make them look attractive. However, the economy is in a precarious position, so a downturn in equities seems inevitable. Bonds should be due for a serious drubbing because interest rates are so low and need to rise. However, if the FED drops rates, bond yields will look attractive again and prices should rise at least temporarily until the inevitable rise in rates occurs.

Personally, I think the FED will not lower rates and may have to raise rates to prevent inflation from our declining dollar. This will crush real estate, equities and bonds (debt). I will happily be in cash. It will the the only asset class I think we can rely on.
 
All interesting and compelling arguments.

But, I wasn't asking strictly out of concern for housing.

I guess I am more fearful than some of you regarding a total meltdown of our economy.

I don't see how any part of our economy will not be decimated by this.

Clearly, I am merely a casual observer of most markets, so I am not sure of all of the interrelationships.

Could someone explain to me how this will unfold? I am not trying to be argumentative, I really don't know.

We're speaking of trillions of dollars evaporating into thin air.

How could it not take down everything?

Who will be left standing?
 
We're speaking of trillions of dollars evaporating into thin air.

Yes, unfortunately we are. This has happened before with other asset classes, but this is the first time we have done this as a nation with housing.

How could it not take down everything?

The valuations of all asset classes will probably decline relative to the value of cash. Asset deflationis a harmful thing because it also causes commerce to decline.

Who will be left standing?

People with little or no debt and a significant amount of their wealth in cash. People who have borrowed huge sums of money to purchase inflated assets will be severely impacted.

This will be a classic day of reckoning. I discussed it in some detail here: Southern California’s Cultural Pathology.

I know it all looks rather bleak, but it is never as bad as people make it out to be. It all depends on how well you prepared.

It is a bit like the change of seasons. Winter is very harsh and it causes the death of many animals. Those that are well prepared make it through and prosper again when spring arrives, and spring always arrives. You can choose to focus on the harshness of the winter and become distraught, or you can prepare for it and focus on the more pleasant spring right around the corner. The winter is coming either way, personally, I have prepared as best I can, and I will react to and accept whatever comes.

Could someone explain to me how this will unfold?

I took a stab at that here: Houses Should Not Be a Commodity

I would also note that in the past when we have had asset bubbles there was short term pain, but the economy always recovers. Hopefully, we will not make the same mistakes Japan did and drag out this deflation over a period of almost 20 years.
 
Sorry, still not getting it.

Much of what you posted is about housing.

I am envisioning trillions more gone from equities.

I don't see how it wouldn't also take down our entire banking system.

Some people are already talking about not trusting any banks with their money.

When I asked about who will be standing, I didn't mean just individuals, I meant entire industries as well.
 
Janet,

There is plenty of cash out there, it's just that no one wants to put into play as a result of fears as to investments. Most economists agree that other than the housing/mortgage industries, both the American and the Global economies are doing very well. It's simply a fear game. . . people are waiting on the side lines until everything gets smoothed out.
 
Ha! Reason's scenario is playing out (in reverse). Up, down, up....

I am tempted to jump in.

Not.
 
"I am envisioning trillions more gone from equities."

This could happen. The deflation of housing will probably cause a decline in consumer demand (no more free borrowed money) which in turn will cause lower profits and lower equity prices.

"I don't see how it wouldn't also take down our entire banking system."

Our banking system is built on faith, and much of that comes from the FDIC. As long as the government will insure deposits, people will put their money in banks. The real danger to our banking system would have come from an over-involvement in subprime lending -- which is something they did not do fortunately. The Wall Street hedge funds will get obliterated, but our banking system will not suffer terribly. Mostly they were not players in this (with some exceptions like Downey Savings or World Bank.)

"When I asked about who will be standing, I didn't mean just individuals, I meant entire industries as well."

The REIC will suffer during this time. There will probably be some bankruptcies in the homebuilding industry as well as some high-profile mergers. Related industries like Home Depot and Lowes will also suffer.
 
IrvineRenter,

You are so right about related industries.

Home Depot had to sell its commercial supply business to an alliance of private equity firms ($8.5 billion deal). But that was $2 billion less than the original agreement. Sale was renegotiated because of the…uh…tightening of credit and problems in the housing market.

In order to save the deal, Home Depot and the participating banks and buyout firms were all forced to put up more money to shore up the financing. Fine print: Home Depot will buy a 12.5 percent equity stake in H.D. Supply for $325 million and will guarantee a $1 billion senior secured loan from the banks.
 
Thanks Graphrix,

I'm afraid some of it was over my head. (That moving-parts quality!)

Since the speech was from 2002, I take it that expains the strong focus on deflation?

This section caught my attention:

The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand--a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.[SUP]1[/SUP] Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending--namely, recession, rising unemployment, and financial stress.

I have always felt (read: guessed) that the effects of this mess would not allow for rampant inflation - and that therefore, the need to raise rates, or even hold them steady, might be overblown.

Which is the greater possibilty, inflation or deflation?
 
Janet, I suspect that half of the traffic on the Internet is related to the inflation vs deflation debate.

The other half we discuss late at night on chat.
 
To expound a little, historically credit bubbles bursting are always deflationary. Printing fiat money to dig out of a hole is inflationary.

Coming Attraction: Monetary cage-match to the death. Get your popcorn now.
 
Could it be there was a master plan afterall?

Maybe bubble creation, then management, is our real fiscal "policy"?
 
Hyper-inflation could occur, if the Fed felt the need to try and prop up markets. Deflation could occur, if cash hoarding becomes so prevalent that no one spends money on anything but the basic food, water, utilities. Both have different triggers and solutions, but there is one sector that will certainly deflate. Residential real estate.
 
The hoarding of cash is not a neccessity for the occurance of deflation. Credit contraction is the only neccessity.
 
The FED is a reactionary beast, not pro-active. Many economic indicators are lagging, and don't accurately predict the future. Many of us know that the housing numbers that come out in september (august sales) will be horrific. At that point it will be too late to react. The only proactive measures the FED have are changing rates and changing the money supply. This helps them maintain the inflation and fuel/slowdown the economy. Housing was never meant to be looked at by the FED nor considered as an investment that needed stimulus.

Bernanke is stuck now. He's got inflation and an already weak dollar in one hand, and a crumbling housing market in the other.
 
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