We liked Ruth Simon’s page-one story in The Wall Street Journal that says $362 billion in subprime mortgages are due to “reset,”’ i.e., “go up,” next year. Funny how they do that, no matter what the Fed does with interest rates. Higher interest rates mean the rate of foreclosures will only pick up from here.

We learn new things: about 150,000 mortgages are resetting every month. About 1.35 million homes will enter foreclosure in 2007, and another 1.44 million next year, according to our friends at the Mortgage Bankers Association.

And get this:

The projected supply of foreclosed homes is equal to about 45% of existing home sales and could add four months to the supply of existing homes, says Dale Westhoff, a senior managing director at Bear Stearns.

So, roughly speaking, half the homes on the market could be in foreclosure? Wow.

We learn a new term: the “2-28” loan. What’s that? A loan with a fixed rate for two whole years that then “adjusts,” (yet another word for “go up”) every year, for twenty-eight years! Are they kidding? Listen to this, from a Fed governor:

In a speech earlier this month, Federal Reserve Governor Randall Kroszner explained how a typical 2-28 subprime loan issued in early 2007 might work. He said the interest rate on the loan would start at 7%, then jump to 9.5% after two years. For a typical borrower, that would add $350 to the monthly payment.

Thanks for that explanation, governor. We see that economics Ph.D. is serving you well.

Good job, Ruth Simon.

Still, are we the only ones who sense a piece of the banking story is missing? Stay tuned.

We also liked a column by Martin Wolf in last Wednesday’s Financial Times because it questions the very definition of a recession and helps address the widespread economic concerns that exist despite reasonably good macroeconomic statistics. He focuses instead on the idea of a “growth recession.”

Is the US going to experience a recession? Two answers must be given to this question: nobody can be sure; and it does not matter. A much more important question is whether the US economy continues to experience a “growth recession”, by which is meant a lengthy period of sub-trend growth. The answer is that it will.

The standard US definition of a recession is two quarters of negative economic growth. This demands both too much and too little: too much because it requires an absolute fall in output, which is an infrequent event in a growing economy; too little, because it is consistent with rising unemployment and declining capacity utilization. But a lengthy growth recession is likely to be far more disturbing even than a sharp recession, provided the latter ends swiftly.

He points out that the economists say the trend rate of growth of the U.S. economy is around 3 percent a year. Anything less would be a growth recession, even if it’s still growth.

Wolf takes in various indicators that have become a litany: housing prices have fallen, write-offs from bad mortgage lending is expected to be about $150 billion, credit remains tight, oil is near record prices, and the dollar still tumbles.

But what’s helpful is his focus on an important driver of the U.S. and world economy: the degree to which weakening U.S. domestic demand is offset by growing exports.

What happens now depends on two things: how weak domestic demand turns out to be, and the extent to which any shortfall is offset by a stimulus from net exports. The latter is “the great unwinding”: the re-import by the US of the stimulus it imparted to the rest of the world between 1996 and 2004, when its domestic purchases grew faster than GDP and the current account deficit exploded upwards.

Wolf cites a new study
by Wynne Godley of Cambridge University that says an improvement in net trade will offset at least part of any lack in demand.

A plausible view of the future, then, is that the US will experience a lengthy period of sluggish growth in domestic private demand, partially offset by fiscal expansion and an improvement in net exports. It is via the latter effect, moreover, that monetary policy should have its principal impact, since households are unlikely to borrow much more while their houses decline in value.

This is the great unwinding. So what does it mean for the rest of the world? It means that the rest of the world will adjust either by increasing demand, relative to potential supply, or by reducing its supply relative to demand. The former adjustment is clearly the more desirable.

This is a helpful look at the big picture.

1. France touts rising fertility rate, bucking trend of graying Europe
Associated Press
16 January 2007

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