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ECONOMIC ANALYSIS: Subprime concerns overblown; so spend, spend, spend

November 19, 2007

An emerging holiday tradition in my family is for the womenfolk to rise very early on the Friday after Thanksgiving to go shopping. The same thing happens across the nation. This event aptly named Black Friday, corresponds to the unofficial beginning of the Christmas shopping season. For the record, I would rather spend the weekend in a chain gang than tag along, but this year I will be encouraging them to shop. Here's why.

The subprime mortgage mess has not calmed down as much as I or most other observers had hoped. One result is continued volatility on Wall Street. This volatility has been interpreted as evidence that the economy is slowing. However, the most recent employment report was 40 percent above analysts' expectations, and thirdquarter productivity growth was a tremendous 4.3-percent annual rate. So why all the worry?

Uncertainty about the subprime market lingers. As I've said before in this column, it is what we don't know about the potential loss of wealth that is causing the volatility far more than what we do know. A number of financial institutions across the world have bought U.S. domestic debt, including mortgage payments. The aggregate value of the risky debt is not known, since it requires tracing back the debt to the loan origination. Individual firms are beginning to understand the depth of their exposure (and will soon be letting all of us know through quarterly reports). But until the magnitude of the loss is known, we should continue to be ready for a roller-coaster on Wall Street.

Financial institutions have responded well. Traditional mortgages remain available, and firms are stepping up outreach to troubled borrowers. We should be encouraged by the realization that it is in the best interest of banks to prevent foreclosures. Even Congress has recognized it is smart for banks and homeowners alike for borrowers to stay in their homes. The most likely spate of regulatory change involves reducing barriers to refinancing loans.

Even the foreclosure data are misleading. The bankruptcy law change in late 2005 caused a rush of new filings. The law change compressed at least a year's worth of potential bankruptcies into two months. Throughout 2006, bankruptcies were at an all-time low-and foreclosures enjoyed the same temporary respite. As we get nervous watching foreclosure rates inching up in 2007, we would be wise to temper our concern with the realization that they are still well within historical norms (2006 was the oddity).

Which brings me back to the issue at hand-why are we so worried about the economy today? I think much of the concern is overplayed sectoral concerns. The financial services industry-folks who always have the ear of the media-are especially worried. I believe their fears largely have motivated the Federal Reserve's preemptive actions of rate cuts and relaxations on liquidity. So, if it is perceptions that matter so much, I hope American consumers will answer loudly Nov. 23 with a robust day of shopping.



Hicks is director of the Bureau of Business Research at Ball State University. His column appears weekly. He can be reached at bbr@bsu.edu.
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