Every so often I write an economic forecast/predictions for a 6 month period ahead, but have not updated my latest calls from December 2007 because frankly they have pretty much all hit on the head and there has not been much to update. But since it has been nearly a year, and government involvement has changed the landscape so radically it is time to do another look ahead.

To see my history of calls I will refer you to my original roadmap in August 2007 (Aug 31, Et tu, September?) and then a review of those calls (May 11: Reviewing August 2007's Roadmap & Views)

... and then my next roadmap in December 2007 (Dec 4: Et tu, 1st half 2008? Predictions for the Coming 6 Months) and then a review of those calls (Jul 14: Reviewing December 2007's Roadmaps & Views)

Frankly the accuracy has been dead on, as I took a very contrarian view to what the vast majority of Kool Aid drinking pundits were touting at the time. At this time Wall Street has finally "caught on" but I am still painting a far darker picture than the consensus as I look ahead.

In a big picture sense 2007 was the year of subprime, and 2008 was the year of major credit contraction and banks blowing up. 2009 will be the year Main Street truly takes the major hits, and state budgets will become a national emergency. 2009 will continue our bailouts but we will move from corporate (I should not use the word move... we will parallel) bailouts and it will be the year of personal bailouts and state bailouts. The wild card is the credit crisis - it is hard to tell right now how much credit issues will improve on a global basis. I am base lining in a scenario that credit will begin to flow to some degree but obviously nowhere near the levels of 2004-2006. If credit remains as tight as it is now, or indeed worsens my quite dark predictions below will look Pollyannish. I also expect the Obama socialism to be a lot more pervasive than the Bush socialism and I imagine that I cannot even imagine today what forms of 'assistance' will be offered....

The Consumer/Housing/Inflation

#1: Mortgages - A year ago all the focus was on subprime - I wrote many times subprime is the tip of the iceburg; literally. An iceburg is mostly underwater and those were the Alt A mortgages, option ARMs, prime mortgages below the surface. Those began going bad as we moved through 2008. 2009 will be worse depsite the governments interference. People will be 'saved' but many of those saved will only be extending the period they stay in their house before they eventually default. We already see this, 1/3rd of modified mortgages thus far already have borrowers who are late on payments.
The problems are multiple

• (a) homes in many parts of the country are still overvalued versus incomes (What Should Median Home Prices Be Today?) - basic affordibility is still an issue; prices detached from the traditional 2.6-3.0 income to home value ratio that dominated for decades. Further, home prices in many parts of the country completely detached in their ratios from rentals - that will revert to a mean.
• (b) mortgage rates despite the Federal Reserves best efforts remain over 6% (they don't control the long term rate, only the short term rate) - in theory the more money we print and more risk we take as a country to our national balance sheet the higher long term interest rates should go (which are what mortgages are based on) - so the more we bailout, the perverse effect is it should increse mortgage rates - this makes mortgages even more expensive and goes back to point (a) - affordability becomes more of an issue at 6.5% rather than 5.25% mortgage rate. I'd argue interest rates should be even higher for all the debt we are amassing - mortgages should be north of 7% and
• (c) "underwater issue" - it simply does not make economic sense to stay in homes where you are underwater. I do expect the federal government to interfere here in 2009 and unlike the Bush era somehow force modifications on principal in a vast way - certainly through Freddie and Fannie. But as home prices continue to decrease that will again only reduce a problem, not eliminate it. Homes will continue to fall in price and people will again be underwater even after the principal modification. Why?
• (d) unemployment - this is the first housing crisis that led the recession not followed. Usually unemployment LEADS to housing issues. We are just now beginning to see the front end wave of serious unemployment - no matter what modifications you make to principal, interest, or the like - if you don't have a job it matters little.

#2: Home Prices - speaking of home prices, it's tough to make a national call since each state has it's own specific issues. I will say we have had horrific drops in many of the hottest markets (30% year over year) and that is "good" in terms of getting to a bottom. I expect a similar year in 2009 in those hot markets but by the last quarter of 2009 to see "improvement" - i.e. a slower rate of home prices as finally home prices begin to fall in line with incomes. Wall Street will absolutely love this since it will signal a bottom in their world. But there won't be a V bottom here - we'll go from a drastic drop in prices, to a slow drop and then in our "recovery" years (2010-2013) a lot of sideways actions as people rebuild savings and the pool of buyers is rebuilt. We "drew in" many of the natural buyers from 2009-2011 into the frenzy of the housing market in 2006-2007 - many people that should be ready to buy next year and the year after already jumped in - so that pool won't be there in force as it should be. That said foreclosure pricing (50% discount to market) can draw in many others who would otherwise be locked out. Foreclosures are already about 50% of the market in California for example - and I expect this to be a sizeable amount of all purchases in 2009 - unfortunately that pricing will continue to wreck havoc for natural home sellers who are not foreclosures, along with new home pricing.

#3 Consumer Spending - if you followed this website for more than a week you know my thoughts on the consumer. We are going through a historic reversion to the mean. We are overbuilt in retail throughout the country and as we move back from a 0% savings rate to even 4% (we used to save 8-9% at some points earlier in our national history) the after effects in a country where 2/3rds of GDP (Gross Domestic Product) is consumer spending will be momentous. But this is a lot bigger than numbers - I truly think we have a half decade ahead of us where attitudes to spending change, a much more serious tone emerges, flamboyant spending is frowned upon, and excess is no longer celebrated as every 3rd reality TV show now portrays. That is because so many in the country will be struggling. I wrote countless times how many surveys show Americans, regardless of income live paycheck to paycheck - budgeting is simply not something many do - now they will be forced to get serious since lifestyles across the board are threatened. As the job losses mount, first half 2009 is going to be a disaster in spending.