A deep consumer-driven recession is just starting - expect at least two years.

First let's look at the overall financial situation the economy is now in, then I strongly suggest that you click through to the Calculated Risk article, scroll down to the bottom, and click on the picture of Howard Davidowitz for his analysis and prediction of the consumer-driven recession. Then I will explain why the snake oil of tax cuts will not solve the problem of the Recession!

Calculated Risk describes how the commercial real estate market is headed down, following the individual mortgage market.

A part of the problem is that the banks that have a lot of exposure to individual mortgage loans find that they don't have enough assets they can rely on to extend loans to commercial real estate. The risk driving down prices of office buildings, shopping malls and apartment complexes.

Another part of the problem is the Commercial Mortgage-backed Securities (CMBS) market. These are a commercial real estate security that operate in the secondary finance market for real estate loans much like the mortgage-backed securities (MBS), Collateralized mortgage obligations (CMO) and Collateralized debt obligations (CDO) do in the home real estate market. As Calculated Risk points out (from the Wall Street Journal)

The CMBS market was the engine that drove the commercial real-estate boom. Over the past few years, the issuance of CMBS allowed banks to get rid of the risk on their books, lend with cheaper rates and looser terms and that made it easy for private-equity firms to do huge real-estate deals.

This kind of transaction hides the risk of loans from the final investors, so that now the large-money investors simply don't know how much risk there is in the loans they have already purchased or the money they lend to banks. It is this kind of risk-invisibility that is driving the credit crunch in all its glory.

Combine this effective freeze on much commercial lending, and deals are not getting done. So what makes the commercial real estate problems so severe a blow to the economy? Back to Calculated Risk:

The typical pattern is for CRE to follow residential by about 4 to 7 quarters, so this slowdown is right on schedule. It's important to note that the impact on the economy will come from a slowdown in new CRE construction (non-residential structure investment) and from rising CRE defaults.

This explains in part the fact that (from Nouriel Roubini ) "excluding spending on gasoline retail sales were up a mediocre 2.4% relative to a year ago; including gasoline they were up 3.6% on the lowest end of forecasters’ expectations." Since inflation is now running above 4%, a 2.4% increase in nominal sales is a net negative is real sales.

But the net negative in real sales is even worse than it looks at first glance. For that you need to go watch as Howard Davidowitz explains in the video at the very bottom of the article at Calculated Risk.. The net negative real increase in retail sales comes on top of an increase of 5% in new retail stores opened this year. All that additional overhead contributed absolutely no new revenue to retailers over the Christmas season. Davidowitz' discussion is a very fact-filled clear analysis, explaining why we are going into a deep consumer-driven recession that will last at least two years.

Two points I want to focus on. First, Davidowitz points out that the real problem is that the consumers are tapped out. The housing bubble was designed (by Alan Greenspan) to keep the economy afloat during President Bush's first term in office. [My analysis, not Davidowitz'.] It did so. But in spite of the tax cuts that the Republicans claimed would stimulate the economy, there was no net demand created by the tax cuts to cause the economy to expand. What net increase in demand that occurred came from defense spending, and from home-owners refinancing their homes as the value went up to pay off credit card debt they had run up. The economy is driven by demand in three areas:

Demand (and GDP) = consumption (70%) + Investment (20%) + government spending (10%)

The consumers are tapped out. No pay raises since 2000, no savings, and now no mortgage gains to tap to keep the economy afloat. A symptom of the inability to the consumers to further support the economy is the rising rate of delinquencies and defaults on credit cards.

Now the investors are finding it more and more difficult to get loans, so deals aren't being made, making investment a net negative also. And military spending, the only part of government spending that was increasing, has little secondary economic impact. Military weapons systems simply are not economically productive. all of which leads me to my second point.

The Republicans are going to be selling more tax cuts as a solution to the economy. But this is a consumer-driven recession, not an investment-driven one. Tax cuts, even if they did work, will not resurrect an economy in a consumer driven recession! Nor will they increase investment in an environment is which investors have no way of knowing which potential investments are high-risk and which are not. Investors will either sit on their cash or invest it overseas in Euro-denominated investments. Neither investment nor consumption can be increased by tax cuts.

So now go and watch Howard Davidowitz's excellent analysis at Calculated Risk. Unfortunately, he confirms much of what I have believed about our miserably mismanaged economy.

Americans will now suffer from listening to the snake oil sold by the conservative ideologues about a free market and minimal government regulation. [For more on this, go see Rick Perlstein's blog, with particular emphasis on his items labeled "The Big Con."]

Oh yeah, and have a Happy New Year.