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Will the U.S. economy collapse? (merged w/ stock thread)

Old 10-29-07, 12:08 PM
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Will the U.S. economy collapse?

These things are discussed here quite often, but I thought this was a nice summation of the key difficulties facing our economy. The most interesting statistic to me was that consumer spending accounts for 70% of our GDP, which, of course, is largely purchased on borrowed money.

Is this scenario likely? Not likely? I suppose it really depends if we have a confluence of events- any one of these things wouldn't do enough damage to the economy.

What would it take for us to get out of this (if we're in it)? Will I be able to rent a West Village apartment for $500 in a few years?

http://nymag.com/guides/money/2007/39952/

The Catastrophist View
What would it take to send the U.S. economy—and New York’s—into free fall? A doomsday primer.
By Duff McDonald Published Oct 28, 2007

Peter Schiff is laughing at me. I’ve just asked him to entertain the following notion: that we dodged a bullet during August’s financial-market turmoil and, with the stock market bouncing right back from every dip, things might be okay. So why worry?

He stops laughing. “Why worry?” he asks. “Because we dodged a bullet but are about to step on a hand grenade.”

Sitting in a corner office of a nondescript building just off I-95 in Darien, Connecticut, Schiff, the president of brokerage Euro Pacific Capital, will spend the next hour spelling out a singularly pessimistic view of the American economy. And he will do so while exhibiting a curious juxtaposition unique to the bearish prognosticator: He speaks of disaster with a smile on his face. No, he’s not happy about our impending doom. But he is happy that people are finally taking him seriously.

Some people, anyway. The recessionary fears that were sparked by the global liquidity crisis in August have eased, largely because of a resilient stock market and a belief that the Federal Reserve’s interest-rate cut in September curtailed deeper losses. When Goldman Sachs invested in its own imploding Global Equity Opportunities hedge fund in August, calling it an “opportunity” and not a “rescue,” people laughed. Guess who laughed last? Goldman, which had reportedly enjoyed a $370 million gain on its $2 billion rescue by October. The optimists stay focused on stories like Steve Jobs’s next stroke of genius.

But Schiff, whom CNBC calls “Dr. Doom,” has not, as bears do when winter approaches, gone off to hide in a cave. Why not? Because every single one of the underlying economic factors that he has identified as cause for concern has worsened. And his is no longer a lone voice in the woods. If you don’t care to listen to a man nicknamed Dr. Doom, you can listen to people like former Federal Reserve chairman Alan Greenspan, esteemed bond-fund manager Bill Gross, or famed money manager Jeremy Grantham. They’re part of a growing chorus of voices that are saying many of the same things as Schiff.

Their bearish arguments come in many shapes and sizes, but here’s the basic one: The past five or six years have been deceptively fortunate ones for the U.S. economy. That’s because any troublesome developments—the surge in oil prices from $28 per barrel in 2003 to about $87 today, for example—have been papered over by rising home prices. Home equity has been used to buy flat-screen TVs, SUVs, and more homes. Wall Street bought up all this debt from lenders, thereby allowing them to lend more.

The softening of real-estate prices in most parts of the United States put a crimp in this system, but it hasn’t stopped it. The question is, what, if anything, will? What will bring on the apocalypse that Schiff and others believe is inevitable? They see it like this:

THREAT NO. 1
The Bottom Continues to Fall Out of the Housing Market
Manhattan’s gravity-defying real estate aside, it’s quite clear the nation is experiencing a genuine housing crisis. In August, pending home sales dropped 6.5 percent, and they currently sit at their lowest level since 2001. The National Association of Realtors conducted a recent survey that showed more than 10 percent of sales contracts fell through at the last moment in August, primarily owing to disappearing loan commitments from banks. The crisis will only deepen, when more borrowers see their adjustable-rate mortgages adjusted upward. There was a foreclosure filing for one of every 510 households in the country in August, the highest figure ever issued, and by one estimate, more than 1.7 million foreclosures will occur in the country by the end of 2008. That’s not just subprime borrowers: According to the Federal Housing Finance Board, while nearly 35 percent of conventional mortgages in 2004 used ARMs, some 70.7 percent of jumbo loans—those above $333,700 (the jumbo threshold in 2004; it’s now higher)—did too.

Historically, bond-market investors have been the boring counterparts to their equity-market brethren. But in his October Investment Outlook, famed bond investor Bill Gross was anything but. The managing director of money management firm pimco pointed out that the Federal Reserve is caught in a bind: It must continue to lower interest rates to ameliorate this burgeoning housing crisis, but in doing so, it “risks reigniting speculative equity market behavior, and … a run on the dollar.” (More on the dollar later.) Gross doesn’t have the answers but observes that the Fed is “in a pickle, and a sour one at that.” Worse yet, concerns that a rate cut might be inflationary actually caused bond yields to rise in the wake of the rate cut, something that doesn’t normally happen. The Fed’s influence, always overstated, might turn out to be nonexistent in a credit market that remains on edge.

Hedge-fund veteran Rick Bookstaber, the author of A Demon of Our Own Design, spells out a potentially disastrous scenario that could unfold regardless of what the Fed does: Continued foreclosures result in a further drop in housing prices, which results in further foreclosures, which result in a further drop in housing prices. Even for those of us not selling, reduced home values result in a reduced sense of security, which results in reduced consumption, which results in a slowing economy, which … you get the point.

THREAT NO. 2
The Derivatives-Related Meltdown, Part II
Anybody who glances occasionally at the financial pages these days knows that mortgages issued to home buyers are packaged together (in a process called securitization) into a collateralized-debt obligation, or CDO. That’s what’s known as a derivative, a security whose value depends on the value of other securities. The price of the CDO, you see, is “derived” from the prices of the underlying mortgages. (It works with credit cards, too, or bank loans—any kind of debt will do.)

In principle, the idea of a CDO makes perfect sense. In buying $5 million worth of a CDO, an investor has essentially lent money to an entire portfolio of homeowners, instead of placing all his eggs in one basket, say, by funding a single $5 million mortgage. In the real-estate-crazy environment of the past decade, the CDO market took off like a rocket. But the buyers of these derivatives made a critical error—they confused the spreading of risk with the elimination of risk. A booming economy made this confusion not just possible but irresistible. With relatively few defaults in the first half of the decade, investment firms, including many hedge funds, came to see CDO returns as a sure thing and loaded up on them, often borrowing money to do so, taking on debt to buy debt and thereby setting up a potentially deadly chain reaction. The readiness of the secondary market to buy all these mortgages encouraged the lenders to run wild and lend to anyone who walked through the door, leading—inevitably, in retrospect—to a decline in loan quality. Analyst Christopher Wood of Asia-Pacific investment house CLSA succinctly defines the problem in his highly readable newsletter Greed & Fear: “[Securitization] has one fatal flaw, which will ultimately prove to be its undoing … it removes the incentive of those making the loan to worry about whether the loan is a good credit.”

Still, it all held together until mortgage defaults began to cut into the yields of these CDOs and holders looked to sell them, only to realize their value had slipped. Forced liquidations as a result of that “price discovery” were a primary factor in Bear Stearns’ hedge-fund calamity in August. And it’s not over yet: The aftershocks of the mortgage meltdown are still being felt, as banks such as Citigroup and Deutsche Bank announce multibillion-dollar write-downs.

Each time one of these write-downs has been announced, the market has had a curiously positive response, taking the news as a sign that the worst was over and the banks were cleaning up their books. But because these derivatives are linked to other debt, there’s no reason to be certain that trouble won’t bleed into other markets. Among other things, the liquidity crisis froze the market in structured investment vehicles (SIVs), a nifty bit of financial engineering that banks use to profit from the spread between short-term debt and long-term debt. No one yet knows how nasty these losses could turn out to be because SIVs are stashed, Enron style, off the books.

THREAT NO. 3
Consumers Run Out of Steam (and Take the Economy Down With Them)
The U.S. economy, for all its worldly sophistication, is driven by mall shoppers and late-night Amazon addicts—70 percent of the gross domestic product is accounted for by consumer spending, which is buttressed by debt. According to the Federal Reserve, total U.S. household debt was, as of August, $2.5 trillion—a 24 percent increase in the past five years. Total credit-card debt, including gas cards and the like, was $915 billion.

The willingness of consumers to keep spending and piling on debt in the midst of a slowing real-estate market is hailed on Wall Street as an act of patriotism, which Schiff considers perverse. Imagine, he suggests, that you ran into a good friend and asked him how he was doing. His reply: “I took out a third mortgage, maxed out my credit cards, and emptied out my kids’ college savings account so I could buy a bigger TV and a new car, and we’re going to Greece on vacation over the holidays. Things are great!” Schiff lets the idea sink in and then finishes the thought: “And we’re celebrating the fact that we’re doing this as a nation?”

In a recent interview, John Santer, a district director of NeighborWorks America, a community-based nonprofit, pointed out that 43 percent of American households spend more than they earn each year, and fewer than six in ten have enough savings to last them three months if they were suddenly out of a job. So where’s the money coming from? From 1991 to 2005, Americans borrowed $530 billion against the value of their homes each year.

James Glassman, a senior economist at JPMorgan Chase, told a Tulsa, Oklahoma, luncheon crowd in early October that before 1985, consumer spending grew in line with income, but since that time, it’s grown half a percent faster on an annual basis. As a result, household savings, which once reached 10 percent of income, is now literally negative. “My guess is that in five years we’ll look back and realize … that the consumer we knew for twenty years is coming to an end,” he said.

Roger Ehrenberg, an ex–Wall Streeter and author of the financial blog Information Arbitrage, forecasts extreme financial pain. “You’ve got a weaker dollar, declining economic fundamentals, and a debt-strapped consumer—I’d call that a bad fact set,” he says. “Lay on top of that the mortgage problem and declining home values, and you can paint a pretty ugly picture.”

THREAT NO. 4
That the Rest of the World Decides They Don’t Need Us and the Dollar Tumbles Hard
The dollar is falling, possibly collapsing, depending on whom you talk to. The greenback has sunk close to its lowest point in the post-1973 floating-exchange-rate era, so low that it’s been overtaken by the Canadian dollar—affectionately known as the loonie—for the first time since 1976. How low will it go? When Alan Greenspan was asked by Lesley Stahl of 60 Minutes last month what currency he’d like to be paid in, his response was telling: “[The] key question … is, ‘In what currency do you wish to hold your assets?’ And what I’ve done is I diversify.” Translation: He isn’t betting on the dollar. And neither is the majority of Wall Street.

Here’s why catastrophists see that as a major problem: About 25 percent of our government debt is held by foreign governments, with the major holders being Japan ($610.9 billion), China ($407.8 billion), the U.K. ($210.1 billion), and our friends in the Middle East, the oil-exporting countries ($123.8 billion). When the current Fed chairman, Ben Bernanke, cuts rates to soften the housing blow for Americans, he also weakens the dollar by making dollar-based investments less attractive. And when the dollar weakens, so, too, does the value of these gigantic positions held by the foreign governments. At some point, they’re no longer going to tolerate the losses we inflict on them by lowering rates, and if that happens and they start dumping dollars, watch out for the peso.

The bulls will tell you that foreign governments understand the American economy is the key to global economic health, and that they’ll suck it up and take it when we devalue their debt. To which Schiff offers another analogy. Imagine if five people were washed up on a desert island: four Asians and an American. In splitting up their duties, one Asian says he’ll fish; another will hunt, another will look for firewood, and another will cook. The American assigns himself the job of eating.

“The modern economist looks at this situation and says the American is key to the whole thing,” says Schiff. “Because without him to eat, the four Asians would be unemployed.” The alternative: Without the American, the Asians might eat a little more themselves and even spend some time building a boat. This is happening as we speak: With the rise of the Chinese consumer class, the local citizenry is now spending, and the country is no longer totally dependent on exports. Which means they’re no longer totally dependent on us.

Readers of the financial press are surely familiar with the buzzword of the moment, decoupling. It’s used to describe how U.S.-Europe and U.S.-Asian trade relationships are becoming less dependent at the same time as European-Asian ties are growing. Most Asian nations, including China, are importing goods to Europe at a much faster rate than they do to the U.S. And the U.S. now accounts for a declining share of European exports. The bearish interpretation: that the longtime global embrace of the dollar is loosening.

THREAT NO. 5
That We Don’t See It Happening Because It’s a Slow-Motion Train Wreck
Last but not least, we can circle back to the Dow Jones Industrial Average making new highs in October—14,087.55 on October 1—offering hope that our equity portfolios will carry us through to the other side of whatever it is we’re on the wrong side of. Before addressing the fact that the equity market might just be clueless, there’s one last dollar-related point to make. The true value of a stock portfolio isn’t really its quoted worth in dollars—it’s what you could buy with that portfolio if you were to sell it.

Given that we as Americans don’t manufacture that much anymore (we’re a service economy!), we are largely talking about foreign-made goods, such as flat-screens from Korea or cars from Germany. Over time, if the dollar continues to slump, foreign manufacturers will raise prices to compensate for what they’re losing in the exchange rate. In that light, a Dow at 14,000 with the euro at $1.42 is really no different from a Dow at 13,000 with the euro at $1.33. (One reason the price of oil has risen so high is that it is quoted in dollars, and the sellers thereof have had to continually jack up the per-barrel price to maintain their own purchasing power at home and elsewhere.)

Still, a rising Dow is better than a falling Dow, and the bulls are piling into every rally. Which still doesn’t impress Jeremy Grantham, chairman of Boston-based money manager GMO, in the least. “The equity market is always slow to pick up on someone else’s crisis,” he says, referring to the turmoil in both the housing and fixed-income markets. “And so you’ve got a slow-motion train wreck that has to work itself through the system.”

How will it work itself through? Grantham points to the recent strength in profit margins, fueled by—you guessed it!—our plummeting savings rate, and says there’s nowhere to go but down. “If you start with an overpriced market and bring profit margins down, that’s more than enough to bring stock prices down,” he says. “It is the most certain mean-reversion in all of finance.” Grantham calculates that the U.S. stock market will have to fall by a full third before it gets to its “fair value.” At which point we will likely be in full-blown recession. And when that happens, Schiff says, we will see a country in downsizing mode, “selling the consumer goods we’ve been buying back to the Chinese. It will be one big, giant repossession.”

So assuming all this is true, that Schiff and his fellow doomsayers are right about the rotten core of the U.S. economy, how will this affect New York City? We’ve grown accustomed to the idea of our local economy, particularly the real-estate market, being inherently stronger than the nation’s and possibly immune to whatever woes strike the rest of America. Wall Street, after all, makes money on downs as well as ups, and the stampede of foreigners and foreign cash could, if anything, be aided by the weak dollar.

Last week, though, the argument against New York invincibility was implicitly made when Merrill Lynch announced a larger-than-expected write-down of $7.9 billion dollars in its third quarter alone, primarily due to losses in the credit markets. Numbers as large as that can paradoxically seem trivial due to the abstract nature of accounting—a “write-down” involves no movement of real-life cash, just a readjustment of some theoretical values—but here’s something nontrivial to consider: Merrill Lynch is one of the largest employers in New York City. While so far only a few Merrill bigwigs have been shown the door, it’s almost certain that a chunk of the company’s rank and file will soon follow. All told, New York–based financial companies had already announced more than 42,000 layoffs as of October, according to one study, and the pace could pick up through the end of the year. That’s people who won’t be bidding up new apartments, who won’t be going out to dinner five times a week, who won’t be testing the outer limits of their credit cards at Barneys. The downstream effects of this could be even more severe, as every Wall Street job is estimated to account for another 1.3 to 2 jobs, meaning that additional job losses could push 100,000.

Meanwhile, the public sector is feeling it, too. A recent report by Nicole Gelinas, published by the Manhattan Institute, forecast a budget deficit for New York City next year and predicted that Mayor Bloomberg, who enjoyed a string of budget surpluses until this year, will likely be forced to leave his successor with a double whammy: a deficit and a projected 50 percent increase in outstanding debt. Of course, the catastrophists could be dead wrong, as they have been for going on a decade now—but to them, it sure smells like the seventies all over again.
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Old 10-29-07, 12:10 PM
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soft patch, but i don't see a collapse
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Old 10-29-07, 12:27 PM
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I don't see a catastrophic collapse, but I don't expect the U.S. economy to perform like it did in the past 60 years either. Times are different.

In the 50's and 60's, you had a post WWII growth spurt catalyzed by an economy that was put on hold and also newfound technology (jets, nuclear, etc.).

In the 70's and 80's, much of the growth was due to women entering the workforce.

I wouldn't be surprised if GDP averages 2% annually in the near future.
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Old 10-29-07, 12:31 PM
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Speaking of consumer spending - I heard a startling statistic (at least to me). Americans are expected to spend 5 billion dollars on Halloween this year, and over 1/2 trillion on Xmas.
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Old 10-29-07, 12:40 PM
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I don't see how the huge rise in the price of oil (gasoline, home heating oil, etc.) won't depress consumer spending down the road - maybe just a little down the road.

btw: Isn't it true that we've never had a housing recession without that being followed by a general recession?
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Old 10-29-07, 12:44 PM
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Yes. And when it does, we're all going to die. Painfully.
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Old 10-29-07, 12:47 PM
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I don't know shit about economics. I am pretty certain that the economy will not collapse for some reason. The low value of the dollar (even to Canada!) is a bit disconcerting, but things will most likely improve when Bush and co are out and the next group of [slightly less corrupt] officials move in.
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Old 10-29-07, 12:54 PM
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There isn't going to be a wholesale collapse. There are too many people who have a vested interest in keeping the boat afloat that they'll do whatever it takes to keep it afloat... or if it must make an emergency landing, ensure that it is a softer landing.

(mixing metaphors was intentional... and a commentary on the situation.)
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Old 10-29-07, 01:00 PM
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Some kind of 'dip' in the economy is certainly coming

The question is how big and exactly when

I am going to guess about a year after a democrat is elected president

From what I have read, the real housing crash is going to start in March of 2008 when the largest volume of ARMs to date are due to reset. Many people holding the loan just can not make the reset payment.

I personally know 3 such people. All either need to refi, sell, or come up with $600-$800 additional each month for a mortgage payment.

point 1 housing

point 2 is credit (bad debt and people just plain running out of credit)

point 3 cost of the war and taxes

point 4 oil/gas/energy/ethanol/etc - and all associated rising costs

I have also read that christmas consumer spending will not be as high as it should be be this year.

Car sales for American makers are still off as well, especially trucks.

It's coming


I did read one interesting article about a theory that the number of millionaires in the world help smooth these crashes out as these people generally spend a lot of money no matter what the rest of the economy is doing. Not sure I buy into that, but it was interesting anyway. We have not had a severe crash since when? 1987? I don't think anyone knows exactly why.
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Old 10-29-07, 01:12 PM
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Originally Posted by classicman2
I don't see how the huge rise in the price of oil (gasoline, home heating oil, etc.) won't depress consumer spending down the road - maybe just a little down the road.
And to think that not that long ago you were trying to scare the bejeezus out of us if oil hit $100 per barrel.
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Old 10-29-07, 01:22 PM
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Are you under the illusion that the price of oil will not affect the economy down the road?
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Old 10-29-07, 01:27 PM
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I wasn't going all over it like you were a while ago and I'm still not.

I'm more concerned where the money goes than how much it is.
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Old 10-29-07, 01:32 PM
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Of course it's not going to have an affect the next hour, the next day, the next week, but sooner (rather than later) it's going affect the economy.

Since consumer spending is the engine that drives this economy, you'd better be concerned where the money goes.
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Old 10-29-07, 01:34 PM
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Originally Posted by classicman2
Speaking of consumer spending - I heard a startling statistic (at least to me). Americans are expected to spend 5 billion dollars on Halloween this year, and over 1/2 trillion on Xmas.
$5 billion seems like a lot of money, but per capita, it's less than $20 per person.
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Old 10-29-07, 01:36 PM
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Originally Posted by classicman2
I don't see how the huge rise in the price of oil (gasoline, home heating oil, etc.) won't depress consumer spending down the road - maybe just a little down the road.

btw: Isn't it true that we've never had a housing recession without that being followed by a general recession?
The economy is net-zero spending driven. If those who are not net savers spend more on gas, utilities, etc. do not have as much to spend on other consumables at the rate they generally did, it is bad for the economy. You can do the same for net savers without as much problem. They may continue to save (but not as much), or they may also spend less on the economy.

So, to a degree, the economy can be kept strong with a tax cut on the net-zero crowd, and you can potentially raise the tax on the net savers. Our problem becomes one of having most of our net-zero people hardly paying much in tax now.
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Old 10-29-07, 01:42 PM
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Am I worried? No.

I took out a third mortgage, maxed out my credit cards, and emptied out my kids’ college savings account so I could buy a bigger TV and a new car, and we’re going to Greece on vacation over the holidays. Things are great!
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Old 10-29-07, 01:55 PM
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Originally Posted by classicman2
I don't see how the huge rise in the price of oil (gasoline, home heating oil, etc.) won't depress consumer spending down the road - maybe just a little down the road.

btw: Isn't it true that we've never had a housing recession without that being followed by a general recession?

consumer spending is already hurt, the latest numbers show mostly increases from sending on food and gasoline
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Old 10-29-07, 02:03 PM
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Originally Posted by classicman2
Speaking of consumer spending - I heard a startling statistic (at least to me). Americans are expected to spend 5 billion dollars on Halloween this year, and over 1/2 trillion on Xmas.
And we spend less than what we spend on one day of giving candy than we do picking our president. How stupid is McPain/Feingold?
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Old 10-29-07, 02:12 PM
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You mean it hasn't? Everytime I turn on the 6 o'clock news all I hear is bad things about the economy.
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Old 10-29-07, 02:23 PM
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Originally Posted by bhk
And we spend less than what we spend on one day of giving candy than we do picking our president.
Yeah, but spending time (or money) choosing a candidate is irrational and stupid.
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Old 10-29-07, 02:27 PM
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Originally Posted by wendersfan
Yeah, but spending time (or money) choosing a candidate is irrational and stupid.
Also, candy is delicious.
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Old 10-29-07, 03:01 PM
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Originally Posted by JasonF
$5 billion seems like a lot of money, but per capita, it's less than $20 per person.
Some would argue that it's better to spend money on Halloween than it is Iraq.
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Old 10-29-07, 03:24 PM
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Originally Posted by sracer
There isn't going to be a wholesale collapse. There are too many people who have a vested interest in keeping the boat afloat that they'll do whatever it takes to keep it afloat... or if it must make an emergency landing, ensure that it is a softer landing.
That's kind of the point, though- if all five of these things happen roughly at the same time, I don't see how they're going to keep it afloat.

I've often thought all you need is a sufficient number of people in serious financial difficulty that stop paying their mortages and credit cards to start a chain reaction in the financial sector that would be difficult to stop without a massive government bail-out.
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Old 10-29-07, 03:36 PM
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I don't think economy is going to collapse. The housing problems may ripple through the rest of the economy, but I'm not putting any cash under the mattress though.
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Old 10-29-07, 03:42 PM
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No unless our government needlessly sticks its nose further into business it doesn't belong.

I don't a fear a recession so much as the government's reaction to a recession.
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