Warren Buffet has been quoted as saying that the larger the stone dropped into water the bigger the waves. The stone dropped that started this financial crisis was definitely a large one. Here is my interpretation of the waves that follow the stone dropping. These waves can overlap but traditionally are made up of peaks and troughs.
The “stone” dropped was the Real Estate market bubble popping. The stone impacting the water was in September 2009 when the financial markets all but shut down clogged with bad debt. When the financial system receives a shock as it did in September, the effects are felt in waves.
The first wave typically comes in the form of fear. If you asked the average US citizen what happen in September 2009, most would not be able to detail the actual impact. But this fear causes the average US consumer to stop spending as much and plan for the worst. During this financial crisis the initial fear coupled with real estate prices falling, caused an extreme contraction in consumer spending. Since 70% of US GDP comes from consumer spending, this contraction leads to the second wave.
The second wave is usually a direct result of the first wave. When consumers spend significantly less, companies are forced to reduce inventory to match this new reduced demand. This reduction in inventory typically causes high unemployment. High unemployment leads us to the third wave.
The third wave again is usually a direct result of the second wave. High unemployment with reduced consumer spending leaves a supply surplus. Actual goods surplus is reduced by lowering prices to what consumers are willing to spend to spur demand. With less demand overall for goods and services, square footage becomes a surplus, which is commercial real estate.
I believe that near term future of the US economy is largely dependent on the third wave. If the consumer can put aside their reduced wealth, fear of job loss and return to over consumption then the economy should start to recover (for the short term). If the consumer cannot jump start the economy, then commercial real estate could be the next stone dropped and we would start all over.
Tags: commercial real estate, gdp, unemployment, warren buffett
