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Shock to the system
A year of unpleasant economic surprises has caused many to question some long-standing assumptions about the way the financial system works.
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Bridges aren't supposed to just fall down.
Baby toys aren't supposed to contain dangerous lead.
Minnesota's economy is supposed to be above average.
And large banks aren't supposed to make billions of dollars in loans to people who can't repay them.
For many, 2007 may be remembered as the year when the seemingly impossible became almost routine. Not since the early 1980s has the state and national economy gone through such wrenching changes and faced so many uncomfortable truths, financial analysts say.
Though hard to believe now, many people started 2007 not knowing what a subprime mortgage was. Now, multibillion-dollar write-downs of these loans -- made to borrowers who had riskier credit profiles -- are almost a daily occurrence at major banks, wreaking havoc on the capital markets and contributing to tightened credit standards for borrowers nationwide.
"It was the year of disillusionment," said Ross Levin, a financial adviser in Edina. "So many things we have come to believe in as truth have changed."
Among the more unsettling discoveries of 2007 is that the Minnesota economy -- once the envy of the nation -- is no longer remarkable. In industry after industry, Minnesota's job growth last year lagged behind the national rate. In June, for the first time in 31 years, the state's unemployment rate was higher than the national jobless rate.
Yet Mark Simenstad, head of fixed-income investments at Thrivent Asset Management in Minneapolis, found it surprising that the state and national economies have managed to avoid deeper slowdowns, given the turmoil in the credit markets. However, the possibility of a short recession next year is "reasonably high," he said, particularly if the job market worsens.
Baby toys aren't supposed to contain dangerous lead.
Minnesota's economy is supposed to be above average.
And large banks aren't supposed to make billions of dollars in loans to people who can't repay them.
For many, 2007 may be remembered as the year when the seemingly impossible became almost routine. Not since the early 1980s has the state and national economy gone through such wrenching changes and faced so many uncomfortable truths, financial analysts say.
Though hard to believe now, many people started 2007 not knowing what a subprime mortgage was. Now, multibillion-dollar write-downs of these loans -- made to borrowers who had riskier credit profiles -- are almost a daily occurrence at major banks, wreaking havoc on the capital markets and contributing to tightened credit standards for borrowers nationwide.
"It was the year of disillusionment," said Ross Levin, a financial adviser in Edina. "So many things we have come to believe in as truth have changed."
Among the more unsettling discoveries of 2007 is that the Minnesota economy -- once the envy of the nation -- is no longer remarkable. In industry after industry, Minnesota's job growth last year lagged behind the national rate. In June, for the first time in 31 years, the state's unemployment rate was higher than the national jobless rate.
Yet Mark Simenstad, head of fixed-income investments at Thrivent Asset Management in Minneapolis, found it surprising that the state and national economies have managed to avoid deeper slowdowns, given the turmoil in the credit markets. However, the possibility of a short recession next year is "reasonably high," he said, particularly if the job market worsens.
"2008 will be the year of sobering up after this binge of cheap credit," Simenstad said.
Among Minnesota companies, one of the most telling events of the year happened May 2, when home lender Residential Capital, or ResCap, announced a $910 million first-quarter loss, while reassuring investors that the problems in its subprime lending portfolio were under control.
The Bloomington-based company's assurances proved to be wildly off the mark, and ResCap, a subsidiary of GMAC, became a poster child for the lax lending standards and excessively cheap credit that fueled the real estate bubble. Since that announcement, the company incurred a $2.3 billion third-quarter loss, and its debt was cut to junk status by major rating services.
ResCap's stunning decline -- it posted a $705 million profit in 2006 -- illustrated how even respected financial institutions underestimated the extent to which the subprime market might deteriorate. "The magnitude of the losses are worse than anyone had expected," Simenstad said.
The surprises at ResCap and other financial companies also shattered a long-standing assumption about the mortgage market: That the packaging of mortgage loans into securities and selling them to investors would shelter big banks from risk.
However, the financial experts who created the securities and the ratings agencies that analyzed them failed to account for a decline in housing prices, which many believed would not happen on a national scale. The declining home values and a rise in defaults caused the value of these securities to plunge and contributed to huge loan write-downs at Citigroup, Bank of America Corp. and J.P. Morgan Chase & Co., among others.
But lenders weren't the only ones feeling the impact. Shares of MoneyGram International Inc. have plunged more than 30 percent since the St. Louis Park-based money-transfer firm made the surprising disclosure that it would take a $230 million loss on subprime mortgage investments.
"When the tide goes out, you find out who was swimming naked and dumping garbage on the beach," said Alex Stenback, a Minneapolis mortgage broker and author of the blog Behind the Mortgage (www. behindthemortgage.com).
For years, affordable food was taken for granted in the United States. But prices for just about every food item went up in response to higher commodity and energy prices. One of the main culprits was the rising price of corn, which is used in everything from ethanol to chicken feed to breakfast cereal.
The higher prices at the supermarket added to a litany of concerns for consumers, including recalls of lead-contaminated toys, ground beef linked to E. coli contamination and soaring energy prices. "We saw an unusual amount of profiteering at the expense of customers' physical and mental well-being," said Ben Popken, editor of the Consumerist, a consumer-awareness blog (consumerist.com).
Through November, consumers in this country spent a record $360 billion on gasoline -- nearly double 2002's oil spending, according to the Oil Price Information Service, a Wall, N.J.-based publisher of newsletters that track fuel prices.
Driving up the prices are institutional investors who are parking money in oil futures because many of the alternatives -- stocks, bonds and real estate -- haven't fared well. Some analysts expect fuel prices to hit $4 a gallon in many communities before the spring.
Though total consumer spending continues to rise, that's likely to change early in 2008, warned Stan Pohmer, a Minneapolis-based retail consultant. "People think it's their patriotic duty to get out and shop during the Christmas season," he said. "But when people get their bills for heating their homes, and there's not a bull market in other investments, there's going to be a soft patch."
Chris Serres • 612-673-4308
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