We'll begin with our own recession warning composite, which accurately signaled oncoming recessions in 2000 and 2007 (see the November 12, 2007 comment Expecting A Recession ). That particular conformation of indicators never deteriorated sufficiently in 2010 to provoke a recession warning, though the deterioration in the ECRI leading index and other measures clearly indicated serious concern. In any event, QE2 effectively forestalled incipient economic weakness in 2010. Given that second quarter GDP came in at just 1.3% annually, and first quarter GDP growth was revised down to just 0.4% (from a prior estimate of 1.9%), it is wholly unclear that the Fed's extraordinary actions have been worth the market distortions, predictable commodity hoarding, injury and social unrest among the world's poor (resulting from food and energy price increases) and significant "unwinding" risks that this policy has produced.


The "guarantee" that Fannie and Freddie sold to investors is a corporate guarantee, not a federal one. Now, it's clear that investors widely view the federal guarantee as "implicit," and the Treasury under Tim Geithner has made it explicit through 2012. But if anyone is concerned about default risk in the U.S., the place they really should look first is at the debt of Fannie and Freddie, as it is debt of insolvent institutions whose disposition has not been agreed upon at all within Congress. It is fascinating that investors don't seem to have this on their radar. Still, if Congress was to decide to make those bondholders whole for an extended period of time, then to the extent that explicit appropriations were not made and funded through taxes or issuance of new Treasury debt, the subsidized portion of Fannie and Freddie's debt would be appropriately viewed as an obligation of the Federal government.

I continue to believe that the primary drag on the economy is not "uncertainty," or taxes, or budget concerns, or health care reform, or regulation. No. What is weighing the economy down, and what will continue to weigh the economy down, is bad debt that our policy makers are transfixed on making whole rather than restructuring. This will eventually happen, because it has to happen. Yet even with that expectation, it will be an extended process, and meanwhile, I believe that we'll have numerous opportunities to take constructive investment stances amidst it all.

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