More than a month ago I wrote that the country was close to a recession, that short-term rates were beginning to approach long-term interest levels, sure evidence of a slowdown and continued low rates.

In addition to low rates, I also said that a portion of our real estate market was powered by a lack of supply which was pushing up prices in many areas as well as the use of high-risk mortgage products that allowed marginally-qualified buyers to purchase high-cost homes.

In other words, the only way we're supporting high real estate prices is by fudging traditional rules. We allow people to buy at levels that would have been unaffordable under past lending standards.

Playing mortgage roulette is fine as long as everyone realizes there are massive opportunities to lose, a thought which brings us to Hurricane Katrina.

During the past four years we've been living on borrowed time -- and money. The philosophical idea has been to shrink the federal government by reducing tax revenues. The practical reality is that while the Congress and the President have consistently advocated lower taxes for the rich, spending has continued without reduction.

As mentioned last week, the nonpartisan Congressional Budget Office says that in fiscal 2000 the government hauled in an extra $236 billion followed by a surplus of $128 billion in fiscal 2001. Since then, it's been all downhill -- a loss of $158 billion in fiscal 2002, $378 billion in fiscal 2003 and $412 billion in fiscal 2004. ("Fiscal" years for the government start each October 1st and end each September 30th.)

This year we expect to "only" overspend by $331 billion. Or at least we did before Katrina.

We continue to rack up vast balance-of-payments deficits with our trading partners. We have enormous trade imbalances with such nation-states as Saudi Arabia and China, neither a model for democracy, human rights or religious freedom.

In effect, a part of our prosperity has been derived from our ability to borrow. The good times have been underwritten by cheap capital at home and self-interest abroad.

But as everyone in bankruptcy ultimately realizes, you can only borrow so much. Credit has it's limits and we are about to find out just where the line should be drawn.

The Congressional Budget Office has just issued a report which estimates that Katrina may result in the loss of as many as 400,000 jobs and perhaps a 1-percentage point drop in the rate of growth. In less than a week such numbers are already outdated: The federal government started with $10.5 billion in Katrina-related assistance and now has now chipped in another $51.8 billion -- and we are only at the beginning of the repair process. NASA, as one example, estimates that it will take more than $1 billion to restore its Gulf Coast facilities as a result of storm damage.

The question is: Just where do we get this money? There is a moral imperative to spend such funds because we have American citizens at risk. But such an additional cost, on top of our ongoing budget deficit, rising gas prices, ongoing Iraqi war and a terrible balance-of-payments situation may cause us to move faster toward a recession.

At this point someone will point out that the effort to restore the Gulf Coast will actually create jobs and generate additional spending and taxes. This is -- to a point -- true. However, there is no possibility that the lives, assets and opportunities lost as a result of Katrina can be fully recovered. Moreover, huge numbers of people will remain homeless and jobless for months if not for years.

With a mild recession we would likely see low mortgage rates because there would be little demand for capital in a contracting economy. Home prices would remain stable if not decline. Those who need to sell and have purchased with little down combined with interest-only loans or option financing will face big problems. Those with big equity and little debt will be far more secure.

Let us be very clear that if there is a recession housing should not be the scapegoat. Instead, the federal money now being spent, the financial institutions that have concocted risky loans and the long-term failure to achieve energy independence should receive appropriate attention.

At some point the incredible run of real estate price increases nationwide must slow, perhaps stop and maybe reverse. It will be interesting to look back in a year to see if that point is now.

For more articles by Peter G. Miller, please press here.

Published: September 13, 2005

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