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By Scott Burns | 09-21-2011 05:41 PM

Wesbury on Today's Economic Hot Zones

First Trust Advisors chief economist Brian Wesbury on the current intensity of the housing downturn, the European sovereign debt crisis, unemployment, and consumer confidence.

Scott Burns: Talking economic hot zones.

Hi there. I'm Scott Burns, Morningstar's Director of ETF Research coming to you live from Morningstar's ETF Invest 2011 Conference. Joining me today is Brian Wesbury, chief economist with First Trust Advisors. Brian, thanks for being here.

Brian Wesbury: You are welcome.

Burns: We're going to play a little game now called "economic hot zones."

Wesbury: All right.

Burns: So, we've got a couple of hot zones out there for concern. I am going to throw them out there to you. Is it hot? Is it something you should worry about? And if so, what inning of the hotness are we in?

Wesbury: Sure.

Burns: So, let's start off with housing. A lot of houses, a lot of empty houses. Where are we in the housing crisis?

Wesbury: I think we are at the bottom, and I think it's probably inning number seven out of nine. We're very, very close to the end. I am not saying that we're going to go shooting straight up from here. There is clearly lots of problems with getting a mortgage, or the financial system itself today. But overall, we are beginning to see price discovery even in Florida, even in California. So the hottest zones are, everybody knows where they are, Nevada, Arizona, and Florida and California.

But the bottom line is that housing starts are about at rock bottom. We're seeing the inventory of unsold new homes plummet. It's at the lowest level it's even been. Houses under construction today are at the lowest they have ever been in recorded history--that goes back to about 1970. And as a result, I think what we're seeing is the process of working through the excess inventory happen, and I think we're very close to the bottom.

Burns: All right. So, hot zone topic number two: European debt crisis. So: Hot? What inning?

Wesbury: It is definitely hot, and this is a harder one. I'd probably say we're in the middle innings. The Europeans are taking their time. They cannot seem to figure this out. Greece has to default.

What they really need to do is come up with some sort of Brady bond, like we did in the early 1980s, to stretch this debt out. I think they can avoid a major crisis if they do.

The question then becomes, does it affect us. Well, there are two ways I think about this. One is, our direct exposure to the PIIGS, let say. So, the five biggest banks in America--that would be Bank of America, Citi, J.P. Morgan, Morgan Stanley, and Goldman Sachs--have $54 billion of exposure to the PIIGS. Now, that's sovereign debt, that's also businesses--so, let say, they are lending to Fiat--and it's also individual debt, so the Onassis family has borrowed from one of these banks. I don't know if they have or haven't, but that's what it would be.

So, that's $54 billion of debt. Obviously, not all of that is going to go bad. There are assets behind much of it. But there is $713 billion worth of capital at these five institutions. So, we could lose every dime of that and still have lots and lots of capital left. That's not the issue.

The issue then becomes what about the indirect debt, the counterparty risk that people talk about? And my view there is, is that the European banking system, the ECB, and European governments are gone to backstop these banks in the sense to keep the potential of default for any of these institutions from spreading and taking down the rest of the world.

So, I look at it as a hot zone, but I think it's viewed as hotter than it really is.

One last point on this, Scott, and that is in the early 1980s, every single Latin American and South American country except for Chile and Colombia went into default, and our banks, the eight biggest banks in the United States, had 260% of their capital lent to those countries, directly to those countries in sovereign debt. In other words, when they went into default, our eight biggest banks were technically in default. They were bankrupt. But we invented the Brady bond, stretched things out, and the U.S. economy actually boomed.

I think what we really need is just to resolve this issue. They need to force the pain on Greece and once we do that, we'll move very, very quickly past the hot zone.

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