U.S. Unemployment Estimates Point to a Debt Time-Bomb About to Explode

March 31, 2020 2:13 PM UTC
If estimates for unemployment levels above 30% persist, banks could be in for a world of pain and even the Federal Reserve can't soften.
  • Taking estimates for unemployment above 30% lightly could be dangerous if coronavirus isn’t contained soon.
  • U.S. banks are facing a credit crunch of epic proportion.
  • If economic weakness persists longer than expected we will likely see a massive cash-grab that could dry up banks’ liquidity.

Goldman Sachs lowered its forecasts for the U.S. economy this week. The revised predictions see GDP losing a whopping 34% in the second quarter, down 10 percentage points from the 24% loss the firm initially expected. Unemployment was revised upward to 15%, a significant jump from the 9% Goldman previously expected. 

That’s in line with the Federal Reserve’s expectations for 47 million lost jobs and an unemployment rate upwards of 32%. Those grim projections could spell disaster for banks—especially if they’re not as short-lived as most are hoping.

Unemployment Could Persist Longer

By all accounts, the U.S. economy has never experienced a shutdown of this magnitude. That suggests that the fall-out is largely unknown.

Many are hoping for a v-shaped recovery in which the U.S. suffers one or two quarters of pain before bouncing back. But that may not be the case according to some economists who say the underlying cause of this recession is far from being cured.

Coronavirus cases in the U.S. are far from being under control, so it feels premature to start predicting an economic recovery. | Source: Statista

Coronavirus has shut down economies across the world completely and will continue to do so unless a vaccine makes it to market. At very least, scientists would need to better understand the virus— how to treat it, how it’s spread, its incubation period—before things can rebound. All of that looks like a long-way off.

With that in mind, the ‘short-term’ pain the U.S. economy is experiencing could stretch longer. 

Unemployment Could Pop the Debt Bubble

For years economists have been warning about a debt bubble among U.S. consumers, who have been dining out on cheap loans since the 2008 financial crisis.

Before coronavirus was splashed across every newspaper in the country, economist David Rosenberg was cautioning about a $16 trillion dollar debt bubble among American consumers. Auto debt, he pointed out, had risen a whopping 60%.

Warnings about consumer debt were rife even before coronavirus threatened the U.S. economy. | Source: Twitter

That huge debt pile looming over consumers is about to come crashing down as lost jobs and reduced wages cause many to miss loan payments. Of course, that’s hard on consumers—but it’s going to be even harder on banks. 

The government’s $2.2 trillion coronavirus relief package is enough to bridge a one-month gap as borrowers struggle to make their April payments. But banks like Wells Fargo that are heavily exposed to the mortgage servicing market will still see a dent in their cashflow. 

But the next question becomes—then what? Social distancing measures are to remain in place until May according to Donald Trump. In other countries around the world like the U.K., experts say this new way of life could become a reality for up to six months. 

The easing measures in place assume a v-shaped recovery. But what if that doesn’t happen?

Marching Deeper into Crisis Mode

Rising unemployment is just one part of America’s out-of-control debt problem. Corporate debt is also a concern, especially with GDP set to lose more than 30%. Banks have already started to prepare for the worst, asking their large clients to leave cheap lines of credit untapped. 

It’s only a matter of time before toilet paper shortages turn into liquidity problems as hoarding spreads to cash collecting. | Source: AP Photo / Wong Maye-E

Hoarding behavior seen among consumers at the start of the coronavirus crisis could spread further through the U.S. economy. This time it won’t be toilet paper, it’ll be cash. 

For now, the Fed is injecting funds into the market to help banks maintain liquidity. But the ramifications of that strategy are unknown— especially if the downtrend persists longer than expected.

CIO of The Bahsen Group David Bahsen cautioned that we’re in uncharted territory when it comes to the Fed’s easing.

The Fed’s balance sheet is headed to north of $7 trillion. That will not mean actively intervening in the market. That will make them the market. The Fed’s significance to capital markets is going to places no one ever thought possible, and the ramifications are not fully understood or appreciated at this time.

The Bottom Line

It’s impossible to understand exactly how the coronavirus will impact the U.S. economy in the long term until it’s under control. That could mean everything from effectively flattening the curve to developing a successful vaccine.

Each of those scenarios would have very different outcomes for the U.S. economy. The prospect of a usable vaccine is unlikely for at least 18 months. A shutdown for that length of time would almost certainly cripple the U.S. economy and cause an untold rise in unemployment. 

Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com.

Sam Bourgi edited this article for CCN.com. If you see a breach of our Code of Ethics or find a factual, spelling, or grammar error, please contact us.

@Laura_h_says

Laura has been working as financial journalist covering US markets for more than a decade. Her work can be found in a wide variety of publications including Yahoo Finance, InvestorPlace, Nasdaq and Benzinga. Visit her website, contact her at lmariehoy@gmail.com, see her LinkedIn profile here, or check her out on Muck Rack. Laura Hoy is a Trusted Journalist.