Krugman and Roach on the Coming Double-Dip

Nobel Prize-winning economist Paul Krugman said yesterday in an interview with Bloomberg TV that he sees a 30%-40% chance of the U.S. slipping back into recession in the second half of 2010. Stephen Roach, long-time Morgan Stanley strategist and now head of MS Asia, said essentially the same thing this morning in his Bloomberg interview.

Both are worried about the housing market and the consumer. And both believe that once the government fiscal and monetary stimulus are exhausted or withdrawn, the hangover from the last decade’s credit bubble will continue its slow, painful process of wringing out excesses and punishing all but the wealthy.

As I said yesterday in my notes on the prime mortgage chapter of the housing bubble hangover, this systemic, generational financial crisis was not over when the Fed and Treasury bailed everyone out and the stock market bottomed. This debacle will have aftereffects for years to come as $2 trillion in toxic mortgage assets, millions of underwater homeowners, and the unemployed-foreclosure cycle weigh down a real estate recovery.

That’s why the government moved on Christmas Eve to extend permanent “get out of jail free” cards to Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE). That Santa Claus surprise was actually a well-planned stocking stuffer to shore up the housing recovery and make sure the implosion of those two massive balance sheets didn’t take the other fragile giants (NYSE:BAC or NYSE:C or NYSE:AIG) down again.

Or, Will Main Street Save Wall Street?

I think when consumer balance sheets and housing are lean-and-mean again in a few years—say 2013—the stock market will make new highs. That’s how Main Street saves Wall Street. The interesting question now is, “How do economic players adapt to this long healing process where rules change and uncertainty still motivates creative profit incentives?”

My friend Joel Block has one idea about how players on Main Street are incentivized to make recovery happen in his first blog post of the new year called, “Have We Hit Bottom?”

Joel is a business consultant who earned his economic street smarts in venture capital and real estate, and now advises entrepreneurs on growth strategies, particularly in real estate syndication.

His idea is for investors to get busy finding real estate bargains, and I found this intriguing because it fits with my idea about “buying inflation” now—and because Joel was inspired by the outlook of a banking insider. Here’s an excerpt from his post about the incentives and the opportunity:

I was speaking last week with a long-time friend who is a senior executive with one of the major banks in the country. He told me that the new strategy for his bank (and the other big ones are on the same track) is to create loans that amortize over a 25-year period instead of the traditional 30-year period. These new loans are five year fixed interest rate loans that are fully amortizing with a balloon due at the end of the 5th year.

The bank’s goal is to set their customers up so that they will refinance in five years. The bank’s expectation is that in five years rampant inflation will raise asset prices dramatically, making refinances easier. Further, many of the problems that exist in the economy now will have taken care of themselves, and refinancing should be easy (or easier).

This executive is convinced that the bank is not setting their customers up to fail, but rather, they are setting their customers up to be able to take advantage of the improvement in the economy five years from now.

Five years is a good healthy period for the “bubble decade” to work things out. I’m with Joel on accumulating solid real estate properties in this environment and now is probably a good time to make some “buy and hold” investments in that asset class. As for equities, I am still a “buy and trade” strategist because the price swings over the next few years (as I said in the very first column here) will be too good to resist.

Double-dip recession or not, the collective anxiety of investors over US debt, deficits, and inflation will keep the stock market as emotional and volatile as ever. And that’s where the short-term trading opportunities are the best.