Forecast: Economic Impact of Katrina

As the tidewaters recede and the dust settles in the aftermath of Hurricane Katrina, many people are wondering what will be both the short-term and long-term effect on our economy and the stock market. First and foremost, this is a disaster of truly astounding proportions. Some estimates suggest that the costs of rebuilding infrastructure, insurance payouts and relocation costs could exceed $300 billion…more than three times the costs of the September 11 terrorist attack. I suspect that when the last nail is hammered home, total spending could approach $1 trillion.

In the short term the destruction and disruption caused by Hurricane Katrina will likely have a negative impact on our economy as hundreds of thousands of Americans find themselves without jobs or active businesses. Disruption of oil supply lines has already caused sharply rising prices at the gas pump and will likely significantly impact home heating costs this winter. With the consumer being the primary driver of our economy over the past several years, these rising costs could easily cause a dampening effect on our economy. Be on the look out for a mini-recession later this year.

However, there is good news. By raising the federal funds rate one-quarter percent this week, the Federal Reserve signaled that they believe the underlying economy remains strong, in spite of Hurricane Katrina. Also, the government is under a great deal of pressure to respond quickly with federal aid for victims of the hurricane. Almost immediately, billions of dollars will be going into the southern region. This inflow of capital should stimulate the economy in a noticeable way in 2006, creating a mini-boom that should more than offset the short-term negative impact that occurs this year.

My optimistic forecast is tempered by the following caveats:

1. Stewardship of taxpayer money. The biggest challenge will be appropriate distribution of the billions of dollars of federal funds. Politicians in general, whether at the local, state or federal level, have a poor record when it comes to spending taxpayer money. Many have elevated graft, corruption and paybacks to an art form. There is already infighting among politicians about who will control the money. It will be vital to the recovery that the funds be spent appropriately and efficiently.

2. Falling real estate prices. Rising real estate prices have helped stimulate our economy for a decade now. Particularly in the southern coastal region, property owners appear to be tiring of the seemingly constant evacuating and rebuilding that has occurred over the past couple of years. When you add overbuilding to the equation, you have a risk of declining prices as supply outstrips demand…the so-called real estate bubble. If the winds of Katrina cause a ripple effect across the country, our economy and our markets will suffer.

3. Inflation. Rising oil prices have already hit every American in his or her pocketbook. If prices continue to rise throughout the next year, as some analysts predict, each of us will feel the effect in many areas other than just at the gas pump. Across the board rising prices will dampen consumer spending, which was responsible for over 75% of the nation’s economy during the second quarter of this year. Our economy can easily handle a modest amount of inflation, but 1980’s style inflation would send our economy and the stock market into a tailspin.

While I have concerns, I remain optimistic that we will rise to the challenges ahead of us and our economy and stock market will flourish in the wake of the single most expensive natural disaster