Plowing Old Ground: New/Old Economic Outlooks
Welcome back to the New Year. In case you haven't noticed we've taken a bit of a hiatus - partly due to laziness and other workloads but also from a reluctance to put up the economic news, which is unrelievedly bad across the bad. Which doesn't mean we haven't been following and collecting the news as is our wont - just that we chose to exercise some holiday spirit and postpone posting. But the time is at hand. After the break you'll find our usual collection, largish this time of course, covering the strategic outlook, Housing in particular (though looking back to Oct clippings which were "merely" confirmed by the abysmal November data and the continuation of the cliff-diving) and some key indicators. The later in particular indicate that not only is the credit crunch continuing but it's metastasizing into other areas, e.g. consumer credit, and will worsen in '09. And employment will similarly follow the normal lag structure and is starting off its' own cliff. While we discuss this more below some of the prior posts lay out a similar story with other charts you may want to refer back to (It's Back: Welcome to the Downturn for Real,Storm Flags Flying: State of the Evolving Downturn,Fragilities Exposed: Downturn, World Economy and Re-Balancing,Let the Triage Begin: Business Performance vs "Stupid Is").
Economic Outlook: Expectations vs Realities
Two of the saddest and most dangerous memes running around, IOHO, are the fact that so many have been caught so flat-footed and still don't see the tsunami wave cresting, nor the ones behind it. The consequences for ill-prepared businessess were the heart of our Forest Gump post ("Stupid Is"). And second the gap between the consensus surveys and what's likely to happen. The "Blue Chip" surveys talk to very competent finance industry economists who suffer from a major defect - they're prisoners of models that presume normal cyclic downturns and recoveries. Well this is anything but normal, partly because of the credit problems and partly because of accumulated problems in the core economy. Instead of consensus we'd point you instead at folks who addin some seroius judgment like Noural Roubini or Paul Kasriel instead of relying on flawed mis-speification of their models. We've tried to capture as much of this as we can manage in the accompanying graphic which combines a long-term look back at GDP, Consumption and Investment with prior graphics on the Business Cycle and a conceptual depiction of where we're at in the cycle.
Credit Crisis and Outlook
A key part of the problem is that Consumers make their spending decisions on the basis of likely future income plus wealth. The primary indicators of future income are changes in Employment plus Real Wages. The latter took a slight bump up because of the sharp downturn in Inflation but the former is just beginning to tip over rapidly and severely. So the W+E delta is still negative ! Which forbodes very poorly for future spending. A major consequence of declining income and dropping expectations is an accelerating drop in consumer spending. Which will in turn further slow the economy and worsen credit conditions. And then of course there's Housing where we still have a long way to go in reaching the bottom of the price declines. Until/unless we perform the same sort of surgery on mortgage valuations for all the toxic garbage that's still on those books this slow unwinding will continue to infect the system. If you'd like a graphic analogy consider this a case of severe combat wounds where gangrene has set in and is no longer treatable by anti-biotics. Which leaves us no alternative but surgery ! OUCH indeed. The accompanying graphic tries to conceptually illustrate the resultant negative feedbacks that in process - a vicious cycle if you will. And as the Business Cycle graphic shows as Consumer spending declines businesses will further restrict their hiring and reduce their capital spending. Not that either was very good at any time in the last ten yars !!
Wealth Destruction 
On the wealth side that's even worse as you can see in the accompanying graphic. US consumers have experience the greatest decline in their net worths in the post-war period. $Trillions of wealth in assets and housing have been "destroyed". Of course that's a problematical argument since much of that percieved wealth was artificially created by bad credit decisions and leverage. On the other hand it was the foundation for holding up consumer spending so Voila', here we are in yet another vicious feedback loop. In the longturn the over-consuming US public is likely to undergo a major shift in spending habits because cheap and easily available credit will be reduced in availability. And because we're likely to shift to a more savings oriented, frugal and fearful outlook. Which is a good thing in the long-run because people are reminded that economic stabilities and growth are outcomes not givens. Unless, as Keynes observed, "we're all dead" before we reach a happy new equilibrium. The net long-term result will be reduced growth in consumer demand and a very slow and difficult recovery.
The bottom line of which is that both '09 and '10 are likely to see continuations of the downturn followed by an extended period of slow growth. In fact the IMF just recently revised it's October World Economic Outlook and foresees US growth. In fact after peaking at 3.1% in 2011 they are prognisticating a very weak rate of 2.3% growth in 2013 !! In other words this won't be a very robust recovery, it'll take a while and will likely be followed by a period of sustained low growth. Just FYI we need 3.3-3.5%/year for reaching full potential where unemployment doesn't rise. That means that for the next five years the IMF anticipates the US growing at less than potential - with all that implies about employment, consumption and socio-political pressures.
Economic Outlook
The Six Lessons from Last Week's Action First, this is going to be the worst recession in the post-World War II era, in our view. The ECRI leading indicator hit a record low for the fifth week in a row – down to - 29.2 as of the November 21st week versus -28.2 the week before. This index, which leads real GDP by two quarters with a 70% historical correlation, is getting further and further away from the prior all-time low of -19.8 that defined the worst recession of the post-WWII era and saw a six-quarter consumer recession coincide with a 45% peak-to-trough decline in the stock market. Perhaps the fact that this bear market is proving to be even more severe is symptomatic of an economic downturn that will also prove to be deeper and more prolonged. After the flurry of data released just before Thanksgiving, we are now tracking close to a 4.5% QoQ annualized fall in real GDP in 4Q. This would be the largest pullback since the 1982 recession, and we see a similar contraction in the first quarter of 2009. Second, capex is in a very steep decline right now. Durable goods orders dropped 6.2% in October, the third decline in a row. Over that time frame, orders have plunged at a 39% annual rate, which is unprecedented. The retrenchment has spread to the tech sector, where order books were expanding at a 7% annualized rate over the three months to June. Currently, that same three-month trend has swung to a negative 13% annualized rate.
`Great Recession' May Just Be Starting as Job Losses Mount, Credit Shrinks
U.S. Consumers Seen Facing ‘Liquidity Squeeze’: U.S. consumers are headed for a “liquidity squeeze” as banks grow more reluctant to provide mortgages and shrink credit-card lines, according to Meredith Whitney, an Oppenheimer & Co. analyst. “A new era in the overall financial landscape” is unfolding in which many households will have to cut debt, she wrote in a report today. The CHART OF THE DAY displays two indicators of consumer indebtedness, the amount of mortgage loans outstanding and credit-card lines from commercial banks. Both reached plateaus this year as housing prices dropped and unemployment rose. “The entire mortgage market hit a wall,” Whitney wrote, adding that home loans probably fell last quarter. There hasn’t been a drop since the second quarter of 1982, according to the Federal Reserve data cited in the chart. The Fed will release third-quarter figures later this month. Whitney also projected that banks will reduce unused credit- card lines by 45 percent during the next 18 months. That works out to $2.13 trillion, based on the total credit lines available from all lenders insured by the Federal Deposit Insurance Corp. as of June 30, according to the report. “We are now beginning to see evidence of broad-based declines in overall consumer liquidity,” she wrote. Along with a rising jobless rate, the reductions will bring “a pronounced downshift in consumer spending.”
In String of Bad News, Omens of a Long Recession Despite months of rescue efforts, hundreds of billions of dollars in government spending and an avant-garde apparatus of financial tools, the American economy has only worsened, and at a faster rate than nearly anyone predicted. This recession, which officially began in December 2007, now appears virtually certain to be the longest downturn — and possibly most severe — since the end of World War II, as evidenced last week by a demoralizing rat-a-tat of grim reports on jobs, sales and public confidence. The reports signaled that even after 11 months, more than the entire length of the last two downturns, this recession has only now entered its fiercest phase, and economists say the pain will not end soon. Instead, Americans retrenched even further in November, sending sales at the nation’s retailers tumbling to the weakest level in more than 35 years and leading the Detroit automakers to record their worst sales in a quarter-century. Manufacturers have not seen conditions this bad since 1982. The decline in spending is likely to continue, depriving the economy of its primary growth engine, as layoffs continue to mount. Half a million Americans, from financial analysts to factory workers, were dismissed in November alone. Rarely has a labor downturn affected such a broad swath of income levels. Most frightening of all is that the worst job losses may be yet to come. If history is any guide, millions more Americans could lose their jobs before businesses start to expand again. “Up until mid-September, a plausible scenario was that it would be a short and shallow recession,” said Edward Yardeni, the investment strategist. “After mid-September, it became quite obvious that that was wishful thinking.”
Merrill's Rosenberg Inspired by Farrell, Kindleberger in Foreseeing Crash David Rosenberg drew on inspiration from market-rules theorist Robert Farrell and asset-bubble historian Charles Kindleberger to predict the economy’s demise this year. Rosenberg, the chief North American economist at Merrill Lynch & Co. in New York, by January had already called the recession that this month was officially declared to have started in December 2007. He also said the Federal Reserve would lower its main interest rate to 1 percent by year-end, one-third of the median estimate of economists surveyed by Bloomberg News; by October, policy makers brought the rate to that level. Rosenberg, 48, refused to trust his computer models, sensing that the end of the credit and housing-market booms would cause a deeper rout than most analysts thought. Now, he predicts the carnage will cause a 2.5 percent contraction in gross domestic product in 2009, and sees historians calling the current era “GDII,” a reference to the Great Depression. “We came off a prolonged period of prosperity that was fueled by excessive leverage and an asset bubble of historical proportions,” Rosenberg said in an interview. “Either you believed that this was sustainable or you didn’t. I came to the conclusion that this was going to end very badly.” It all came down to the premise that the downturn in housing was going to have a lagged and severe impact on everything from economic growth to interest-rate spreads and stocks. Personal savings, Rosenberg’s “key metric,” would head higher as Americans tried to repair tattered finances resulting from the slumps in property values and stock prices. That’s where Rosenberg differed from the majority in his profession, who he said were using terms like “contained” to describe the impact of the subprime mortgage crisis, or “resilient” when talking about consumer spending, which had risen for a record 17 years. “You have to have your models, but you have to question the results,” Rosenberg said. “You have to ask yourself: Where could the model be wrong this time? Bubbles go further than you think, but they do not correct by going sideways,” he said, quoting the fourth of “10 Market Rules to Remember,” by former Merrill analyst Farrell. The severity of today’s housing bust, and the resulting collapse in credit, indicate that the U.S. won’t soon emerge from the already yearlong recession, according to Rosenberg. “What we know about periods of asset deflation and credit contraction is that the impact on the economy tends to last for years not quarters,” he said, projecting housing is likely to contract through the end of 2009.
In 2009, Economy Will Depend on Unlocking Credit The problem, as Mr. Bagehot observed, is trust — or rather, the lack of it. Even after receiving millions, in some cases billions, of dollars from the government, banks are reluctant to lend money. Crucial parts of the financial system have stopped functioning. The exuberance of the boom, which led bankers to make loans to people who could not repay them, has given way to a seemingly intractable fear of making any loans at all. How long this situation lasts will determine the immediate course of the nation’s economic life. Will the recession, already a year old, drag on through 2009 — or even longer? Will the stock market revive soon or shrivel further? What of the beleaguered housing market? The answers to those questions will depend on the availability of credit in all its forms — home mortgages, personal and business loans and bonds sold by corporations, states and municipalities. For now, many banks are hoarding money rather than lending it. Their holdings of cash have nearly tripled to just over $1 trillion in the last three months, according to Federal Reserve data. In the capital markets, bond investors who embraced risk in good times have abandoned all but the safest of investments. Many have rushed to buy ultra-safe United States Treasury securities, driving the yields on those investments to historic lows. Once the credit markets stabilize, bankers hope, investors will start buying other types of debt, unlocking the flow of credit. A big worry is the future of securitization, a key mechanism of modern banking that enables banks to bundle loans and bonds into securities for sale to investors. This crucial market is moribund now that many of its creations have plunged in value. Some question when, or if, certain areas of securitization will revive.
Nouriel Roubini Says Worst Still Is Ahead of Us: Unfortunately, the worst is ahead of us. The entire global economy will contract in a severe and protracted U-shaped global recession that started a year ago. The U.S. will certainly experience its worst recession in decades, a deep and protracted contraction lasting at least through the end of 2009. Even in 2010 the economic recovery may be so weak -- 1 percent growth or so -- that it will feel terrible even if the recession is technically over. There also will be recessions in the euro zone, the U.K., continental Europe, Canada, Japan and the other advanced economies. A hard landing for emerging-market economies may also be at hand. Among the so-called BRICs, Russia will be in an outright recession in 2009. Growth in China will slow to 5 percent or less, representing a hard landing for a country that needs expansion of close to 10 percent to move 10 million to 15 million poor rural farmers into the urban industrial sector every year. Brazil will barely grow in 2009. Even India will experience a sharp slowdown. Most other emerging market economies will suffer a similar hard landing. This severe global recession will morph into a stag-deflation, a deadly combination of economic stagnation/ recession and deflation. In the advanced economies, with aggregate demand falling below growing aggregate supply, slack in goods markets will lead to deflationary pressures as companies’ pricing power is restrained. Likewise, rising unemployment will constrain labor costs and wage growth. These factors, combined with sharply falling commodity prices, will cause inflation in advanced economies to ease toward negative territory, raising concerns about deflation. Deflation is dangerous as it leads to a liquidity trap: nominal policy rates can’t fall below zero, so monetary policy becomes ineffective and even quantitative easing may not work. Falling prices mean that the real cost of capital is high and the real value of nominal debts rise. This leads to further declines in consumption and investment, thus setting in motion a vicious circle in which incomes and jobs are squeezed, aggravating the fall in demand and prices. As traditional monetary policy becomes ineffective, other unorthodox policies will continue to be used: policies to bail out investors, financial institutions, and borrowers; massive provision of liquidity to banks in order to ease the credit crunch; and even more radical actions to reduce long-term interest rates on government bonds and narrow the spread between market rates and government bonds. Some Forecasters See a Fast Economic Recovery, 2008: Annus Horribilis, RIP
Housing and the Economy
U.S. Home-Price Decline Accelerates, GDP Shrinks as Crisis's Grip Tightens The decline in U.S. house prices accelerated in September and the economy shrank in the third quarter at a faster pace than first estimated as the grip of the credit crunch tightened. The S&P/Case-Shiller home-price index fell 17.4 percent from a year earlier. The Commerce Department said gross domestic product dropped an annual 0.5 percent as household spending slid the most since 1980. While consumer confidence rose this month, the Conference Board’s gauge remained near the lowest on record. “The economy is turning down pretty dramatically,” Treasury Secretary Henry Paulson said at a press conference in Washington to outline new government efforts to unfreeze credit. “It’s very important that lending continue to be available.” Today’s reports underscore concerns that the economy is at risk of a contractionary spiral as lenders cut back credit, causing spending to fall and companies to slash investments and payrolls. The Treasury and Federal Reserve today began two new programs to bring down interest rates on mortgages and consumer loans, committing at least $800 billion. Stocks climbed on the Fed’s plans, with the Standard & Poor’s 500 Stock Index rising 0.7 percent to close at 857.39, posting its first three-day gain since September. Treasuries rose after the central bank’s proposal to buy up to $600 billion of debt issued or backed by housing-finance companies spurred some investors to buy government securities as a hedge. Economists anticipate that the drop in GDP worsened in the current quarter because of the deepening credit crunch. The collapse of Lehman Brothers Holdings Inc. in September triggered a renewed bout of turmoil, forcing the Fed to step up as a lender of last resort.Existing Home Sales in October, Existing Home Sales (NSA),Mortgage Rates in U.S. Decline Most in Seven Years With Push From Fed Plan
Existing Home Sales: Turnover Will Slow This is another reminder that the only reason existing home sales appear to have "stabilized" is because of the high number of REO sales. Sales excluding REOs have plummeted. I've argued before that REO resales are real sales and should be included in the NAR statistics, but I suspect these REO buyers might hold these properties longer than recent turnover would suggest. If these are owner occupied buyers, they have probably been waiting to buy, and they have saved a down payment and qualified under the tighter lending standards. They probably won't sell until they can make a reasonable profit to buy a move up home - and it will probably be a number of years before prices recover.If they are investors, they are likely buying REOs for cash flow - not appreciation, unlike the speculators in recent years - and these investors will probably hold the properties for a number of years too. This suggests to me that turnover will slow further.Case-Shiller House Prices: Free Falling, Price-to-Rent Ratio, House Price-to-Income Ratio,
More on New Home Sales First, here is a long term graph of new home sales and inventory from the Census Bureau.Although home builders have sharply reduced housing starts - and are now starting fewer homes than they are selling (reducing inventory) - new home sales have fallen rapidly too. It has been a race to the bottom! Also - New home sales in October might be at the lowest level since 1982, however adjusted for owner occupied units, the current year is the worst on record. In 2008, sales through October (before revisions) have totaled 436 thousand. This is slightly ahead of the pace in 1991 (432 thousand sales through October). However sales have slowed in the 2nd half of 2008, and it appears that annual sales will be below the 509 thousand in 1991. This would mean sales would be the lowest since 1982 (412 thousand). Of course the U.S. population and the number of households were much lower in 1982. In 1982 there were 54.2 million owner occupied units in the U.S., in 1991 there were 61.0 million, and there are approximately 76 million today. If we use a ratio of owner occupied units to compare periods, the low in 1982 was 412 thousand X (76/54.2) = 578 thousand units (based on the number of owner occupied units today). The calculation for 1991 gives 634 thousand units (to compare to today). By this measure, 2008 is the worst year for new home sales since the Census Bureau started tracking new home sales (starting in 1963).October New Home Sales: Lowest Since 1982
House Prices vs. PCE This graph compares the YoY change in real house prices with the YoY change in real PCE. For this limited data set (house price data is only available since 1987) the YoY changes move somewhat together, although house prices started declining before PCE during the current economic downturn. This difference in timing could be because of homeowners withdrawing equity from their homes (the Home ATM) even after prices first started falling. However recent data shows that the Home ATM is now pretty much closed - and as expected consumption has started to decline sharply. Based on this general relationship, I wouldn't be surprised to see the YoY change in real PCE fall to -4% or so at some point next year.
Meltdown far from over, new mortgage crisis looms The full scope of the housing meltdown isn't clear and already there are ominous signs of a new crisis -- one that could turn out the lights on malls, hotels and storefronts nationwide. Even as the holiday shopping season begins in full swing, the same events poisoning the housing market are now at work on commercial properties, and the bad news is trickling in. Malls from Michigan to Georgia are entering foreclosure.Hotels in Tucson, Ariz., and Hilton Head, S.C., also are about to default on their mortgages. That pace is expected to quicken. The number of late payments and defaults will double, if not triple, by the end of next year, according to analysts from Fitch Ratings Ltd., which evaluates companies' credit. That's bad news for more than just property owners. When businesses go dark, employees lose jobs. Towns lose tax revenue. School budgets and social services feel the pinch. Companies have survived plenty of downturns, but economists see this one playing out like never before. In the past, when businesses hit rough patches, owners negotiated with banks or refinanced their loans. But many banks no longer hold the loans they made. Over the past decade, banks have increasingly bundled mortgages and sold them to investors. Pension funds, insurance companies, and hedge funds bought the seemingly safe securities and are now bracing for losses that could ripple through the financial system. "It's a toxic drug and nobody knows how bad it's going to be," said Paul Miller, an analyst with Friedman, Billings, Ramsey, who was among the first to sound alarm bells in the residential market. Unlike home mortgages, businesses don't pay their loans over 30 years. Commercial mortgages are usually written for five, seven or 10 years with big payments due at the end. About $20 billion will be due next year, covering everything from office and condo complexes to hotels and malls. The retail outlook is particularly bad. Circuit City and Linens 'n Things have sought bankruptcy protection. Home Depot, Sears, Ann Taylor and Foot Locker are closing stores. Those retailers typically were paying rent that was expected to cover mortgage payments. When those $20 billion in mortgages come due next year -- 2010 and 2011 totals are projected to be even higher -- many property owners won't have the money.
Key Indicators
U.S. Durable-Goods Orders, Consumer Spending Tumble as Recession Deepens U.S. business investment weakened last month and consumers are retrenching worldwide, reports today showed, heightening pressure on policy makers to take stronger steps to combat the credit squeeze. Americans cut spending by 1 percent in October, the biggest drop since the last recession in 2001, while British households slashed expenditures last quarter by the most in 13 years, government agencies said today. A U.S. Commerce Department report showed orders for durable goods slumped twice as much as forecast as domestic and foreign demand dried up. The intensifying global economic downturn spurred China's central bank to cut its benchmark interest rate by the most in 11 years today, while the European Union proposed $259 billion in stimulus measures. In the U.S., President-elect Barack Obama held his third press conference in as many days to name former Federal Reserve Chairman Paul Volcker as an economic adviser. ``It's about as bad as the 1970s and 1980s,'' said David Hensley, director of global economic coordination for JPMorgan Chase & Co. in New York. ``We're looking at back-to-back very deep'' slump in the global economy this quarter and next. The decline in personal spending in the U.S. last month followed a 0.3 percent drop in September, the Commerce Department said today in Washington. Adjusted for inflation, spending fell 0.5 percent, a fifth consecutive decrease. The last time price-adjusted spending dropped as many months in a row was in 1990-91.
EU Proposes $259 Billion Plan to Stimulate Economy, Limit Effect of Crisis
Charge-Offs Start to Shred Card Issuers More credit-card holders who fall behind on their payments are eventually defaulting, deepening losses for thousands of banks that issue plastic. The worsening trend indicates that charge-off rates among credit-card issuers, which stood at more than 6% in the third quarter, are poised to rise more than expected in the fourth quarter and into next year. That means additional misery for financial firms already besieged with losses on everything from soured mortgages to bad bets on capital markets. Card-industry executives are worried about escalating "roll rates," a term that refers to the percentage of cardholders who go from merely late on their payments to not making them at all. Among cardholders who are between 60 days and 89 days overdue, about 20% of such card balances eventually are being charged off by card issuers as uncollectible, according to Auriemma Consulting Group Inc., a Westbury, N.Y., financial-services consulting firm. The percentage is up by about a third from last year, before the U.S. economy tipped into recession. The problem can be even worse for bundles of outstanding credit-card balances that are securitized by some of the largest issuers.
Credit Card Companies Take What They Can Get After helping to foster the explosive growth of consumer debt in recent years, credit card companies are realizing that some hard-pressed Americans will not be able to pay their bills as the economy deteriorates. So lenders and their collectors are rushing to round up what money they can before things get worse, even if that means forgiving part of some borrowers’ debts. Increasingly, they are stretching out payments and accepting dimes, if not pennies, on the dollar as payment in full. “You can’t squeeze blood out of a turnip,” said Don Siler, the chief marketing officer at MRS Associates, a big collection company that works with seven of the 10 largest credit card companies. “The big settlements just aren’t there anymore.” Lenders are not being charitable. They are simply trying to protect themselves. Banks and card companies are bracing for a wave of defaults on credit card debt in early 2009, and they are vying with each other to get paid first. Besides, the sooner people get their financial houses in order, the sooner they can start borrowing again. So even as many banks cut consumers’ credit lines, raise card fees and generally pull back on lending, some lenders are trying to give customers a little wiggle room.
No-Layoff Policies Crumble The deepening recession is prompting layoffs at long-established employers that avoided job cuts in previous downturns. These layoffs demonstrate both the severity of the current recession and the continued erosion of workplace norms that once shielded many U.S. workers from permanent job loss. Several of these employers are in hard-hit industries. Employment in the car rental and leasing sector, for example, fell 3.3% in October from a year earlier, according to the U.S. Bureau of Labor Statistics. Gentex Corp., a Zeeland, Mich., automotive supplier, conducted its first layoffs in 34 years this month amid plunging car sales. Declining gambling revenue prompted the Little River Casino in Manistee, Mich., to dismiss 100 of its 950 employees in November, the first layoffs in the resort's nine-year history. Some workplace experts say such layoffs show that the stigma associated with permanent job cuts -- unthinkable to many employers three decades ago -- continues to decline. They say companies find it easier to let go of workers when rivals and other employers also are eliminating jobs. Kevin Hallock, a professor at Cornell University's School of Industrial and Labor Relations, says as layoffs become more common, managers may find it easier to discount the human and business costs. He recalls a group of senior executives who broke into tears after announcing their company's first layoffs. When Mr. Hallock returned to the company six months later, the same executives were discussing another round of job cuts in "the starkest economic terms."