Recession Unlikely, Housing Sector Correction Nearly Over
Kurt Brouwer February 21st, 2008
This report is essentially an interview with Gail D. Fosler, the chief economist for The Conference Board. This is the organization that brings us surveys such as The Consumer Confidence Index and the Index of Leading Economic Indicators. Had I seen it earlier, it would have been a solid addition to the Good News On The Economy post. Oh well.
This piece makes two important points — that a recession is still unlikely and that the slump in housing is nearly over [emphasis added]:
Recession Unlikely, Housing Sector Correction Nearly Over (The Conference Board Straight Talk Newsletter, February 20, 2008)
“Despite continuing turmoil in the housing and financial markets, a U.S. recession is not imminent, The Conference Board reports today.
“While the correction in the financial sector is just beginning, the correction in the housing sector is nearly over,” declares Gail D. Fosler, President and Chief Economist of The Conference Board. Her analysis appears in StraightTalk, a newsletter designed exclusively for members of The Conference Board’s global business network.
While the U.S. economy has weakened, business activity and corporate profits continue to rise. Consumer spending is continuing at a rate of 2 to 2.5 percent a year, and with the exception of the auto industry, the economy is showing gains virtually across the board.
“Exports are booming and imports and import penetration are down,” says Fosler. “While there is continuing uncertainty about the economic outlook, economic shocks from the contracting financial sector are not enough to tip the U.S. economy into recession.”
It is certainly true that exports are one of the bright spots in our economy. The point about consumer spending is also true. Both of these factors are positive, which puts them at odds with the picture that the entire economy is falling apart and a recession is imminent.
…Housing Market Correction About Over
The housing market correction is about over, says Fosler. Given the lags in the impact of the housing sector on the economy, even at current activity levels, housing will likely subtract about 0.4 percentage points from 2008 growth. Housing affordability is beginning to improve, and with the recent interest rate cuts and home price declines, it should improve further and limit the downside risk. January and February are not big months for housing, but rising affordability bodes well for the spring selling season.
Demographic trends also favor housing. The rise in households is increasingly outpacing the rise in permits, so the ratio is rising over time and is reaching a point normally associated with recovery in housing activity. The long housing boom of the past 15 years has taken the home ownership rate up from 64 percent to a peak of 69 percent in 2004, reflecting an intrinsic demand for housing. All of this adds up to good structural demand for housing if the credit markets and lending institutions can ease the credit flow.
Fosler is one of the few who are saying that the slump in housing is nearly over. A second point she makes is that the long-term outlook for housing demand is very good. I fully agree with this point because our population is growing (from new births and from immigration) and it is clear that we will need lots more housing in the coming decades.
…Financial Sector Still Struggling
The bad news is concentrated in the financial sector. Recent data indicate that financial sector profits decreased dramatically over the second half of 2007. Basic earnings data show that financial services profits collapsed from about $10 per share in the second quarter of 2007 to a loss of almost $2 in the fourth quarter. Not only have these losses been substantial, but they have been concentrated in some of the largest financial institutions, both in terms of assets and market capitalization. Top global financial institutions have disclosed roughly $125 to $150 billion in asset writedowns associated with the recent financial turmoil. But when all the dust settles, even if their profitability is damaged, their balance sheets are likely to be little affected. Because of the mark-to-market rules, the writeoffs associated with structured products, including subprime mortgages, are likely to be revalued over the course of the year as the markets begin to trade those securities…”
The financial sector is struggling and the bad news is far from over. Banks and other institutions have taken lots of writeoffs related to subprime loans and other loans. One interesting point the report does not make is that major banks made money last year despite all the trouble (see Despite Writeoffs, Major Banks Made Money In 2007). No doubt the financial services industry will continue to struggle for several months as this process unfolds.
I will keep watching and thinking about our economy, but so far I am still guardedly optimistic. What about you? Do you think we are sliding into recession or just muddling through a slow patch?
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Economists are notorious for being horrible forecasters. Just recently, they insisted that there was no housing bubble, that housing prices don’t go down and that even if that were to happen, housing is such a small part of GDP that it wouldn’t impact the whole economy. Wrong, wrong, wrong.
Ms. Fosler’s comments are so off the mark and out of touch with reality that I barely know where to begin (I almost think she’s being sarcastic!). Let me touch on just two of her conclusions.
“The housing market correction is about over”
That would make the current one likely the shortest on record. No statistics on delinquencies, foreclosures or inventories of houses for sale support this statement. Also, lending standards have been tightened and the pool of available buyers has therefore shrunk dramatically. Additionally, the home ownership percentage she states is at unsustainable historically high levels and was pushed there by incredibly lenient lender underwriting that is now history. Unwinding this fiasco has a few years left to run.
“The bad news is concentrated in the financial sector”
Trouble for the financials reverberates throughout the economy and impacts almost everyone, with some hit harder than others. There is a huge deleveraging taking place and a repricing of risk. Consumers and businesses alike are being hit by tighter credit and increasing borrowing costs, despite the Fed’s efforts to the contrary (look no further than the auction credit markets for proof of this). When the financials are hurting, there’s a clear domino effect.
Her comment that financial institution “balance sheets are likely to be little affected” is laughable. Did she forget about Citigroup, Merrill Lynch, UBS, etc. having to quickly raise tens of billions of dollars of fresh capital to strengthen their balance sheets as their stocks cratered?
Anyone who can see the forest through the trees knows that we’re in a recession already, just ask the people on the frontlines, like any large company CEO. By the time the economists make that acknowledgement, it’ll be over.
Good to hear from you again Penelope. From what I have seen the housing correction has been underway for close to two years — at least from the peak prices. So, Fosler may be correct on that one.
I think you misinterpreted her comment on balance sheets. She meant that there would not be a huge and immediate hit to their balances sheets because the securities they are holding will eventually begin trading again and will be priced higher.
Also, on the credit crunch theme — commercial lending at banks is booming right now so the idea of a credit crunch is mistaken. You are correct that the auction markets for tax-exempt financing are broken now. Also, securitization of mortgages is limited, but traditional credit markets seem to be fine.
I believe that the average housing downturn lasts roughly four years. I think that you’re correct about being almost two years into this one. It’s anyone’s guess how long this current downturn will run, but it’s depth (and possibly length) will be greater due to the mortgage mess.
Banks’ balance sheets are getting hit from every direction. Besides mortgages, they are seeing accelerating deterioration in loans for automobiles, credit cards, schooling, etc. They also got stuck with billions in leveraged buyout paper that is dropping rapidly in price and huge SIV’s that need rescuing. Their capital is under distress these days and a chunk of it has evaporated permanently, leading to the exact reason why commercial lending is not “booming right now” and the “credit crunch” is very real. Banks are gun-shy and too worried about the potential problems already on their books to want to aggressively expand their loan portfolios at this time. Review the recent quarterly earnings reports from any of the money centers or regionals for verification.
Well, the data would indicate that you’re mistaken. From Carpe Diem:
‘…According to quarterly banking data
released yesterday by the Federal Reserve on “end of period levels” through the end of 2007 for all banks, bank credit/loan volume is at an all-time record for all types of credit (business, consumer, real estate)! See charts above, click to enlarge. If there is some paralysis/collapse of the U.S. credit markets, how can bank loan volume be at all-time historical record high levels?That’s historical data and grows every year due to inflation alone. I’m guessing that if we’re in a recession, it started late in Q4 and the evidence right now is more anecdotal than quantitative.
Here’s more recent commentary from the Fed on Jan. 30th:
“Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets.”
http://www.federalreserve.gov/newsevents/press/monetary/20080130a.htm
From today’s NY Times:
“For many months, we called it the subprime mortgage crisis, because that was where the problem first became apparent. But that label is far too narrow, and serves to obscure what is at stake.
“Rather ominously, borrowing costs for even the most creditworthy of firms have started to rise,” said Paul Ashworth, an economist with Capital Economics in London. Homeowners who can still get mortgages have seen rates rise in recent weeks, and banks say they are tightening their standards for both credit cards and commercial real estate loans.”
“The principal cause for concern today is the paralysis of the credit markets,” Martin Feldstein, a Harvard economist and an adviser to President Ronald Reagan, wrote in The Wall Street Journal this week. “The collapse of confidence in credit markets is now preventing that necessary extension of credit. The decline of credit creation includes not only the banks but also the bond markets, hedge funds, insurance companies and mutual funds. Securitization, leveraged buyouts and credit insurance have also atrophied.http://www.nytimes.com/2008/02/22/business/22norris.html?pagewanted=1&_r=1&dlbk
And, your point would be what exactly? The subprime lending mess is something we have covered extensively. That exotic securities have been created based on subprime loans is old news. That complex Wall Street creations have led to tears is also an old story.
Mr. Feldstein is a brilliant man and is entitled to his opinions, but not his own facts. Credit is being extended to creditworthy borrowers based on data from the Feds. Bank loans as of the end of Q4, 2007, were being made in large numbers. Rates on mortgages are reasonable and almost certain to go down. Where exactly is the credit crunch? Answer: exactly where it should be. That is, no one wants to purchase or lend against the complex securities Wall Street created until their actual value can be ascertained.
In a nutshell, my point is that credit problems started in one area and have rapidly spread (similar to cancer), creating many unintended and unforeseen consequences.
The evidence right now is still anecdotal and will take awhile to show up in the statistics. Often times, where there’s smoke, there’s fire…
Will the political wrangling over the proposed 700 billion dollar buyout of bad credits be the end of capitalism as we know it? Karl Marx was right all along, he’s just 8 years off.