Breaking the Mold

THE BE YOUR OWN ECONOMIST ® BLOG

Yesterday the Conference Board reported (http://www.conference-board.org/economics/ConsumerConfidence.cfm) that March consumer confidence fell to 64.5, just a tad above its 61.4 low of five years earlier.

You can update the chart below in your mind’s eye with the most recent figure. Notice that confidence had begun to recover following the 2001 recession. Then came the Enron-induced stock-market slump and the Iraq invasion. That reduced confidence to its 2003 low point. As soon as Saddam fell, the index and the economy rebounded.

Now the economy and the index have fallen again. If confidence drops below 60, it will be down to levels reminiscent of the 1991 Gulf War and the 1990-91 recession as well as the recessions of 1981-82 (10% unemployment) and 1980 (15% inflation). If confidence drops below 50, we’ll begin exploring depths the index has never reached.

Consumer Confidence

(Click on chart to enlarge)

Recessions shaded

On April 24, the day before the Conference Board released its consumer-confidence estimate, the Census Bureau reported 526,000 new-home (http://www.census.gov/const/newressales.pdf) sales in March. Update the following chart in your mind’s eye with that number and you’ll see that this series has also fallen to levels not seen since the 1990-91, 1981-82 and 1980 recessions. New-home sales have not only fallen by a record absolute amount, they have also fallen relatively more than in past slumps

New-Home Sales

(Click on chart to enlarge)

Recessions shaded

These charts also reveal that declines of this magnitude always accompanied past recessions. Since the real-estate debacle initiated the current slump, and a number of leading real-estate experts say that real-estate will continue to drop, it seems reasonable to assume that these indexes have further to fall. Moreover, if gasoline prices keep going north, helping to propel confidence south, what chance do consumer expenditures have? It doesn’t look good.

Yet there are those who say that the worst is behind us and that we’re not in recession and there won’t be one. If that’s true, we’ll have broken the mold, and consumer confidence and new-home sales just don’t mean what they once meant.

(The charts were taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)

© 2008 Michael B. Lehmann

What Do They Know That We Don’t?

THE BE YOUR OWN ECONOMIST ® BLOG

The stock market is up but the economy is down. Why?

The customary explanation: The economy in general, and corporate earnings in particular, are set to rebound in the second half of this year because the good news - in the form of falling interest rates, tax rebates and surging exports – will more than offset the bad news – in the form of weak housing and rising gasoline prices.

Maybe so, but today’s Wall Street Journal, in an article by Kelly Evans, (http://online.wsj.com/article/SB120874691199830457.html?mod=todays_us_page_one) entitled “Firms ‘Notably Downbeat’ on Economy,” provides reason for doubt:

“U.S. companies, burdened by worries about slow sales and tighter credit, have turned pessimistic, a new survey shows…

“Companies in several industries, including manufacturing, telecommunications, finance, and retailing, reported falling profit margins and slumping demand for their products during the first three months of 2008, according to a quarterly survey by the National Association for Business Economics……

“The respondents largely concluded that recent government steps to help stimulate the economy would have no effect on their business.”

An April 11 Journal article by Phil Izzo with the title, “U.S. Economy hasn’t Hit Bottom, Survey Says,” (http://online.wsj.com/article/SB120776362649702195.html) reinforces that view:

“The weakening U.S. economy has further to fall, according to the majority of economists in the latest Wall Street Journal forecasting survey.

“By a 3-to-1 ratio, respondents said the economy is in a recession, and almost three-quarters said the economy hasn't yet hit bottom…..”

Economists have a bad record forecasting the business cycle’s turning points, and most were late calling the current recession. But, who knows, this time they may be right.

Finally, an April 12 article in The Economist with the headline “The long hangover” carried this subtitle: ”America’s economy is in recession. Don’t expect a quick recovery.”

A key paragraph informed us:

“In its latest World Economic Outlook, published on April 9th, the IMF slashed its forecasts for America's economy both this year and next. It now expects GDP to shrink in every quarter of this year. By the fourth quarter the economy will be 0.7% smaller than a year before. (Only three months ago the fund expected a rise of 0.9%.) Nor does the IMF expect 2009 to be much better: GDP will grow, but at well below its trend rate.”

So much for the experts. What do ordinary folks think? The chart below measures the Conference Board’s survey of consumers’ confidence in the economy. You can see the last entry in the chart was about 90. Now update it with the most recent reading: 64.5 in March.

Consumer Confidence

(Click on chart to enlarge)


Recessions shaded

That’s just about where the economy was at the bottom of the last downturn when our invasion of Iraq began. If it slips below 60, we’re in real bad news.

Makes you kind of wonder what the stock-market optimists know that no one else knows.

(The chart was taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)

© 2008 Michael B. Lehmann

Remember the Recession?

THE BE YOUR OWN ECONOMIST ® BLOG

Yesterday the stock market retreated because General Electric reported disappointing earnings as well as disappointing prospects for the remainder of the year. Investors thought GE’s diversification had insulated it from the business cycle and guaranteed strong profit growth regardless of the economy’s ups and downs. GE’s poor results brought them back to earth. If GE can’t make it, maybe this recession is worth our attention.

Good point. We have focused so heavily on the financial crisis that we seem to have forgotten about the real-economy contraction that continues to threaten us. That’s a mistake. The Fed and the Treasury may have prevented the financial markets’ disintegration, but the glut of homes and the attendant collapse of home prices – the root cause of our problems – is still with us. And that glut of homes and price-slide continues to dissipate household wealth and reduce aggregate demand.

A number of home-rescue packages are in the works. If the one that is implemented can stop the foreclosures and stabilize the housing market, that might help halt home values’ downward spiral. But partisan politics and a presidential-election season give pause. We may end up with too little, too late.

Meanwhile, the optimists have directed their attention to the economic-stimulus package’s tax rebates and the Fed’s interest-rate reductions. “After all,” they say, “Didn’t these work well in pulling us out of the 2001 recession?” That’s true. Once again, however, there was no housing glut and home-price collapse in 2001. “Yes,” they respond, “But wasn’t the dot.com bust just as bad, and we have nothing like that now.”

Good point. But keep this in mind. The 2001 tax cut and interest-rate cut contributed to the 2002/2003 recovery. They did not prevent the 2001 recession. Some investors seem to think that the recent tax rebates and lower interest rates can forestall recession today. We’ll see, but maybe not. And if recession does grip the economy, corporate earnings will contract and the stock market will fall. Then we’ll have a stock-market slump and a housing contraction, exacerbating the reduction in household wealth.

The economy will eventually recover, but it’s difficult to have confidence in any recovery until the glut of homes is removed from the market and housing prices stabilize. And that will take time.

© 2008 Michael B. Lehmann

Taxpayers’ Money

THE BE YOUR OWN ECONOMIST ® BLOG

When it comes to the housing crisis, many folks – especially in Congress - have become very careful about not wasting taxpayers’ money.

In an article by John D. McKinnon and Damian Paletta, under the headline “Bush to Expand Help on Mortgages,” today’s Wall Street Journal (http://online.wsj.com/article/SB120769266029299359.html?mod=todays_us_page_one) reported that President Bush will issue a directive to the Federal Housing Administration that will, “…expand a government program that helps struggling borrowers keep their homes…”

The article went on to say:

“The proposal stands as the White House's version of a concept Democrats also have been weighing -- using the government's power to induce lenders to reduce payments for struggling homeowners. The administration's approach is narrower in terms of the number of homeowners who could qualify, which will provide some political cover from Republicans leery about being seen to bail out lenders or borrowers who made bad bets by taking out risky loans……

"’We must also work to help the innocent victims of the housing crisis, without providing a taxpayer-funded bailout to speculators, scam artists, or recklessly irresponsible borrowers,’ said House Minority Leader John Boehner (R., Ohio).”

Problem is: No one’s been talking about “a taxpayer-funded bailout to speculators, scam artists, or recklessly irresponsible borrowers.” All proposals seek to help homeowners in their one-and-only home.

Besides, won’t the economic-stimulus package, which will shortly provide a rebate to most taxpayers, ultimately be paid for with taxpayers’ money? Sure, taxpayers are getting a tax cut now. But that adds to the federal deficit, and the increased debt must ultimately be retired with taxpayers’ funds. Why not accord the same allowance for homeowner relief? If we can give away money to everyone who merely earned income, why can’t we be equally generous with homeowners who are about to lose their homes? Moreover, there’s a collective benefit to the entire economy – which helps all of us - when we pursue these types of relief.

The point is: The longer we wait, the worse the situation becomes. As foreclosures rise, the supply of homes on the market grows. This further depresses prices, which leads to a downward price-spiral as more homeowners face foreclosure and abandon homes whose mortgages now exceed their homes’ market value.

The latest – March 18 – minutes from the Federal Reserve’s Open Market Committee (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20080318.pdf) made the point forcefully:

“Participants noted that the contraction in the housing sector had deepened and that considerable uncertainty surrounded the outlook for housing. Although some stabilization in housing markets was likely needed to help underpin an economic recovery in coming quarters, there was little indication that that process had yet begun. Elevated rates of foreclosures and large inventories of unsold property were likely to depress home prices for some time. Lower home prices would eventually buoy home buying, but in the meantime the prospect of continued price declines could lead potential homebuyers to defer purchases for a time, further damping housing activity and adding to downward pressure on home values. Participants noted that the trajectory of house prices was a major source of uncertainty in their economic outlook.”

Damn the torpedoes! Full speed ahead!! The glut of homes on the market lies at the root of today’s problem. A homeowner bailout (aka rescue package) will minimize the number of distressed properties that are dumped on the market. That will be taxpayers’ money that is well spent.

© 2008 Michael B. Lehmann

The Lost Highway

THE BE YOUR OWN ECONOMIST ® BLOG

Hank Williams sang about “The Lost Highway,” and warned us to stay off it.

Yesterday’s New York Times, in an article by David Leonhardt and Marjorie Connolly, reported that “81% in Poll Say Nation Is Headed on Wrong Track.”
(http://www.nytimes.com/2008/04/04/us/04poll.html?_r=1&sq=marjorie%20connelly&st=nyt&adxnnl=1&oref=slogin&scp=2&adxnnlx=1207436746-L/Mp4o6GRtqc2dktyyRRig)

The article said:

“Americans are more dissatisfied with the country’s direction than at any time since the New York Times/CBS News poll began asking about the subject in the early 1990s, according to the latest poll……

“The dissatisfaction is especially striking because public opinion usually hits its low point only in the months and years after an economic downturn, not at the beginning of one. Today, however, Americans report being deeply worried about the country even though many say their own personal finances are still in fairly good shape……

“Only 21 percent of respondents said the overall economy was in good condition, the lowest such number since late 1992, when the recession that began in the summer of 1990 had already been over for more than a year. In the latest poll, two in three people said they believed the economy was in recession today…..”

If 21% of respondents said the economy was in good condition, that means almost 80% said it’s not in good condition. Moreover, the article said this kind of pessimism usually takes hold in the depth of recession, not at recession’s start. If this is how people feel today, how will they feel as the economy slumps further?

This is a very gloomy omen. So much hangs upon what consumers will do: Home purchases, residential construction, new-vehicle expenditures, general consumption, and so on. Why should households spending head north if most of us think the rest of the economy is heading south?

If these poll numbers mean what they appear to mean, we are really on the lost highway.

© 2008 Michael B. Lehmann

The Glass-Steagall Act and Shadow Banking

THE BE YOUR OWN ECONOMIST ® BLOG

Recently the Federal Reserve announced that it would provide assistance to investment banks, such as Merrill Lynch, Goldman Sachs and Lehman Brothers, as well as commercial banks such as Citibank, Bank of America and Wells Fargo, by exchanging U.S. Treasury securities in the Fed’s portfolio for less-secure securities, including mortgage-backed, in the investment banks’ and commercial banks’ portfolios. Both investment banks and commercial banks benefit if they can swap lower-value securities for higher-value securities.

The investment banks (called shadow banks by those who accuse them of reckless borrowing and lending) now have a benefit previously reserved for commercial banks. That prompted some observers to ask, “Shouldn’t the investment banks be regulated like commercial banks if the Fed extends commercial-bank benefits to the investment banks?”

Today’s New York Times (http://www.nytimes.com/2008/03/29/business/29regulate.html?adxnnl=1&ref=todayspaper&adxnnlx=1206810825-jlYwIO2HagML52mFHEJHwA) began the answer to that question. In an article by Edmund L. Andrews entitled “Treasury Dept. Plan Would Give Fed Wide New Power,” the lead paragraph said:

“The Treasury Department will propose on Monday that Congress give the Federal Reserve broad new authority to oversee financial market stability……..”

The article went on to say:

“While the plan could expose Wall Street investment banks and hedge funds to greater scrutiny, it carefully avoids a call for tighter regulation.”

We’ll see how Congress and the Treasury Department resolve the tension between oversight and regulation. But there’s a historical irony insofar as commercial banking and investment banking activities were both part of regular bank operations – and therefore subject to the Fed’s control - until the Glass-Steagall Act separated them in 1933. The objective: Make commercial banks safer by forbidding them to engage in investment banking. The irony exists because now we’re trying to make investment banking (shadow banking) safer by bringing it back under the Fed’s control.

Before 1933 and Glass-Steagall most large banks carried on both commercial banking and investment banking functions. Today’s JP Morgan Chase (commercial bank) and Morgan Stanley (investment bank) are the successors of JP Morgan, an institution that combined commercial banking and investment banking operations under one roof.

Here’s what happened. Commercial banks are centuries old. They made short-term self-liquidating loans to businesses that wished to acquire inventories for prompt resale. These commercial loans were called self-liquidating because the sale of the inventories provided the proceeds for the loans’ repayment. A modern example might be a retailer borrowing from the bank to purchase toys for the Christmas season, followed by the prompt repayment of the loan from Christmas revenues.

Investment banking arose in the 19th century to provide railway funding. Railroads were huge undertakings that required large amounts of capital for construction and rolling stock. They could not build on a pay-as you-go basis. The road had to be completed before any revenue could be generated. That made it difficult for railways to raise the necessary funds. The investment banks assisted by buying the railways’ stocks and bonds, and paying for those securities by issuing checking accounts to the railways in exchange. This was known as securities underwriting, and the investment banks resold the securities to their customers.

Banks engaged in both commercial banking and investment banking, but investment banking was much riskier because the securities could fall in value before resale while the checking account the bank had issued would not. That’s what happened in the Great Depression. Stocks lost 90% of their value from 1929 to 1933, wiping out banks’ assets and their ability to meet their obligations (depositors’ checking accounts).

Congress passed and President Roosevelt signed the Glass-Steagall Act in 1933 in order to avoid similar disasters in the future. Henceforth banks would have to decide if they wished to be commercial banks or investment banks. If they wished to be commercial banks, they could no longer underwrite corporate securities. If they wished to be investment banks they could not issue checking accounts or hold bank deposits for customers. The idea was to keep bank deposits safe by removing them from the fluctuations of the stock market. Investment banks would have to work with their own funds or borrowed funds.

The Glass-Steagall Act was repealed in 1999, but commercial banking and investment banking activities remain separate under the law. That’s why the current attempt to bring “shadow banking” (i.e. investment banking) under the Fed’s purview is so ironic. It once was under the Fed’s oversight, until investment banking was separated from commercial banking to protect depositors. Now that investment banking has evolved to the point that it borrows huge sums to fund risky investments, and thereby threatens the solvency of the commercial banks, we’re bringing investment banks back under the Fed’s control.

© 2008 Michael B. Lehmann

Glimmer of Hope?

THE BE YOUR OWN ECONOMIST ® BLOG

Yesterday the National Association of Realtors reported (http://www.realtor.org/press_room/news_releases/2008/existing_home_sales_rise_in_february.html) February existing-home sales were 2.9% higher than January’s, although 23.8% below a year ago. Prices were 8.9% lower than last year.

Some analysts were encouraged by these data and expressed the view that falling prices may, at last, have attracted buyers into the market. Perhaps the long slump may be coming to an end.

According to Lawrence Yun, the Realtor’s chief economist:

“We’re not expecting a notable gain in existing-home sales until the second half of this year, but the improvement is another sign that the market is stabilizing. Buyers taking advantage of higher loan limits for both FHA and conventional mortgages will unleash some pent-up demand. As inventories are drawn down, prices in many markets should go positive later this year.”

Today Standard & Poor’s released (http://www2.standardandpoors.com/spf/pdf/index/CSHomePrice_Release_032544.pdf) January data for its S&P/Case-Shiller Home Price Indices. The report said:

“The 10-City Composite set yet another new record, with an annual decline of 11.4%. The 20-City Composite recorded an annual decline of 10.7%.

“’Unfortunately it does not look like early 2008 is marking any turnaround in the housing market, after the declining year recorded throughout 2007,’ says David M. Blitzer, Chairman of the Index Committee at Standard & Poor's. ‘Home prices continue to fall, decelerate and reach record lows across the nation. No markets seem to be completely immune from the housing crisis, with 19 of the 20 metro areas reporting annual declines in January and the remaining – Charlotte North Carolina – eking out a benign 1.8% growth rate. Looking deeper into the data, you can see that 16 of the metro areas are also reporting record low annual growth rates. The monthly data show that every one of the MSAs has now declined every month since September 2007, marking five consecutive months. On top of that, the declines have increased through time, in general, as 13 of the 20 MSAs reported their single largest monthly decline in January.’”

Clearly, the optimism is not universal.

Who’s right?

We’ll see. Just remember we’re in a bear market for real estate. And, just as in the stock market, there can be bear traps that fool premature optimists with temporary price increases. This is a severe price deflation that will be compounded by recession when that development is at last acknowledged by the powers that be.

Stay tuned.

© 2008 Michael B. Lehmann