Popular Economics Weekly

What better confirmation that real estate is in recovery than 2 consecutive quarters of higher prices in the S&P Case-Shiller home price index, which measures changes in same-home prices in 10 and 20 metro areas since the late 1980s?

Standard & Poor’s reports the Composite 10 index increased 0.3 percent in September, and the Composite 20 index increased 0.3 percent (both Seasonally Adjusted). Eleven cities posted increases, nine showed price declines.

“We have seen broad improvement in home prices for most of the past six months,” says David M. Blitzer, Chairman of S&P’s Index Committee. “However, the gains in the most recent month are more modest than during the seasonally strong summer months…Nationally, the U.S. National Composite rose by 3.1 percent in both the 2nd and 3rd quarters of 2009. Both the 10-City and 20-City Composites posted their fifth consecutive monthly increase with September’s report."

Combine this with existing-home inventories that have declined to the 7-month level, and we are back to 2006 levels. We also see that the surge in housing supply began in 2006, in the middle of the subprime frenzy.

How do we know that we are returning to more normal? The supply of housing and demand for housing are coming into some kind of equilibrium. One fundamental is the price-to-rent ratio, which has begun to stabilize. It is the ratio of current home prices to housing rental rates. Rents can only go up as fast as incomes, whereas prices can be goosed by very lax credit terms and artificially low interest rates.

The Calculated Risk Blog has calculated that the ratio has returned to 1987 levels for the Case-Shiller Index. A caveat is that if rents fall further, and the ratio (of price over rents) holds, prices could again fall since there is no longer easy credit that would raise the ratio artificially as during the bubble years.

Even more convincing evidence was the surge in October new-home sales. Sales of new one-family houses in October 2009 jumped 6.2 percent—to a seasonally adjusted annual rate of 430,000. It is even 5.1 percent above the October 2008 estimate of 409,000. This is leading to a huge drop in inventory. There were 6.7 months of supply in October - significantly below the all time record of 12.4 months of supply set in January.

Higher new-home sales and low inventories contribute to future growth in the construction, insurance, and financial sectors. So we are seeing a significant increase in economic activity that will translate into more job creation.

Harlan Green © 2009

The Mortgage Corner

Nationwide housing affordability, bolstered by affordable interest rates and low house prices, hovered for the third consecutive quarter near its highest level since the series was first compiled 18 years ago, according to the National Association of Home Builders.

The NAHB’s Housing Opportunity Index (HOI) is just one of several that show rising housing affordability at a time of declining incomes and housing values. What makes buying opportunities so special this time, as opposed to past downturns, is the record low interest rates. The various government stimulus plans have been buying down conforming and ‘high balance” conforming 30-year fixed interest rates to below 5 percent.

The HOI showed that 70.1 percent of all new and existing homes sold in the third quarter of 2009 were affordable to families earning the national median income of $64,000, down slightly from a near-record 72.3 percent during the previous quarter and up from 56.1 percent during the third quarter of 2008.

"At a time when housing is at its most affordable, we applaud the recent actions taken by Congress and President Obama to stimulate housing by extending the federal tax credit beyond its Nov. 30 deadline and expanding it to a wider group of eligible home buyers," said NAHB Chairman Joe Robson. "With interest rates now lower than last quarter, the tax credit will encourage even more home buyers to enter the market and help stabilize housing and the economy by creating new jobs, stimulating home sales, reducing foreclosures, cutting excess inventories and stabilizing home prices."

Indianapolis was the most affordable major housing market in the country during the third quarter, a position the metro area now has held for 17 consecutive quarters. Almost 95 percent of all homes sold were affordable to households earning the area’s median family income of $68,100.

Housing inventories continue to decline, so prices are firming in most areas of the country. Existing-home inventories have just declined to 7 months, and are now below 2007 and 2008 levels. This probably means that housing affordability is at its high point, as household incomes are declining at the moment and interest rates cannot go much lower. The September S&P Case-Shiller index for existing, same-home sales showed California cities San Francisco, Los Angeles, and San Diego with 3 of the top 4 price increases.

Due to the increased affordability, first-time homebuyers accounted for 47 percent of purchases and were mostly buying using FHA insured loans. Investors bought 15 percent of homes in October, according to a recent Campbell Communications survey. About 72 percent of these purchases were cash. Current homeowners bought 38 percent of homes sold in October and used a mix of financing.

The key to continued affordability will be maintaining the record low interest rates. This should continue until at least March 2010, when the Federal Reserve has said it will discontinue purchasing Mortgage Backed Securities that set the price of fixed rate mortgages. The Fed has bought almost $1 billion to date, but it is the private financial sector that must replace the Fed’s purchases next year. That will happen when we see a decline in default and foreclosure rates, which are dependent on an improving jobs market. Stay tuned.

Harlan Green © 2009

Popular Economics Weekly

We might have a merrier Christmas than was thought even one month ago. October’s retail sales surged 1.4 percent, which means that consumers may have decided to unleash their pocket books for the holiday season. This, and several other economic indicators should give the pessimists pause. The recession is over, and those businesses will profit from it that are also willing to spend again on expanding their production of goods and services.

Even BusinessWeek in jumping on the bandwagon. It projects that businesses will begin to hire and payrolls stabilize over the next couple of months with more than 80 percent of S&P 500 index companies exceeding estimated earnings in Q3. Corporate profits have as much as tripled over 2008 for the likes of JP Morgan Chase, Travelers Insurance, and a handful of S&P 500 members.

What was remarkable about the retail sales figure was that sales were led by a rebound in auto sales from a post-clunkers slump, said Commerce Department. This means the auto industry is recovering. Even GM said that it could begin to pay back some of the $50B billion it had borrowed from the Treasury.

Firing on all cylinders after selling or killing off its stale assets before its emergence from bankruptcy, a revitalized GM will look to pay off the extra $6.7B USD that the government loaned it during the bankruptcy process.  According to both The Detroit News and The Washington Post, GM’s board of directors and the U.S. Treasury have agreed on a repayment plan that would involve GM paying $1B USD per quarter, starting on December 31.

Also, Single-family starts were at 476 thousand (SAAR) in October, down 6.8 percent from the revised September rate, but 33 percent above the record low in January and February (357 thousand). Just like for total starts, single-family starts have been at this level for five months, in part because the government is paying first-time buyers as much as $8,000 to buy a home. But any further improvement will depend on a drop in the vacancy rates, which are at a historical high

We have another indicator of a “V” shaped recovery, if one looks at a history of industrial production. It shows that in the severest recessions industrial production tends to have the highest bounce back. This recession mirrors the worst—in 1948, ‘54, ‘58, ‘74, and 1981. So those expecting a "V" shaped recovery would expect industrial production to be tracking at or above the "severe recessions" line (since this was the worst recession since the Depression), according to the Calculated Risk Blog.

A quicker recovery also seems more likely because exports, a large part of industrial production, should continue to grow due to the cheap dollar exchange rate. Real exports of goods and services (after inflation) increased 14.7 percent in the third quarter GDP report, vs. a 4.1 percent decrease in the second quarter.

A merry Christmas depends on merry consumers who are in a spending mood. Third quarter real personal consumption increased 3.4 percent, in line with the jump in GDP growth, but much of it was also auto sales due to the cash for clunkers program. The good news from the latest retail report is that auto sales have picked up even after expiration of the cash for clunkers program, showing that consumers want a Merry Christmas.

Harlan Green © 2009

Popular Economics Weekly

Why is this recession so deep and long lasting? Because its underlying cause was magnified by a fickle private business sector that ran for the exits at the first sign of trouble. That is, private businesses seem to have little tolerance for uncertainty these days and so are quick to cut jobs and investment spending when it threatens their bottom line profits.

And with a weak regulatory environment and meager social safety net, it has become easier for businesses to lay off workers. The result is the sudden loss of consumer demand for their goods and services, which exacerbates the normal up and down business cycle and results in a recession at least once every decade.

That is why government support is necessary to shorten the recovery periods. Without that aid, consumers would have very little spending power and businesses no one to sell their products and services to, until the private sector decides it is safe to expand again. Government and the Federal Reserve have basically done a good job in shortening the length of recessions. The average recession length since WWII is 10 months, vs. 18 months before WWII.

So when this recession began brewing in 2007—not only did businesses begin to slash their workforce, but banks and investors began to hoard their assets. The result is more than 7 million jobs have been eliminated in less than 2 years, banks are holding $800 billion in excess reserves beyond capital requirements, and investors are hoarding more than $9.6 trillion in so-called MZM accounts—Money at Zero Maturity— such as money market and bank deposits.

Such was the panicked reaction of private sector business to collapsing credit markets that the Federal Reserve was not able to halt the downturn when they lowered interest rates, the usual result of such actions. In fact, banks stopped lending altogether, causing what is called a liquidity trap. This is when the money in the economy is no longer circulated by companies or consumers, but sits unused. The result has been a freeze in business activity, which is leading to a deflationary spiral, the most dangerous kind of recession. That is when not only prices drop, but incomes also.

This recession began December 2007, according to the National Bureau of Economic Research, causing 4 quarters of negative GDP growth, and probably ended sometime in July-August 2009. So it lasted at least 20 months, far above the average post-WWII duration.

One would think it is self-evident that when the private sector becomes risk-averse it is government’s job to step into the breach by substituting government spending for the lack of private investment. But such New Deal thinking only came into vogue during the Great Depression.

It was Roosevelt’s first Labor Secretary, Francis Perkins, also the first female cabinet member in history, who was the prime mover of much of the New Deal, including social security, unemployment insurance, and many of the depression-era public employment projects such as the WPA that employed millions, paying small, subsistence wages. She did this long before economists began to think of such aid, and even before Lord John Maynard Keynes formulated his economic theories in 1935 that justified such support during dire times.

The seriousness of the current Great Recession has warranted similar government aid. Only this time it is being done with both direct and indirect government stimulus spending. The Treasury is disbursing most of the $787 billion ARRA and $300 billion in TARP funds, while the Federal Reserve is purchasing upwards of $2 trillion in various asset-backed securities to support the record low interest rates.

The result to date is maybe 1 million jobs saved or created, a real estate market slowly gaining in strength, and an economy growing for the first time in a year. The Fed has said they won’t even begin to raise rates until the job market recovers. That means the unemployment rate has to decline back to the 6-7 percent range from today’s 10.2 percent rate.

It could take years, given the hiring reluctance of private employers. The Federal Reserve in particular has learned the lessons of the Great Depression, which was prolonged because credit was tightened too soon. Fed Chairman Ben Bernanke is in fact a student of the Great Depression. The government is almost the only source of economic activity at present, but a real recovery will happen only when private business dares to venture back into the marketplace.

Harlan Green © 2009

Popular Economics Weekly

The recession has ended with the large increase in Gross Domestic Product for the third quarter just ended. So positive signs are accumulating that the economic recovery will be sustainable. That means it will continue to grow even when the various government stimulus plans cease sometime next year. I am even more optimistic than the New York Times’ Paul Krugman in seeing a sustainable recovery. He believes another stimulus package will be needed if we want to bring back the 7 million jobs already lost in this recession.

The main reason for such optimism? A weak dollar is causing soaring exports, consumers have decided to increase their spending, and labor productivity has soared, meaning much more is being produced even with a reduced work force.  Employers will have to begin hiring soon, however, as workers are again closer to the 40 hour week, and it is cheaper to hire than pay more overtime to existing workers.

Since consumers make up 70 percent of economic activity, they must be the main driver of any recovery. And consumers have shown they will dig into their pocket books when they feel confident that their situation is improving. But we should not be looking at comparisons to the bubble years to know what kind of recovery this will be. Those years were an anomaly that won’t be repeated anytime soon.

The most positive sign was the 3.5 percent increase in third quarter Gross Domestic Product. It expanded in all areas, including an increase in residential construction. But consumers and businesses also increased their spending. Exports (read manufacturing mostly) in Q3 increased 14.7 percent, vs. 4.1 percent in Q2, while imports increased even more—16.4 percent vs. a decrease of 14.7 percent in Q2.

This is why personal consumption contributed 2.36 percent to Q3 growth, the highest percentage since Q1 2007. Residential construction contributed the most in 3 years. (Construction spending as a percentage of GDP had begun to decline in 2005—just when subprime loans became widely available.)

But because our economy is so dependent on consumers, it will be job creation that determines how much consumers will spend. With labor productivity soaring upwards of 6 percent (via more technology investment), employers have the luxury of increasing production up to a certain point without increased hiring.

The big surprise was the rise in private residential construction. It rose 0.8 percent in September, but is still 12 percent below last year’s total to date–another sign of a real estate recovery. Residential investment grew 23.4 percent in the Q3 GDP report, reversing the 23.3 percent decline in Q2, and contributed 0.53 percent to Q3 GDP.

The Calculated Risk Blog has broken down the components of residential investment, and single family construction tops the list. So it will also be one of the largest components of any sustainable recovery. Its historical contribution looks to be around 2 percent, which means 4 times the current production of approximately 460,000 units annually. During the bubble years 2004-06 it regularly exceeded 2 million units annually, hence the current oversupply.

The Federal Open Market Committee also reaffirmed its commitment to keep interest rates low and credit markets flowing. It said, “The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The Fed’s statement highlights how necessary is continued fiscal and monetary policy to keep interest rates low and support this recovery. For example, more than 80 percent of all mortgage originations are sold to the government GSEs—Fannie, Freddie, FHA/VA. Confidence has not yet returned to private sector business, unfortunately, the reason for such high unemployment. So confidence has to return to the private business sector, as well as consumers, before we see any substantial job creation.

Harlan Green © 2009

Popular Economics Weekly

The first reading of third quarter Gross Domestic Product growth (July-September)—the government’s main estimate of U.S. economic growth—soared 3.5 percent. This was a massive reversal of 4 quarters of shrinking growth, the longest decline since World War II and the Great Depression.

Does it mean the end of this, the greatest recession to date? Probably so, as other indicators—such as the Conference Board’s Index of Leading Economic Indicators, and the Institute of Supply Manager’s industrial and service sector surveys—show growth into next year.

But what kind of growth will it be? Most prognosticaters believe it will be tepid at best. Why? Because the main driver of an economic expansion is employment, and that might not improve for years. It actually took 4 years to recover all the jobs lost from the 2001 recession. But that was a special case where very little actual government stimulus spending was injected into the economy.

It took the National Bureau of Economic Research (NBER) Business Cycle Dating Committee over a year and half after the 2001 recession ended to call the trough of the cycle. And it took 21 months after the 1990-1991 recession ended for NBER to date the end of the recession.

We believe, however, employment—and the economy—will recover sooner this time for just the opposite reason. A massive amount of government spending is targeted at not only creating and retaining jobs, but supporting crucial industries. This is economist and Vice Presidential advisor Mark Zandi’s estimate of the government’s contributions to growth. He is saying that most of its effect will be in this year, even though it will contribute through 2010. He does not say why it could be a drag to growth in the last 2 quarters of 2010.

The ingredients of a sustained recovery are in the Q3 report, in other words, such as:

• Residential investment was up at a 23.4 percent annualized rate, breaking a streak of 14 straight quarterly declines, and contributing 0.53 to the percent change in GDP.
• Personal Consumption Expenditures (PCE) was up at a 3.4 percent annualized rate, and contributing 2.36 to the percent change in GDP.
• Investment in Equipment & Software was up slightly at a 1.1 percent annualized rate.
• However, non-residential structure investment was down 9.0 percent at an annualized rate. I.e., businesses are not yet expanding their facilities.

The main driver was personal consumption expenditures in this consumer-driven economy. Consumer spending bottomed out in December 2008, and has been stable or rising since January.

That is the most hopeful sign that consumers will be able to afford this recovery. But household incomes will have to rise for it to be more than a hopeful sign, and that has not yet happened.

Disposable personal income (after taxes) has been basically flat since a big plunge in May-June 2008, which is coincidentally when the unemployment rate jumped from 5 to 5.5 percent. So once again, the key to income growth, and so economic growth, seems to be jobs. We will therefore have to see some improvement in the jobless rate in the coming months, before a sustainable recovery is certain.

Harlan Green © 2009