The Mortgage Corner

First American CoreLogic just released its first monthly report on distressed sales, which are gradually improving. It also indicates that the recovery still has many bumps on the road to a sustained recovery. And Professor Robert Shiller, co-author of the S&P Case-Shiller Home Price Index, doesn’t yet see much light at the end of the tunnel.

The report indicated that distressed home sales – such as short sales and bank owned (REO) sales – accounted for 29 percent of all sales in the U.S. in January: the highest level since April 2009, reported Calculated Risk.

Professor Shiller has turned pessimistic of late, in part because real estate sales haven’t continued to improve from last fall, even though prices have stabilized. Existing-home prices hit bottom in May 2009, according to Case-Shiller’s 10-city index and have been rising since.

Shiller attributes his current doubts to what he calls “trends in news media coverage,” which help to mold conventional wisdom. The news is not good, in other words, what with the constant reports of mortgage defaults and distressed sales that have made very little of a dent in inventories.

The peak in distressed sales actually occurred in January 2009 when distressed sales accounted for 32 percent of all sales transactions. After the peak in early 2009, the distressed sale share fell to 23 percent in July, before rising again in late 2009 and continuing into 2010.

And it is the accumulation of distressed sales—whether short sales or foreclosures—that is helping existing-home sales, but decimating new-home construction and sales. There is an almost bottomless inventory of existing homes—at least 5 million loans (and so homes) have 90 day delinquent mortgages, according to Fannie Mae, that might soon come on the market as well. So it is only when the distressed share of sales shows a continuous decline will we know that real estate is on the path to recovery.

Of the 25 largest markets, California had the largest share. Riverside, CA, had the largest percentage of distressed sales in January (62 percent), followed closely by Las Vegas (59 percent) and Sacramento (58 percent) (Figure 2). The top REO (banked owned) market was Detroit where the REO share was 48 percent, followed closely by Riverside (47 percent) and Las Vegas (45 percent). San Diego’s short sale share was 19 percent in January, making it the highest ranked short sale market, followed by Sacramento (18 percent) and Oakland (16 percent).

Better news was the improvement in pending home sales, which rose in advance of the April 30 deadline for the home buyer tax credit. California recently added a $10,000 tax credit good through September to help boost first-time home sales. Indeed, there already is evidence of notable improvement in some housing markets as the National Association of Realtors, which compiles the data, reported multiple offers in some markets. The Midwest was the strongest market in February, jumping 21.8 percent, with the South, the biggest region, and the Northeast showing solid month-to-month gains, while the West declined.

Harlan Green © 2010

Popular Economics Weekly

One thing was clear from last week’s Financial Crisis Inquiry Commission hearings. Though extremely sorry, the main players—such as former Fed Chairman Alan Greenspan, as well as Robert Rubin and Charles Prince of Citibank—wouldn’t take responsibility, or return their rich payouts for helping to cause the financial market crash in 2008 that almost precipitated a second Great Depression.

Why the difficulty in pinning down who was responsible? Firstly, it hasn’t yet seemed to occur to them, or anyone, that they committed a crime. That in looking out for their short term profits, without considering the longer term consequences, what they did was indefensible. “The buck stopped there,” said one New York Times cartoon, implying some kind of group think caused the collapse and loss of more than $11 trillion in wealth, in spite of repeated warnings from underlings that much of Citibank’s mortgages were junk. “We all bear responsibility” was Rubin’s paean to the commission, as if he didn’t consider himself one of those responsible, even though he was Chairman of Citibank’s executive committee.

Secondly, no one seemed to even understand the consequences. A string of unprecedented financial innovations created institutions that “don’t take into account the kind of communities we want to build”, said economist Robert Shiller in a recent New York Times Op-ed. Yet as leaders of their respective institutions it was certainly their job to foresee any downside consequences. There were certainly precedents, such as the creation of extreme asset bubbles in Japan. In fact, the Federal Reserve had worried about Japanese-style deflation in the early 2000s, the result of Japan’s own busted real estate and stock bubbles.

On the contrary, the biggest players only saw the upside. Greenspan in fact trumpeted the advantages of exotic (and unregulated) derivatives that spread the risk more widely, that he thought lessened the dangers of default. Yet Greenspan of all people should have foreseen the crash.

I remember well that he encouraged risky mortgages by recommending adjustable rate mortgages as preferable to fixed rates because their interest rates were lower, even though he admitted at hearings he only borrowed at fixed rates! A housing bubble was most unlikely, he said, because home owners couldn’t buy and sell their homes like stocks. Their transaction costs were higher, the housing market was less liquid—and moving costs were considerable.

This was when the Fed had been holding down short-term interest rates in 2003-4 almost as low as today in a bid to fight Japanese-style deflationary fears, and boost a recovery that hadn’t yet added one net job from the end of the 2001 recession. Because inflation was so low then—below 1 percent—the cost of money was in fact less than zero, which made it advantageous to mortgage with little or no down payment.

Why could some of the “smartest guys in the room” so miscall the worst downturn since the Great Depression? Greenspan for one, a disciple of Ayn Rand, believed that free markets embodied the highest moral order (his words). What made it moral? Greenspan, as Ayn Rand, et. al., believed that free market forces were the most efficient and impartial allocator of resources. So when crises did occur, they functioned as a market clearing device, and any attempt to mitigate their effects only prolonged the adjustment to new circumstances. Such crises embodied the forces of ‘creative destruction’ and shouldn’t be tampered with, in other words.

This is why many conservative economists who decried the stimulus spending said “let the banks fail”, so that bad debt can be wiped out. Creative destruction—the replacement of failing businesses with more vibrant ones—happened in nature, so why shouldn’t it be allowed to happen in the urban jungle?

The problem was that Greenspan’s ideology was outdated, and had become group think. The invisible hand of Adam Smith was no longer sufficient to control market forces that had become complex beyond understanding. Bubbles were caused by ignorance of fundamentals, including fundamental market forces that could go easily out of control when greater risk taking was encouraged, with no limits on borrowing.

Household incomes had been steadily shrinking in real (after inflation) terms since the 1970s, except for a short while in the 1990s, so the housing bubble and easy credit encouraged many households to spend borrowed money to keep up their standard of living, a standard that was now beyond their means.

There was too much room for greed, in a word, or as Alan Greenspan once famously said,

“It is not that humans have become any greedier than in generations past. It is that the avenues to express greed had grown so enormously.”

A sustainable economic system has to take more than individual self-interest into account. It must also include the interest of future generations, which means the Captains of Industry-and government-have to be held accountable for those generations as well.

Harlan Green © 2010

Popular Economics Weekly

The March unemployment rate held at 9.7 percent, and 162,000 payroll jobs were added to payrolls. We believe this marks a turning point. Employers were hiring in all areas, including 48,000 temps hired by the Census Bureau for the 2010 population count. Even 15,000 construction jobs were added, with winter not over in many regions.

Barron’s Gene Epstein in a recent column says that manufacturing is leading the recovery at this stage, with the ISM index jumping to a “cyclical high” of 59.6 percent. Such a reading would translate to a 5.4 percent increase in Q1 GDP, after a 5.6 jump in Q4 2009. If in fact two such quarters of growth should happen (we won’t know until end of April), it will be a more robust recovery, rather than the subpar one currently forecast.

The service sector is not far behind as the ISM’s non-manufacturing index, at 55.4, shows solid month-to-month acceleration in March for the third month of growth in a row. New orders lead the report with a really hot 62.3 reading for the sharpest month-to-month acceleration in five years. Export orders are especially strong, jumping more than 10 points to 57.5, offering further evidence that demand strength out of Asia is pulling the global economy forward. Backlog orders are also rising, at 55.5 for a 9-1/2 point gain in the month.

The true measure of strength for consumers is the wages and salaries component of personal incomes, as we said last week, which jumped 0.4 percent in the latest month after edging up 0.1 percent in December. Both personal income and the wages and salaries component are still sluggish on a year-ago basis with personal income up just 1.1 percent in January and the latter component down 1.1 percent. But real, after inflation, personal consumption expenditures have in fact been improving since January 2009

The jobs picture provides a clue to the ‘U’ shape of this recovery. In fact, we could see a return to normalcy by December 2010, versus the 47 months it took to reclaim the 5 million jobs lost in the 2001 recession.

Though it may sound repetitious, so much of what happens in 2010 will depend on the consumer. Consumer spending is warming up with chain store sales rising 4.7 percent annually, but spirits, a reflection of the jobs market, are chilled. Reuters/University of Michigan consumer sentiment index slipped back in the mid-March reading to 72.5 vs. February’s 73.6. Both current conditions and expectations are down with expectations showing particular weakness. Expectations are the leading component and are pointing to extended weakness ahead. Inflation expectations are subdued at 2.8 percent one-year out.

All of this really means that 2011 could be the year real estate, which is most dependent on a job recovery, recovers as well.  The key will be to work off the excess inventory of so-called ‘distressed’ homes—possibly 5 million, according to Fannie Mae.  But even that number of potential defaults and/or short sales could drop if as we believe hiring picks up substantially this year.

Harlan Green © 2010

Financial FAQs

Behavioral Economist Robert Shiller in a recent New York Times Op-ed said, “We need to invent financial institutions that take into account the kinds of communities we want to build. And we need to base this innovation on an approach to economics that captures the richness of human experience—and not efficient-market economics.”

Dr. Shiller is one of many economists decrying the lack of sustainable financial institutions that have led to so many recessions, including the current Great Recession—sustainable institutions that build communities rather than destroy them. Their lack has been mainly because they targeted the wrong economic goals—productivity over sustainability, or efficient markets (i.e. markets with minimal oversight) over markets that attempt to sustain longer-term economic growth.

We seem to have mastered the means of production, as economist John Maynard Keynes predicted in his 1930 treatise, “Economic Possibilities for our Grandchildren”, yet not how to put such growth on a sustainable path that benefits future generations rather than indebting them. As the originator of an economic theory that advocated government support during the Great Depression, Keynes believed that markets did not cure themselves without widespread suffering. The “animal spirits” of a populace that was discouraged by prolonged unemployment had to be boosted by governmental job creation measures in order to boost economic growth, if private sector employers weren’t hiring.

In other words, most modern economic theory has concentrated on producing the maximum amount of goods and services (hence emphasis on efficient markets), but ignoring their social welfare aspects. I.e., how sustainable is such a system that venerates individual effort (i.e., self-interest), but ignores its results? When whole communities are destroyed by a succession of bursting asset bubbles—it was first the dot-com bubble in 2000, then real estate bubble, and now the credit bubble bust that has almost destroyed our banking system—then it is time to begin looking for a more sustainable economic system that preserves assets for our grandchildren.

Economists, sociologists and psychologists in particular are beginning to look at systems that capture the “richness of human experience” advocated by Dr. Shiller. One pioneer is economist Hazel Henderson, who helped to found the Calvert family of eco-friendly mutual funds. She also created the Calvert-Henderson Quality of Life Indicators (at http://www.calvert-henderson.com) that helps to measure what makes up a better quality of life. For example, its education component highlights why U.S. elementary education has flagged—the U.S. is ninth in the list of eighth grade math and science scores, for instance—behind nos. 1 and 2 Singapore and Taiwan, and what should be done to remedy it.

The research of behavioral economists such as Dr. Shiller are also debunking the efficient markets’ economists who generally advocate privatization (and deregulation) of financial institutions in the belief that individuals are the best regulators of their own behavior. Behavioral economists find that most people either do not have the time or knowledge to make intelligent financial decisions without some regulation to govern errant behavior. Former Fed Chairman Alan Greenspan once famously said,

“It is not that humans have become any greedier than in generations past. It is that the avenues to express greed had grown so enormously.”

Though private enterprise is the foundation of capitalism, and its source of wealth, we now know it only enriches the few without adequate regulation and governmental oversight.

And so Lord Keynes concludes, “The strenuous purposeful money-makers may carry all of us along with them into the lap of economic abundance. But it will be those peoples, who can keep alive, and cultivate into a fuller perfection, the art of life itself and do not sell themselves for the means of life, who will be able to enjoy the abundance when it comes.”

Harlan Green © 2010

The Mortgage Corner

We may yet see a spring recovery in real estate. The S&P Case-Shiller Home Price Index shows continued gains for home prices in January, gains that may be accelerating given more recent data on new and existing homes, says Econoday.

Case-Shiller’s adjusted reading for its composite 10 index showed a solid 0.4 percent gain in the month, the second straight 0.4 percent gain. The 20 index shows a second straight 0.3 percent gain. Home prices tend to swing lower in the light demand months of the winter, a factor to keep in mind when looking at the unadjusted rates. Unadjusted data, which the news wires run prominently, show a third straight 0.2 percent monthly decline for the 10 index and a very deep 0.4 percent decline for the 20 index.

In fact, 8 of the 20 cities surveyed had higher prices over last year. Data through January 2010, released today by Standard & Poor’s for its S&P/Case-Shiller Home Price Indices show that the annual rates of decline of the 10-City and 20-City Composites improved in January compared to December 2009. The 10-City Composite is now unchanged versus where it was a year ago, and the 20-City Composite is down only 0.7 percent versus January 2009. Annual rates for the two Composites have not been this close to a positive print since January 2007, three years ago.

Any improvement in real estate prices may also help consumer confidence, which improved in March but not by much, at 52.5 vs. a severely depressed February reading of 46.4 (revised from 46.0), said the Conference Board. The 52.5 reading shows little change from the prior four-month average of 51.8. Jobs currently hard to get fell to 45.8, down 1.5 percentage points for the best reading since August and pointing to mild improvement for March’s employment report due on Friday of this week.

Says Lynn Franco, Director of The Conference Board Consumer Research Center: "Consumer confidence, which had declined sharply in February, managed to recoup most of the loss in March. However, despite this month’s increase, consumers continue to express concern about current business and labor market conditions. And, their outlook for the next six months is still rather pessimistic. Overall, consumer confidence levels have not changed significantly since last spring."

The looming expiration of the extended home buyers’ tax credit may also help sales. The New York Times reported seeing more sales activity in certain markets.

The number of Des Moines homes under contract in February rose by a third from the January level. The number of pending contracts jumped 10 percent in Naples, Fla., 14 percent in Houston and 21 percent in Portland, Ore.

“These deals will be reflected in the national sales reports when they become final, this month or next,” said the Times. “There is no evidence that prices have begun to move in response to the higher volume. Indeed, so many homes are coming on the market that prices might well fall further.”

We believe that improved incomes and yes, even jobs this year, may mean a more sustained real estate rally. In fact, Barron’s Magazine predicts a whopping 190,000 payrolls job increase on this Good Friday when the Labor Dept. issues its March unemployment report. Its total should be boosted by the 1 million workers just hired for the 2010 population census.

Harlan Green © 2010

The Mortgage Corner

The first 2 months of 2010 have been brutal for real estate. Construction, new and existing-home sales have fallen—in part because the new-home tax purchase credit lapsed in December, before being renewed until June 2010. This is on top of the “atypical” winter weather that has basically halted new-home construction. But some prices are firming, a good sign for a spring and summer recovery.

Housing starts have been volatile lately and this time the culprit was atypically severe winter weather. Snow storms bumped down housing starts in February, leading to a 5.9 percent drop, following a 6.6 percent rebound the month before. February’s annualized pace of 0.575 million was up 0.2 percent on a year-ago basis.

Highlighting the impact of the snow storms are starts by region.  The February drop in starts was led by a 15.5 percent plunge in the South which typically has relatively good weather for groundbreaking that time of year.  Also, starts in the Northeast fell 9.6 percent. Both regions were hit by heavy snow storms during the month. Starts in the Midwest rose 10.6 percent while the West gained 7.9 percent.

Sales of new single-family houses in February 2010 were at a seasonally adjusted annual rate of 308,000, according to estimates released jointly today. This is 2.2 percent below the revised January rate of 315,000 and is 13.0 percent below the February 2009 estimate of 354,000.

But January was revised 6,000 higher to 315,000 with December revised 3,000 lower to 345,000. Supply swelled to 9.2 months in line with a similar reading on the existing-home side. Sales fell most steeply in the two least active regions, the Northeast and Midwest, while showing a small decline in the South and a gain in the West. Interestingly, prices firmed in the month, up 6.1 percent to a median $220,500 and up 5.1 percent to an average $282,600.

Existing-home sales, which are finalized transactions that include single-family, townhomes, condominiums and co-ops, slipped 0.6 percent nationally to a seasonally adjusted annual rate of 5.02 million units in February from 5.05 million in January, but are 7.0 percent higher than the 4.69 million-unit pace in February 2009.

NAR chief economist Lawrence Yun also said widespread winter storms in February may mask underlying demand. “Some closings were simply postponed by winter storms, but buyers couldn’t get out to look at homes in some areas and that should negatively impact near-term contract activity.

“Although sales have been higher than year-ago levels for eight straight months and home prices are much more stable compared to the past few years, the housing recovery is fragile at the moment,” he said.

The national median price of existing-homes was $164,300, down 2.4 percent from one year ago, but condominium prices held steady at $170,200. The Northeast region had a whopping 7.5 percent median price increase for all homes over February 2009, but all other regions had median price drops.

The bottom line will be whether existing-home inventories begin to decline significantly during this selling season. Total housing inventory at the end of February rose 9.5 percent to 3.59 million existing homes available for sale, according to NAR, which represents an 8.6-month supply at the current sales pace, up from a 7.8-month supply in January. Raw unsold inventory is 5.5 percent below a year ago.

“The key test for a durable recovery comes in the next few months as the tax credit deadline approaches,” Yun said. “If we see a surge in home buying comparable to last fall in the months leading up to the original tax credit deadline, then enough inventory should be absorbed to ensure a broad home price stabilization.”

Harlan Green © 2010

Financial FAQs

Recent events have shown that financial markets are still very susceptible to crashes, and economies susceptible to serious recessions, such as the recent Great Recession. But does that have to be? The fault doesn’t only lie with the irrational exuberance of investors who believe that markets (and housing prices) only go up. Such financial gyrations also come from faulty economic thinking, thinking that hasn’t changed for more than 200 years.

Adam Smith, the founder of much of what is called classical economics, thought that an “invisible hand” (i.e., a free market) created maximum conditions for the production of goods and services—which suited the small market economies that existed in 1776, and provided a theoretical blueprint for the Industrial Revolution then sweeping Great Britain. His theories helped to solve the problems of mass production, but not how those goods should be distributed. And that is where the science of economics has fallen down.

In fact, most recessions result from overproduction, including the Great Depression. The current Great Recession resulted from an overproduction of housing, as the 2001 recession resulted from overexpansion of the dot-com sector. That is really the definition of an overheated economy. Some kind of inflationary asset bubble is created, which eventually causes prices to plunge (or crash), which leads to a downward spiral in production and jobs.

Only now are economists beginning to think about the consequences of mass production. They are beginning to look for a more sustainable model for economic growth, one that isn’t susceptible to such wide swings.

Economist John Maynard Keynes was the first modern economist to address this issue. He said in an essay entitled, “Economic Possibilities for our Grandchildren (1930)” that, “assuming no important wars and no important increase in population, the economic problem may be solved, or be at least within sight of solution, within a hundred years. This means that the economic problem is not—if we look into the future—the permanent problem of the human race.”

We are 20 years away from that date, and yet how close to achieving his utopian prediction, when “…the economic problem, the struggle for subsistence, always has been higherto the primary, most pressing problem of the human race…”?

There is not much research to date on sustainable markets, meaning markets that leave some wealth for our grandchildren, as Keynes wished. The current Great Recession is an excellent example. It left a mountain of debt, due to a massive deregulation of the financial markets and the consequent massive overleveraging of debt.

Even the sustainability of social security and Medicare are in doubt, as well as the credibility of the U.S. Treasury’s ability to repay some $10 trillion in federal debt. We are not the most indebted of developed countries, as this map shows. But the near-failure of our financial system has highlighted the dangers of over-indebtedness.

There are other forms of sustainability beside responsible budgets that provide sustainable social safety nets, of course. There are sustainable production methods that don’t deplete non-renewable resources, and sustainable environmental practices that don’t emit toxic pollutants.

The most sustainable economic theory would still embrace an emphasis on increasing average household incomes, which have actually decreased since 2000 for those under 65 years of age. But that can only happen with an emphasis on job creation, which current economic policies and theories do not foster. In fact, household incomes have fallen back to 1998 levels, so severe has been this recession.

The main problem with the various job creation theories is their total disagreement on methods that create what is called aggregate demand, the engine for any economic growth. That is the demand for goods and services that must grow for producers to have the incentive to produce more, and so create new jobs.

So-called neo-classical (mostly conservative) economists still believe in Say’s Law, for example, that says if more ‘things’ are produced, it will create demand, per se, which will in turn cause consumers and investors to want to buy/invest more. This is the faulty thinking that still underlies much of modern economics. It justified skewing tax breaks to producers and investors in 2001 while reducing government oversight, in the theory that with less restraints employers will automatically create new jobs.

But the main characteristic of a recession is that a surplus of things drives down prices, and so drives up unemployment, as we have said. This in turn reduces aggregate demand, which economists express as a formula:

where aggregate demand (Yd) is the sum of all personal consumption (C) + private investment (I) + government expenditures (G) + any net of exports over imports (X-M).

We know that during most recessions personal consumption, private investment, and exports tend to fall, so in order to create stable aggregate demand during such downturns government has to step up its spending. Only then will the economy be stimulated by putting enough money in the hands of consumers, who comprise 70 percent of economic activity.

This in turn means taking the focus off individual, self-interest, as a goal of economic development, and focusing on the economic self-sufficiency of families, communities and countries. By focusing on the welfare of the whole, economists can begin to focus on the welfare of future generations, as well as those of past and present generations.

Harlan Green © 2010

Popular Economics Weekly

The Labor Department’s employment report was much better than the headline, which showed 36,000 payroll jobs lost. This was mostly due to a drop in construction employment from the severe winter. But it also showed signs of an incipient spring thaw. Private service-producing jobs actually increased by 42,000, mainly in education and health care, and temporary help jobs continued to rise—up another 48,000.

Jobs are coming back, in other words, but unevenly. The unemployment rate seems to have topped out, and is at 9.7 percent for the second consecutive month.

The question is what are employers waiting for? Retail sales are showing a 2 percent growth rate month-to-month—and are up 4.7 percent in a year.  Consumers have increased overall spending, including for motor vehicles.

A big surprise was the rise in consumer debt, a sure sign of increased consumer purchases. Consumer credit broke a record cycle of decline in January, rising $5.0 billion and led by a $6.6 billion rise in non-revolving credit (car loans, mobile homes, education, boats, trailers, vacations). But revolving credit (credit cards) still declined, down $1.7 billion but much less than December’s $9.4 billion plunge. Today’s news is good but consumer reluctance and/or inability to borrow on their credit cards is still a sign of economic distress.

Housing is in the January blahs, with pending, new, and existing-home sales down due to seasonal factors. Sales are bound to improve with the spring sales season, however. Prices should also improve after a year-end slowdown. The Case-Shiller 20-City Home Price Index is actually increasing when seasonally adjusted.

The seasonally adjusted 20-city composite rose 0.3 percent in January, equaling the rise the month before.  This version of Case-Shiller has increased in six of the last seven months (September 2009 was flat).  But recent numbers are much softer than those seen during last summer when even seasonally adjusted prices were rising in the 1 percent vicinity. This is per Econoday.

Much of what happens in 2010 will depend on the consumer. Indeed, the consumer’s mood is still downbeat, reflecting a jobs market that is not improving and income growth that is stagnant.  The Conference Board’s consumer confidence index fell back sharply in February, dropping nearly 10 points to 46.0.  This is the lowest level since the 40.8 reading for April 2009 but is still above the recession low of 25.3 seen in February 2009. Expectations, the index’s leading component, fell more than 13 points last month to 63.8 reflecting a sweeping sentiment downturn in income, employment, and business conditions.  

The view for current conditions is even worse as this index dipped nearly 6 points to an abysmal 19.4 and the lowest reading since 17.5 set in February 1983. Weakness is clearly tied to pessimism over the jobs market. Only 6.2 percent of the survey sample describes job prospects as good. A miniscule 3.6 percent describes jobs as currently plentiful with 47.7 percent calling them as hard to get.

Yet consumer confidence is notoriously fickle. Barron’s Gene Epstein pointed out in a recent column that consumer confidence tanked during the earlier part of past recoveries. It fell 16 percent in the summer of 1992, for example, yet “We now know that in the third and fourth quarters of ‘92, real GDP growth accelerated to a healthy annual rate of 4.2 and 4.3 percent, respectively, accompanied by a steady rise in consumer spending and a steady fall in the unemployment rate..

So the February jobs report may actually be a sign of better things to come.

Harlan Green © 2010

Popular Economics Weekly

We are beginning to see a many-shaped recovery. That is, some sectors show a ‘V’ shaped recovery, such as manufacturing. Employment is becoming a ‘U’ shape, while real estate could very well take the longest to recover, and so look like a ‘W’. This means it will be uneven, for starters, so that some sector areas of the country will recover before others.

Let’s start with manufacturing, which is being powered by our less expensive exports thanks to the Dollar’s lower foreign exchange value.

It had a record plunge during the recession, which probably ended last fall. It is too early to tell, but 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).

In fact, manufacturers’ new orders, a leading indicator, is up eight of the last nine months. It increased $3.7 billion or 1.0 percent to $370.4 billion, reported the U.S. Census Bureau. This followed a 1.0 percent November increase.

An employment recovery is already taking a ‘U’ shape, with the jobless rate dropping to 9.7 percent in January.

The month-to-month percentage change in employment is more useful, especially when compared with past recessions. It is a very shallow ‘U’ shape, but could still recover sooner than the 2001 jobless recovery, which took 47 months to return to pre-recession levels.

The shape of a real estate recovery is more uncertain. That is because the vacancy rate of unoccupied homes is still rising, meaning a huge overhang of unsold housing inventory. And maybe 20 percent of all homeowners have no equity left or are ‘underwater’ in their properties, which could lead to more defaults. This has basically stopped new home construction. So though defaults have leveled off at present, they could increase again, driving down both sales and home prices further.

The latest Case-Shiller Home Price Index shows that prices in most metropolitan areas are still trending downward, but at a slower rate. Only Dallas, Denver, San Francisco, and San Diego prices have turned positive over the past year.

In fact, most of the economy has been expanding for at least 6 months, but net revenues have either been hoarded as reserves against future losses, or used to pay down debt. Consumers’ outstanding debt has been shrinking for an unprecedented 11 months. Only when consumer credit begins to expand again will consumer spending return to historical levels.

Harlan Green © 2010

Popular Economics Weekly

The Federal Reserve decided to raise their nominal discount rate by 0.25 percent—the rate they charge banks to borrow Fed money—to 0.75 percent last week. The reason is to get banks off the Fed’s dole. Banks had been borrowing from the Fed, because the money was so cheap. The Fed is now saying it is time for banks to look for funds in the private sector.

But it also signaled that this wasn’t the beginning of a sustained tightening. “"The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy."

This is a sign the Fed sees business activity increasing. We have already talked about the surge in manufacturing in what is looking like a ‘V’ shaped recovery.

Industrial production posted another strong gain for January-but this time the strength was real and not weather related. Industrial production in January advanced 0.9 percent, following a 0.7 percent jump in December. The January was marginally better than the market projection for a 0.8 percent gain.

The service sector is also on a sustained recovery. The headline composite rose 1.4 points to 50.1, a level indicating very little month-to-month change in overall activity for the bulk of the economy. New orders, the life blood of business, did show a month-to-month increase at 52.1, the slowest increase over the last four months. In a reflection of the prior gains in orders, the business activity component, which can roughly be described as a production reading, rose more than 4 points to 53.7.

Lastly, consumer spending has been expanding since April 2009. This was remarked upon by the Federal Reserve in its latest Beige Book report. “Ten Districts reported some increased activity or improvement in conditions, while the remaining two–Philadelphia and Richmond–reported mixed conditions. This was an improvement from the last Beige Book that reported eight Districts with increased activity or improving conditions and four Districts showing little change and/or mixed conditions.

And is why retail sales have been increasing since last fall.

The bottom line is that the Fed has decided to no longer subsidize the so-called ‘carry trade’, whereby banks were able to borrow monies at next to zero interest and lend or invest it at prevailing market returns. This is why profits of the largest banks have been surging. The release of minutes from the January FOMC hints at why the Fed has begun to tighten.

“Information received since the Federal Open Market Committee met in December suggests that economic activity has continued to strengthen and that the deterioration in the labor market is abating. Household spending is expanding at a moderate rate but remains constrained by a weak labor market, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software appears to be picking up, but investment in structures is still contracting and employers remain reluctant to add to payrolls.”

It remains to be seen how the markets will react to the first interest rate rise in more than 2 years.

Harlan Green © 2010