Saturday, January 31, 2009

Residential housing: the drag drags on

I am sure that you have all heard about the Steep Slide in Economy as Unsold Goods Pile Up. I won’t bore you with my view of the report because others have already done a superb job of interpreting it. Here are several well-articulated takes on the various components of the Bureau of Economic Analysis’ massive GDP report:

But here are my two scents worth on the report: housing continues to be the bane of the U.S. economy's existence, even though new residential construction (housing starts) hit its lowest level...ever (at least since the series started in 1959)!

Residential construction's share of overall GDP is slipping quickly.

But it's drag on the economy is not.

This is truly amazing. Have you ever seen the DVD series Planet Earth? There are several shots of a predator (let's say a lion) attacking its prey (perhaps a Zebra); and even though the prey was likely to escape, the predator just wouldn't let go. Something like that.

Rebecca Wilder

Friday, January 30, 2009

At least for a little while, credit markets breathe a sigh of relief

Credit markets are improving. From Fortune:
An appetite for risk has returned to the fixed income market, where investors are beginning to spurn safe, low-yielding treasuries to buy corporate bonds instead. Corporations sold $70 billion worth of debt in the first half of January, according to Bloomberg data, hitting a pace not seen since May.
This is good news. The traders at my firm are giddy with anticipation of a fully functioning credit market (at least in nonfinancials). And certainly, the bond market is slightly less dour about the economy's ability to produce inflation.

The chart illustrates the bond market's expectations of inflation over the next ten years, which is measured as the difference between the 10-yr Treasury and the 10-yr Treasury Inflation-Protected Securities (TIPS). Currently, the market sees prices rising 0.9% for the next ten years. Sounds unbelievable to me, but compared to the low of 0.04% in November, this is certainly an improvement.

However, volatility (as measured by the CBO's VIX index) is still high, so it is entirely possible that the market turns a 180 next week for any number of reasons.

I suspect that eventually, markets will internalize the potential macroeconomic effects of the 6-month 20% annualized real money supply growth.

Credit markets are functioning again - at least in nonfinancials. But this feeling of reprieve could go away just as quickly as it came. The housing market is still flashing red; this is problematic. As of today, the Fed has purchased around $69 billion in MBS (haven't settled yet in the H.41 statement) since the program started on Jan. 5 - I wish that they would be slightly more active here.

Rebecca Wilder

Thursday, January 29, 2009

In 2008, adverse housing wealth effects killed consumption

This recession is especially rough because of the record retrenchment in consumer spending. High gas prices, the financial crisis, and a dismal housing market pushed consumers to the brink. The current cycle is set to be the worst consumer spending cycle since 1950.
The chart illustrates annual growth in quarterly GDP and private consumer spending (the C out of Y = C + I + G + NX) spanning the years 1947:2 to 2009:1 (forecast). The forecast in 2008:4 and 2009:1 is based on Wachovia's published forecast and consistent (if not slightly more benign than) with consensus expectations of the BEA's GDP release on Friday. Consumption is expected to reach -2.0% annual growth by 2009:1 (-1.5% in 2008:4), it's biggest decline since 1951:3.

Consumers have been shocked with high gas prices before and survived; annual consumption growth hit a low of -1.0% in the early 1980's. However, the quick evaporation of housing equity in the last year took households by surprise.

According to the S&P Case-Shiller composite-20 monthly house price index, national home values fell 16.4% in 2008 alone through November (just eleven months). That is 6.4% more than the decline from the housing price peak in July 2006 through the end of 2007 (10.4%).

The chart illustrates the regional loss in home values over the same two periods: eleven months of 2008 through November, and from the peak in activity through December 2007. Across most regions, home values fell sharply in 2008 (only through November) relative to the previous period declines.
  • Phoenix saw the biggest declines in 2008, -30%, and a relatively mild decline through 2007, -17%.
  • Las Vegas, Miami, San Francisco, San Diego, and Los Angeles saw a similarly devastating slash in home values in the eleven months of 2008.
  • Portland saw a sharp decline in the eleven months of 2008, -11%, compared to the previous 16 months, -2%.
  • Dallas, Denver, Cleveland, and Boston are the only cities to see smaller declines in 2008 relative to the previous period.
The qualitative evidence is incontrovertible: this cycle is marked by serious adverse real estate wealth effects. On average (as measured by the Case-Shiller composite 20 index), home values have been declining since July 2006 - over two years - but households saw their biggest declines in home equity in just eleven months of 2008. The associated pull-back by consumers will set records, as households retrench amid record housing equity losses.

Rebecca Wilder

Wednesday, January 28, 2009

My faves for the day (January 28, 2009)

Today I am in a feisty mood, so the sarcasm may be a little thick. Please read tomorrow in the AM if you are averse to such behavioral shifts.

Gotta love the unions! From HSH Blog, UAW Ends Unprecedented Benefits: "I’m sure there isn’t one person among us who would mind getting paid even when there’s no work to be done. Sounds like vacation right?"

And I just love, and I mean, love this post title from WSJ Marketbeat, Fed Does Not Lower Rates, Opts for Really Long Statement. It’s almost like Fed officials were sick and tired of writing those darned statements, so they went by the book on this one. Gotta hate the new lackadaisical Fed. And by the way, what is the WSJ’s intended meaning here?: “The Fed’s statement clocked in at 411 words, not including the paragraph that lets everyone know who voted for what; compare that with the August 5, 2008 statement, which was just 181 words, again not including the roll call.”

RW: CONFUSED! But wait, we are talking about the Fed, here.

Bing – I love this guy; blogs whatever the heck that he wants….and for Fortune, no less. Here’s his latest from How do they sleep?: “What kind of people make these decisions? And if somebody were to throw them out of a window, would their injuries be covered?”

I love it, the WSJ is totally feeling my pain today, from The Lone Dissenter: Lacker Wants to Buy Treasurys: Federal Reserve Bank of Richmond President Jeffrey Lacker, a proud dissenter in prior years, is back. He voted against today’s Fed decision, not for keeping rates steady but for only inching toward buying Treasury securities. The FOMC post-meeting statement said Mr. Lacker “preferred to expand the monetary base at this time by purchasing U.S. Treasury securities rather than through targeted credit programs.”

I really like this blog,, Dennis Kucinich’s Date With Karen Silkwood: “Instead of nationalizing banks, we should nationalize the money system by placing the Federal Reserve under the U.S. Treasury… I’ll soon be introducing legislation to accomplish this.”…And Boom2Bust, “Good luck… and watch your back.”

RW: I think that Jackson would have liked this idea!

In a feisty mood? Read Stefan Karlsson’s blog, Say What?: “OK, now let's see here, some economist by the name of Harm Bandholz have discovered that real M2 growth does not correlate with current economic activity, as measured by the index of coincident indicators. From that he concludes that it should not be included in the index of leading indicators. Huh? Since when is the index of leading indicators supposed to correlate with current activity?”

A travesty defined: Postal Service May End Saturday Delivery: “Massive deficits could force the post office to cut out one day of mail delivery per week, Postmaster General John E. Potter told Congress on Wednesday. "If current trends continue, we could experience a net loss of $6 billion or more this fiscal year," Potter said. If this happens, Netflix will indeed need to start turning around delivery on Saturdays.”

RW: Great. In the middle of a severe recession, and I am worried about Netflix. They better start to vamp up their operations. You know, returning on Friday is the same as Saturday, and that better not change or else I am canceling my account……….okay, maybe not. What is your current favorite show?

The deficit spending almost officially begins: from Calculated Risk, House Passes Stimulus Plan

And finally, my favorite moment of my faves for the day: Kerry Hawkins Photography!

I love this one. It looks like a cloud!

Rebecca Wilder

A new Fed record!

This is likely a FIRST for an FOMC statement (and I only say "likely" because I am not planning to sift through each and every meeting announcement since Volcker):
Voting against was Jeffrey M. Lacker, who preferred to expand the monetary base at this time by purchasing U.S. Treasury securities rather than through targeted credit programs.
Put it another way: Voting against was Jeffrey M. Lacker, who preferred to directly monetize the government debt, rather than expand the monetary base through targeted credit programs.

Rebecca Wilder

The Fed just can't get away from the itemized bailout

Here's a way to reduce the size of your balance sheet: write down assets. According Bloomberg, that is what the Fed plans to do under the "Homeownership Preservation Policy":
“The goal of this policy is to avoid preventable foreclosures on such assets through sustainable loan modifications and other actions that are consistent with the Federal Reserve’s obligation to maximize the net present value of the assets for the benefit of taxpayers,” according to the document.

The Fed’s “Homeownership Preservation Policy” lets the central bank or its agents “promptly” review applicable mortgages to determine whether the borrowers should be offered a loan modification, the document said. Qualified borrowers must be at least 60 days late on their payments.
And the itemized bailout continues. The Fed bails out AIG and Bear Stearns (and Citigroup), but leaves Lehman Brothers and Washington Mutual to fail. By extension, delinquent mortgage holders related to assets acquired through the bailout of AIG and Bear Stearns THAT ARE 60 DAYS LATE will be offered a loan modification.

I find it very hard to believe that (1) the Fed can get this program running smoothly in a timely fashion, and (2) the $74 billion of assets that may or may not be tied to 60-day delinquent mortgages will make a darn bit of difference.

The Fed should continue with its MBS purchase program, and leave loan modifications alone. The Fed acquired just $5.8 billion of MBS on its balance sheet since January 5, when the program got underway, or just 1% of the $500 billion allocated two months ago.

It occurs to me that the Fed may be going down the following path: it puts in half an effort into each program before dropping it for another "cooler and more effective" program. Fortunately, the money supply is still growing - the main reason that the Conference Board's leading indicator rose in December - but unfortunately, I am becoming increasingly skeptical of the Fed's ability to stay on its chosen path. And that is bad for credibility.

Rebecca Wilder

Tuesday, January 27, 2009

This is a recession; bankers shouldn't be forced to lend

My impression of the TARP re-capitalization program was that of an emergency government effort to keep banks from being forced to write down capital losses and risk insolvency. I don't remember reading it as a "forced lending program." This is a severe recession; it is an environment where big firms announce 71,400 new job cuts in one day, and not an environment for new loan origination. That would be completely irrational.

The chart illustrates total monthly bank lending growth since 1950. Bank lending comes to a standstill in recessions. In the last two months of 2008, bank lending fell $104 billion, or slowed to 5.6% growth over the year. That makes sense.

Yesterday, the Wall Street Journal made a splash, reporting that lending has declined for the top beneficiaries of TARP funding:
Lending at many of the nation's largest banks fell in recent months, even after they received $148 billion in taxpayer capital that was intended to help the economy by making loans more readily available.

Ten of the 13 big beneficiaries of the Treasury Department's Troubled Asset Relief Program, or TARP, saw their outstanding loan balances decline by a total of about $46 billion, or 1.4%, between the third and fourth quarters of 2008, according to a Wall Street Journal analysis of banks that recently announced their quarterly results.

Those 13 banks have collected the lion's sh
are of the roughly $200 billion the government has doled out since TARP was launched last October to stabilize financial institutions. Banks reporting declines in outstanding loans range from giants Bank of America Corp. and Citigroup Inc., each of which got $45 billion from the government; to smaller, regional institutions. Just three of the banks reported growth in their loan portfolios: U.S. Bancorp, SunTrust Banks Inc. and BB&T Corp.
TARP definitely has its problems, but it was developed to prevent a systemic crisis, and not to force lending. Were it not for TARP, more banks may have failed, and lending would be negligible, if not falling precipitously.

The government should allow the bankers to make rational lending decisions, and right now focus its efforts on keeping the banking system afloat. And later, in the resolution phase of the banking crisis, the government should focus on the actual availability of credit and regulation (the flow of lending). If the resolution phase of the crisis occurs sooner rather than later, the economy will start to mend, and bankers will eventually lend again...without the forcible hand of Congress.

A necessary condition for an economic recovery is not a fully functioning credit system, but rather the other way around. In order for the credit system to heal, it must be on firm economic ground.

More on credit: new-loan origination has likely stalled, but consumers continue to draw on revolving lines of credit.

I thought that credit-card balances would start to fall with revolving credit, but no. Credit card lending has hit new highs: Q4 2008 lending averaged an annual growth rate of 12.%, which is 5% greater than the 2000-2008 average growth rate (7.6%). This can only mean that consumers are charging an increasing share of their weekly expenses onto a credit card.

This could make sense with the massive job loss over the last year, but that is not always the case (at least since the first data point in 2000). During the period of "jobless recovery", the almost two years of rising unemployment after the 2001 recession ended, there was a reduction in consumer revolving credit growth; it hit a low of -4.9% in April 2003. Amid weak labor market conditions in the early 2000's, credit card balances fell.

Too many people have too many credit cards; this needs to change. Default rates will rise further, and credit-card lending will eventually decline. But until that happens, I expect this series to continue to grow, as the mass layoffs slash disposable income, and consumers draw on available resources in order to smooth consumption.

Rebecca Wilder

Monday, January 26, 2009

Rents dropping in major metro areas - not good for the macroeconomy

This was bound to happen, with foreclosures on the rise and rock-bottom home sales going to the lowest bidder. And that bidder is likely a property investor, who will rent out the property until market conditions improve to re-sell. Well, guess what: this is driving down rents across the country's top metro areas.

From Business Week:
The economic crisis has opened up opportunities for apartment tenants. The inventory of vacant apartments is expanding, and rents are dropping quickly in major metros across the country

For renters with leases about to expire, it's time to negotiate. Landlords are working extra hard these days to keep units filled.

Of course, your ability to hold on to an apartment—especially a luxury unit—depends on how secure you feel about your own job. Americans lost about 2.6 million jobs in 2008 (mostly in the final quarter of the year) and are likely to lose millions more this year. They are losing money on stocks and other investments and are cutting back on costs by downsizing and moving in with family members or roommates as they hunker down for a deep recession.

Landlords, as a result, are forced to offer discounts to fill vacancies. Apartment vacancies spiked in September after the collapse of Lehman Brothers and the eruption of the financial crisis.

Sounds great. Right? Wrong. This will likely put downward pressure on the CPI, since owners' equivalent rent of primary residence accounts for 24% of the construction of the CPI (see Table 1 in the BLS' news release). Not good for the deflation bears.

Furthermore, mortgage rates must fall to entice would-be buyers out of the renting market and into the housing market. Falling rents could be bad for the housing recovery. The feedback loop is tight in this recession.

Rebecca Wilder

More bad news in the labor market this morning

The ubiquitous theme: job cuts

Tata’s Corus to Cut 3,500 Jobs in U.K., Netherlands

Caterpillar to Cut 20,000 Jobs; 2009 Forecast Trails

Sprint Nextel Cutting 8,000 Jobs to Fight Off Slump

ING Cuts Jobs, Replaces Chief Executive, After Loss

Rebecca Wilder

Six weeks later and not a whole lot has changed

Time flies. Just six weeks ago, the Federal Open Market Committee (FOMC) met to discuss current policy initiatives. At that meeting, the FOMC explicitly (or as I thought) identified its policy intentions (at least the Board of Governors' intentions):
  • "the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets"
  • "stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant"
  • "evaluating the potential benefits of purchasing longer-term Treasury securities"
  • And from the minutes, "size of the Federal Reserve's balance sheet would need to be maintained at a high level".

And since that meeting, the Fed has followed through with the following:

  • $17.97 billion purchase of agency debt ($24.16 it currently holds minus $6.19 held on Dec. 17th)
  • $5.78 billion purchase of mortgage-backed securities (MBS)
  • Bernanke is still "considering" Treasury purchase program

The Fed has not done a whole heck of a lot since its last meeting: $17.97 billion in agency debt holdings and $5.78 billion in MBS asset purchase hardly qualifies as "large quantities". And furthermore, the mortgage and housing markets are still in need of "support". Mortgage rates are essentially where they were one year ago, and home values continue to decline.

It makes me wonder what exactly is the Fed's next move? The FOMC's usefulness is all but done - the federal funds target is almost at zero - and it's up to the Board of Governors to follow through on their policy announcements. There is likely more dissent in the ranks of the Fed than the minutes of the December FOMC meeting revealed.

Whatever glimmer of light that emerged just one month ago seems to have dimmed a bit: mortgage rates increased slightly, libor is climbing again, and of course, the banking system has taken a turn for the worse. Is nationalization in the cards?

At any rate, it seems that the Fed is on a holding pattern, which of course, has not been explained. Wednesday's announcement is unlikely to move markets, however, the meeting's minutes (released later) may provide more clues. It's like playing the game memory - trying to piece together the clues provided incrementally by the Fed in order to ascertain what exactly is the Board of Governors' next move.

Rebecca Wilder

Sunday, January 25, 2009

UK vs. US in graphs

The U.S. and U.K. economies are in hot (not boiling) water. Some call it the brink of a debt disaster:
"The United States and the United Kingdom stand on the brink of the largest debt crisis in history.

While both governments experiment with quantitative easing, bad banks to absorb non-performing loans, and state guarantees to res
tart bank lending, the only real way out is some combination of widespread corporate default, debt write-downs and inflation to reduce the burden of debt to more manageable levels. Everything else is window-dressing."
Although the feedback loop cannot be discounted, the real problem here is the tidal wave-sized recession that the financial crisis has brought upon the two economies. The U.K. posted a 1.5% contraction in the fourth quarter (about 6% negative growth, annualized) ,while the U.S. is expected to post an equally dismal 5.5% decline in economic activity.

Ex post, it is easy to identify the six errors that led to the financial crisis (hat tip, Mark Thoma). And here is Dr. Doom (a.k.a., Nouriel Roubini) saying that "the U.K. looks more like the U.S. (rather than Iceland): an economy of excesses, but where the solvent government has the fiscal resources over time to fix the system and bailout the financial institutions". One thing is for sure: the housing boom in the U.S. and in the U.K. ended with a bang, rather than a fizzle:

The housing boom was big in the U.K....

...And even bigger in the U.S. (as measured by the Case-Shiller index)

The charts list the price-rent ratios in the U.S. and the U.K., through the third quarter in the U.S. and December in the U.K. The price-rent ratio is indexed to 2004, and the CPI housing component is used to measure rent, and is used to determine whether home-ownership is overvalued or undervalued. It is obvious that both housing markets were (and still are) overvalued. The peak of the U.S. bubble - 1.2 - saw a 20% appreciation in home values relative to rents in just two years (2004-2006) - that is a nice bubble!

At this point, the outlook in for both economies is rather dismal. It probably won't start "feeling better" until the latter part of this year - and that is far from guaranteed.

Rebecca Wilder

Friday, January 23, 2009

Mortgage rates rise on inflation????

Today I was checking out mortgage rates with hopeful thinking that they would continue to fall, and at some point, some demand in the housing market would develop. I went to and saw that mortgage rates, along with Treasuries on the longer end of the yield curve, ebbed upward over the last week
The benchmark 30-year fixed-rate mortgage rose 31 basis points to 5.59 percent, according to the national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.30 discount and origination points. One year ago, the mortgage index was 5.57 percent; four weeks ago, it was 5.84 percent.
Overall, mortgage rates are essentially unchanged from a year ago. But then, in the same article, I read that bond investors are worried about inflation with the oncoming $825 billion stimulus package (expected to be on Obama's desk by Feb. 16th):
When bond investors foresee inflation, the result is higher bond yields. That carries into higher mortgage rates. Maybe it's not a coincidence that, in the last week, the biggest jump in bond yields happened on President Barack Obama's inauguration day. The new president and his advisers have said that it would be safer to err on the side of overspending, rather than not spending enough.
This is completely ridiculous. Bond investors are still worried about deflation - falling prices - and most certainly not about inflation. Look at the expected inflation rate in the Treasury Inflation Protection Securities (TIPS) market (Source data is from the Fed, here):

The chart lists the market inflation expectations through January 21, 2009, which sits at 0.58%. That is the difference between the nominal 10-yr Treasury bond and the inflation-adjusted (real return) 10-yr TIPS.

The market expects annual inflation will be just 0.58% for the next 10 consecutive years! That is quite remarkable, and to me, rather unthinkable. With the amount of reserve base that Bernanke's pumping out, I find it quite impossible that inflation would be less than 1% for even the next two years.

Rebecca Wilder

Two policy reports; two different stories

Today, the Bank of Japan (BoJ) released its Monthly Report of Recent Economic and Financial Developments. And on the other side of the globe, the Bank of Canada (BoC) released its quarterly Monetary Policy Report Update. The reports, read side by side, reveal that Japan's outlook is far worse than is Canada's.

Here is my take on the two reports:

The BoJ report is nothing short of dismal. Economic conditions have deteriorated “significantly,” where exports “decreased substantially”, corporate profits “continue to deteriorate”, investment “declined substantially”, and consumption has “weakened.” And for an economy that relies so heavily on exports, almost 19% of GDP (the U.S. export market is almost 14% of GDP), a currency that has reached its 14-year high on a trade-weighted basis is not good news.

The BoC states that Canada is in a recession amid a 1.3% growth rate in the third quarter; and furthermore, that exports are “down sharply”, and domestic demand is “shrinking”. However, the BoC was rather optimistic about global coordinated fiscal policy, citing the risk of its effectiveness in stimulating global growth as “roughly balanced”. Here is their global outlook:

Chart source: The Bank of Canada's Monetary Policy Report Update. The numbers in parentheses are the BoC's projections from the October 2008 Monetary Policy Report.

Overall, the BoC is rather optimistic, with global growth returning to 3.7% in 2010, as most countries move toward potential growth. Of course, this hinges on the success of "bold and concerted policy actions", especially on the part of the U.S.

Rebecca Wilder

Tuesday, January 20, 2009

No posts until this weekend

Unfortunately (no, really), I am too busy to write until this weekend. I have put off revisions on an article for entirely too long, and now it's down to the wire - must finish!

If I haven't replied to your email just yet, I will this weekend. Same for comments.

Thank you all for reading,


Forced consolidation in the home building industry

With home values falling over the last few years, new construction coming to a standstill, and inventories building with fierce pressure, consolidation in the home building industry is inevitable. Some say that up to 50% of the homebuilders in the industry will fail, if they haven't already.

The chart illustrates the Census Bureau's estimate of new construction put in place: residential, nonresidential, and public. The annual growth rate of residential construction spending has been negative since 2007, while nonresidential construction has likely hit a peak, but is still growing. Public construction is positive, and will likely improve with the new stimulus plan. However, the funds, as they are appropriated, will not filter into the economy for quite a while.

But it looks like the credit crunch is coming down hard on small-sized homebuilders in the SouthWest. From the IHT:
Dave Brown, one of the best-known home builders in Tempe, Arizona, had kept his head above water through the housing downturn, not missing a single interest payment on his loans. So he was confounded a few months back when one of his banks, spooked by the decline in his company's revenue, suddenly demanded millions of dollars in additional collateral to continue carrying loans on his projects.

He was unable to come up with the money, and in October, JPMorgan Chase foreclosed on five of his developments. Shortly thereafter, Brown Family Communities, 33 years in the business, decided to shut its doors....

...As defaults and delinquencies rise, home builders, once prized banking customers, have become pariahs. Even builders who are up to date on their interest payments or still managing to sell houses are getting trampled, as in the case of Brown.

"They're not distinguishing the track records of one borrower against another," said John Fioramonti, a real estate consultant in Tempe. "If you're a builder, you are a bad risk."
With the pullback accelerating, complaints among builders of hardball tactics and shoddy treatment by banks are mounting, as is a general sense of betrayal.

"The behavior of the banks is unprecedented," said Mick Pattinson, a home builder from Carlsbad, California, who has organized a national coalition of builders to draw attention to what they regard as unreasonable treatment. "Yes, there was overleveraging in the industry. But the aftermath doesn't need to have been as brutal as it has been."

Some experts defend the banks, saying they are starting to do what is necessary to come to grips with the turmoil in real estate. For months, they have been under pressure from U.S. bank regulators and their shareholders to curtail lending to a faltering industry.

"The lenders are not operating irrationally or unfairly, generally speaking," Fritts said. "They have to protect themselves."

Access to credit is essential to builders, who rely heavily on borrowed money to finance land acquisitions and home construction....(you can read more here).
Rebecca Wilder

Monday, January 19, 2009

GDP: getting the reported growth numbers straight

World economies are expected to post dismal fourth quarter 2008 economic growth rates. For those of you who are slightly confused across world growth reports, here is a primer on GDP growth: annual average growth rates, quarterly growth rates, quarterly growth rates on an annualized basis... If not, then you will want to skip this post.

Tough times ahead are expected for the European Union (EU) and t
he US

The EU Commission released its interim forecast for the European Union, which detailed some bad economic news. EU economic growth is expected to mark just a 1.0% growth rate in 2008 and -1.8% in 2009. Furthermore, its forecast for US GDP growth is expected to be 1.2% in 2008 and -1.6% for 2009. And that includes a 200 billion euro fiscal stimulus (1.5% of GDP), and a $775 billion plan in the US.

The Bureau of Economic Analysis will report its advanced estimate (first out of three releases) of fourth quarter 2008 US GDP growth on January 30. The EU's interim forecast shows the US economy contracting at a 1.2% rate over the quarter, which would be reported by the BEA as -4.7% annualized growth. This translates into a 1.2% growth rate for 2008 as a whole and -1.6% growth in 2009. (I believe that the fourth quarter economic will be slightly worse than -4.7%; but for the purpose of this analysis, let's use the EU's numbers.)

A 1.8% drop EU growth and 1.6% fall in US growth for the year 2009 is horrendous. The average EU annual growth rate from 1997-2001 was 2.9%, while since 2004, it has grown at least 2.0% every year (see page 44 for these and the US statistics). In the US, 1991 was the last time to post negative annual growth, which was just -0.2%. An annual growth rate of -1.8% is very ugly.
And here is where I know that it gets slightly confusing: the EU reports q4 2008 US growth as -1.2%, while the BEA would report it as -4.7% (again, it will probably be worse on Jan. 30). And furthermore, why is -1.8% so bad when the quarterly pattern is -4.7%?

A primer on reported GDP numbers:
  • The EU reports quarterly growth rates on a quarter over quarter basis (q/q), not annualized.
  • The US reports quarterly growth rates on a quarter over quarter and annualized basis (q/q, annualized).
  • Annual growth rates (ex: 2008 growth) represent the pattern of growth for each year on an yearly average basis, not a q4/q4 growth pattern.
  • The EU defines a recession as two consecutive quarters of negative economic growth; and therefore, it was officially in a recession immediately following the release of q3 2008 GDP, since q2 was also negative.
  • The US uses a more broad-based approach, as defined by the Business Cycle Dating Committee (BCDC) at the NBER. A recession was reported on December 1, even though the US contracted in the third quarter of 2008 only.
  • A contraction in economic activity is represented as a negative growth rate.
How the EU reports quarterly growth: on a q/q basis, which is simply the quarterly growth pattern for each quarter of reported GDP.

How the BEA reports quarterly growth : on a q/q, annualized basis
, which is the annual growth rate that would occur if each q/q rate was the same over four quarters.

A simple lesson on compounded annualized growth.
Assume that the same growth rate, g, occured for each quarter, starting from the initial point X0. Note that g*100 = g%.
  1. X1 = (1+g) X0 and X1/X0 = (1+g)
  2. X2 = (1+g) X1
  3. X3 = (1+g) X2
  4. X4 = (1+g) X3

Therefore, substituting 1. into 2., and 2. into 3., and 3. into 4., you get: X4 = (1+g)^4 * X0.

In this simple example, X4/X0 = (1+g)^4 = (1+ga), where ga is the annual growth rate, and (X4/X0-1)= ga. If we only know two consecutive periods, then solve for the annual growth rate, ga, to get the compounded annualized growth rate (CAR) for the whole year: (X1/X0)^4 - 1= ga = (1 + g)^4 - 1. This is what the BEA reports, the annualized growth rate, ga, or ga * 100 in percentages. It does this for ease of comparison across quarters.

Let's say that q4 growth occurs as the EU Commission forecasts, so q4/q3 = (1+g) = (1 - 0.012), then the annualized growth rate is (1-0.012)^4 -1 = -0.047, or -4.7%. Now you can understand the lunacy that CR describes in this post.

Annual US growth

Year over year growth is reported as the percentage change of each year's average over the 4 quarters of reported GDP. The BEA's reported 2008 real GDP will be the average of the following:

  1. q1 = $11646.0 real chained 2000 dollars
  2. q2 = $11727.4
  3. q3 = $11712.4
  4. q4 = $11571.85 (calculated using the EU's forecast of -4.7% quarterly annualized growth)

Average 2008 GDP = (q1+q2+q3+q4)/4 = $11664.4, and 2007 GDP = $11523.9. The 2008 growth rate = ($11664.4/$11523.9 - 1) * 100 = 1.2%.

US annual growth of -1.6% in 2009 is truly dismal

It is not uncommon for reported annualized quarterly economic activity to contract more than 1% - especially during a recession. But it is unusual for overall economic activity to fall by more than 1% on average over a year (see charts above). In fact, 2009 growth is likely to be the worst since 1982. And the way things are looking now, it may even be worse than that. Wachovia forecasts US economic activity to contract 2.3% in 2009.

Rebecca Wilder

Sunday, January 18, 2009

Housing market still on red alert, but there are signs of stabilization

The housing market - the epicenter of the credit crisis - has yet to stabilize: prices continue to decline; starts are at record lows, and are expected to fall further; and the inventory build in the existing home market remains at troublesome levels; and then there is the shadow-inventory that looms.

US policymakers are moving on with their bank bailout plan , which is now centered on the assets that derive value from the housing market. The pending question is: when will home values stabilize?

Since renting and owning a home are substitutes, economists often use the price (home values) to rent ratio to determine the relative value of home ownership. Generally, as the price-rent ratio rises above its trend value, then home ownership becomes more over-valued (the opposite is true for a lower than normal price-rent raio).

The chart illustrates the national price-rent ratio, which is calculated as the quarterly home price index (either OFHEO or S&P Case Shiller) divided by the Bureau of Labor Statistics' owner-occupied price index. Into the third quarter of 2008 (the latest data point), home values were still very much overvalued compared to renting, indicating that national prices still have some downward momentum to go.

But at the city level, some price stabilization is afoot.

The chart illustrates the third quarter 2008 deviation of price-rent ratios across all 54 metro areas in the U.S. (the data come from this Time article, where about 2/3 of the way down, you will see the link, click here) relative to their 15-year averages. There is a sense of over correction in key cities, where the price-rent ratios in Cleveland, Riverside-San Bernadino, and Detroit are 18.7%, 16.7%, and 15.3% below their long-run averages. These markets would be considered hot buys in normal economic times.

A correlation with foreclosures? Sure (source: Realtytrac).

The chart illustrates the 10 states with the highest new foreclosure filings for December 2008. reports that 2008 saw 2.3 million foreclosure filings, which is 81% higher than in 2007 and 225% than in 2006. Except Except for Indianapolis and Kansas City, each metro area that is overvalued is in either California and Ohio, or top foreclosure states.

Foreclosures are pushing prices down, and this sort of price discovery (finding an equilibrium where supply meets demand) is a necessary evil in market corrections; but some markets have over-corrected. The good news: states like California and Ohio may be seeing stabilization in their housing markets.

However, some states are set for further corrections. Cities in New York (New York-White Planes), Maryland (Baltimore), Virginia (Richmond), Florida (West Palm Beach, Jacksonville), and North Carolina (Charlotte), for example, have price-rent ratios that are still at least 24% above the long run averages.

Rebecca Wilder

Saturday, January 17, 2009

Credit Easing Policy - Now we know what to call the Fed's easing measures

The US is in a bit of a rut, that is for sure. And the banking crisis, which has currently resulted in just 27 failed banks since January 2008, is ongoing, while the economy is taking a serious turn for the worse. Pretty soon, a systemic crisis will emerge, with mass bank failure and a wipe out of depository institution capital. Or not.

The Fed is trying desperately to avoid this situation through reserve creation and various targeted lending programs. I am still interested as to why Fed officials have used so much air time differentiating current Fed policy from the Bank of Japan's (BoJ) quantitative easing policy (QEP) during Japan's lost decade. Finally, we know. When spoken in reference to the Fed's current balance sheet efforts, we must use the term credit easing.

From Bernanke's speech this week:
The Federal Reserve's approach to supporting credit markets is conceptually distinct from quantitative easing (QE), the policy approach used by the Bank of Japan from 2001 to 2006. Our approach--which could be described as "credit easing"--resembles quantitative easing in one respect: It involves an expansion of the central bank's balance sheet. However, in a pure QE regime, the focus of policy is the quantity of bank reserves, which are liabilities of the central bank; the composition of loans and securities on the asset side of the central bank's balance sheet is incidental. Indeed, although the Bank of Japan's policy approach during the QE period was quite multifaceted, the overall stance of its policy was gauged primarily in terms of its target for bank reserves. In contrast, the Federal Reserve's credit easing approach focuses on the mix of loans and securities that it holds and on how this composition of assets affects credit conditions for households and businesses. This difference does not reflect any doctrinal disagreement with the Japanese approach, but rather the differences in financial and economic conditions between the two episodes. In particular, credit spreads are much wider and credit markets more dysfunctional in the United States today than was the case during the Japanese experiment with quantitative easing. To stimulate aggregate demand in the current environment, the Federal Reserve must focus its policies on reducing those spreads and improving the functioning of private credit markets more generally.
Okay, so the Fed does not have an official target for bank reserves, but rather credit spreads. Therefore, it is engaging a credit easing policy (CEP), rather than a quantitative easing policy (QEP). But Fed officials have also claimed that a large difference between the Fed's and the BoJ's easing policies is the following: Japan’s quantitative easing program focused on the liability side, expanding cash in the system and excess reserves by a large amount. Janet Yellen also made this same claim. This is a difference that I just don't see in the data.

You have the BoJ's QEP...

...And then there's the Fed's CEP

But to me, the biggest difference is timing. The Bank of Japan announced its QEP over three years after the banking crisis had officially begun in November 1997. And the Fed officially announced its CEP - at least its intent to keep the balance sheet "elevated" - just over a year after the US banking crisis started August 2007.

And furthermore, the Fed has really jumped into its reserve creation with full force - 108% reserve growth in the month of its CEP announcement (December 2008). The Bank of Japan took their time, incrementally raising the reserve target over its several years of QEP. Japan's monetary base (reserves plus currency) grew by just 2/3 in the three years (66%) following the QEP announcement.

So whether or not the Fed is actively seeking a reserve target, which it's not, seems to me to be irrelevant. What I do find interesting is the fact that Yellen announced that the BoJ focused on currency reserve creation. That just doesn't show up in the data (see currency growth in the charts above).

To be sure, the area in which the Fed has had its greatest impact is in the commercial paper market. The Fed's $334.6 billion net-purchase of commercial paper has lowered spreads (Chart source: The Federal Reserve).

It is a relief to have a new term to describe the Fed's easing policy, credit easing. It has become quite clear the the Fed's primary objective is to lower spreads on debt in non-Treasury market's, and that CEP is - for now - working.

The Fed's measures, while drastic, are working. But I am still unclear as to what the Fed's exit strategy will be, and this is all that Bernanke has given us:
"We are monitoring the maturity composition of our balance sheet closely and do not expect a significant problem in reducing our balance sheet to the extent necessary at the appropriate time."
If the appropriate time is after evidence of inflation has emerged, well, then it will already be too late. For now, though, the Fed's biggest worry is this nasty recession that is underway; and its repercussions on the already-impaired credit markets.

Rebecca Wilder

Thursday, January 15, 2009

A World of economic reports in the last week

US import demand was strikingly weak: Global Trade Posts Sharp Decline

Canadian banks are tightening up as the economy worsens: Bank of Canada Survey Finds Worst Climate in a Decade

Eurozone consumers are feeling the pain of the fragile economy: European Confidence Dropped to Record Low in December

What a record in England: Bank of England Cuts Rate to Historic Low

"The Bank of England cuts its key rate by a half percentage point to 1.5%, the lowest level in the bank's 315-year history, marking the latest in global policy makers' efforts to fend off the threat of deep recession."

US Consumers are are pulling the purse strings: Dismal holidays over, but retail outlook still dim

And Japan's manufacturing sector is suffering: Japan's machinery orders plunge

The world's private sector is retrenching. This time, coordinated global policy is a must. And this time, trade is not going to save any one economy (see this WSJ article).

Rebecca Wilder

Wednesday, January 14, 2009

You should care about the surge in non-borrowed reserves

Nonborrowed reserves surged and nobody seems to care; perhaps its is because the reasoning is just so obvious. But I find the following rather interesting: previous to January 2008, the sharp decline in non-borrowed reserves signaled that a problem was brewing in the banking system; but now, the surge in non-borrowed reserves indicates the Fed is assuming an increasing amount of risk, partly on the behalf the U.S. household.

Non-borrowed reserves before January 2008

In December 2007, the Fed introduced the Term Auction Facility (TAF), and loans totaled $40 billion that month. Non-borrowed reserves plunged by the amount of TAF lending, and there was a roar in the media. Markets took this as a signal that banks were having a tough time making their reserve obligations; possible bank runs? Here was Felix Salmon’s take on it in “Why Non-Borrowed Reserves Don't Matter”.

The Fed calls the TAF loans “borrowed bank reserves” – total reserves = borrowed reserves + non-borrowed reserves – since the program is mostly a substitute for the discount window. Therefore the pluge was simply a technical issue, rather than an immediate problem in the banking system.

The sharp decline in non-borrowed reserves didn't matter: there were plenty of reserves (excess reserves, actually) in the system, and some called it a false alarm.

Non-borrowed reserves since October 2008

Starting in early October 2008, the Fed has beefed up its lending programs to include the following: Term Securities Lending Facility (TSLF), the asset backed commercial paper money market mutual fund liquidity program (ABCP MMMF), the commercial paper funding facility (CPFF), the money market investor funding facility (MMIFF), the term-asset backed securities loan facility (TALF), and international currency swap lines. Reserves stemming from lending under these facilities are called “non-borrowed” reserves.

Since October 22, non-borrowed reserves have surged $587 billion, while contemporaneously, borrowed reserve lending (TAF and discount window) has been slowing, if not falling. But now we should care!

The collateral accepted under the TAF program and at the discount window is sometimes less risky than the collateral being accepted under the new lending programs, especially that of the TALF or the TSLF. Therefore, the surge in non-borrowed reserves indicates that the Fed's portfolio is rising in risk, including various foreign currencies, commercial paper, mortgage-backed assets, and assets backed by student loans, auto loans, and credit cards.

In conclusion, the Fed’s measures are growing in risk. First, it is assuming some collateral that the open market has shunned. And second, the Fed’s exit strategy becomes increasingly hazy with rising non-borrowed reserves; the risk of inflation is on the move.

Rebecca Wilder

Tuesday, January 13, 2009

Banking crisis is still afoot: Fed balance sheet to rise

Admittedly, there are some signs of relief in credit markets. One of these signs, as noted in the Econbrowser article, is: that the Fed's balance sheet is falling. I don't think that this is a sign of thaw, rather just a technical consequence of the Treasury unwinding its supplemental financing with the Fed. Furthermore, there are several big-ticket items that have yet to be recorded on the Fed's balance sheet. It will rise again.

It is kind of hard to believe that the Fed would start to pull back in the wake of headlines like this:
Bonds Rally, but Banks Are Still Bruised
UBS needs to stem client withdrawals to turn corner
Royal Bank of Scotland May Face LyondellBasell Losses
WellPoint sees 4Q investment losses of $349M
Deutsche Bank Trading Losses Reveal Industry Setback
TIPS Irresistible to Gross as Protection Is ‘Cheap’
U.S. 10-Year Treasuries Little Changed Before Economic Reports

And Bernanke's speech today: The Crisis and the Policy Response

The Fed is just getting its various new programs underway, which have not appeared on the balance sheet yet; these programs will raise the Fed's balance sheet.

  • The Fed is already purchasing MBS in support of AIG (already recorded on the balance sheet), but it only just started purchasing MBS on the open market; its holdings of MBS (likely in the SOMA account) will be recorded on future balance sheet statements.
  • The Fed made changes to its Money Market Investor Funding Facility (MMIFF), which currently holds a balance of $0. If newly-eligible participants bite, then the balance sheet will rise.
  • The Fed has only just announced its Term Asset-Backed Securities Loan Facility (TALF), which will be initiated in February. This will raise the Fed's balance sheet.

Originally, the Treasury Supplemental Financing Account (TSP) was created to sterilize the Fed's massive liquidity flows into the banking system. And now that the Fed has no intention of sterilizing its flows, and with the Treasury liquidating its account, the funds are returning to the banking system as reserves. Therefore, the Fed has not increased its lending programs in recent weeks.

The Fed balance sheet has been rather stable since the week ending November 19 2008, when the Treasury started liquidating the TSP account. Spanning November 19, 2008 to January 7, 2009, the balance sheet has been reduced by just $1.3 billion; the TSP account decreased by $249.7 billion; and total reserves increased by $199.4 billion (through the week ending December 31). It doesn't look like the Fed is pulling back its liquidity programs. It's on a holding pattern both until the new programs get underway, and while the Treasury calls back its funding.

It seems to me that a better proxy of a healing banking system would be a reduction in the massive amounts of excess reserve holdings. Admittedly, the rate of increase is showing signs of decline; but the level of excess reserves stood at $799 billion, or roughly $794 billion greater than the level just four months ago. That sounds like a still very stressed commercial banking system.

Rebecca Wilder

Monday, January 12, 2009

Can the U.S. afford a banking crisis and a recession?

Massive government spending is afoot. Banking crises are usually very expensive, and for the major post-War episodes worldwide, average real government debt soared by 86%. Interestingly, the rise in debt is usually the result of a precipitous decline in tax revenues – driven by a severe recession, or a 9% average loss in output – rather than costs to stem the banking crisis. Accordingly, the government response to this banking crisis is different: the government is spending on two bears: (1) a recession, and (2) a fire in the financial system.

Fiscal deficits occur during recessions: tax revenues decline and spending rises

The chart illustrates government spending and tax receipts as a percentage of nominal GDP spanning the years 1947 Q1 to 2008 Q3. Generally, spending rises and receipts fall during recessions; the downward momentum in economic activity causes incomes and profits to fall, thereby reducing tax receipts, while contemporaneously, public spending rises with increasing unemployment.

But this time, government debt is set to soar

The chart illustrates the U.S. debt held by the public (all federal debt held by individuals, corporations, state or local governments, foreign governments, and other entities outside the United States Government less Federal Financing Bank securities) as a percentage of GDP through 2008 Q3, and forecasted through 2009. With already announced (or in place) spending on the financial bailout and the oncoming stimulus package, public debt held in 2008 Q4 (using Q3 nominal GDP and current Q4 public debt) will be roughly 44%, and over the nexxt, it will surge to 58%. New debt in 2009 Q4 includes the Congressional Budget Office’s projected $1.2 trillion deficit in 2009 plus an $800 billion stimulus package.

So does this mean that U.S. government debt will rise by the average banking crisis' 86%, given that it has already allocated a significant amount of resources toward the banking crisis?
  • Loans to AIG, JP Morgan, Citigroup
  • $700 billion TARP
  • The Federal Reserve’s various lending programs has cut their Treasury holdings by $252 billion, putting the taxpayer on the hook if losses are made on the corresponding collateral.

This time, the new debt is different because the U.S. government is spending to stem the financial crisis AND to mitigate a recession (the stimulus package). Rogoff and Reinhart argue that new debt incurred during and following a banking crisis (a large one like this) is on average due to the recession alone (via reduced tax revenues). Since the government is allocating massive resources in an effort to stem the financial crisis, some could argue that the average banking crisis recession, 9% output loss and severe loss in tax revenues, may be averted. Therefore, the actual debt load will not surge 86%.

Can the government handle such a massive debt load?

Kenneth Rogoff says yes in this interview (hat tip, Mark Thoma):


Region: Well, let's talk about the U.S. debt and its long-term consequences, in the context of the current economic crisis. The Stabilization Act authorizes $700 billion, some of which will contribute to the growth of national debt. Economists such as NYU Professor Nouriel Roubini suggest $2 trillion …

Rogoff: I have, as well, suggested $1 trillion to $2 trillion.

Region: Yes, I think up to $2 trillion "to fix the system" are your words.

Rogoff: That is because the bailout process is just at the beginning. Look at history. Carmen and I have a paper coming out—it's another chapter from our book—looking at the aftermath of banking crises. We argue that it is highly misleading to look at reported ex post fiscal costs because these are subject to a great deal of accounting manipulation and typically do not reflect true economic costs. If, instead, one looks at things that are less manipulable, like the run-up in public debt, it's clear that the costs of a financial crisis are just staggering.

For example, even though this interview won't be published for a couple of months, I think it's safe to say there'll be a huge stimulus package, some of it surely dissipative. We'll probably bail out the mortgage holders before this is over, some large class of them. Auto companies, municipalities and so on.

Perhaps the costs will be less. But I doubt it.

Region: And the long-term growth consequences of that additional debt?

Rogoff: Fortunately, adding a trillion dollars in debt is quite manageable for the United States. Of course, it is not a fun way to spend money, bailing out the financial system. We'd rather spend it on health, education, infrastructure or the environment. (That is, if the expenditures are well crafted and packaged with policy changes and structural improvements.) The fact is that for all the railing against the Bush deficits, the United States grew decently until recently, so that our debt/GDP burden is still modest by European or Japanese standards.

The rising debt burden will have some effect on growth. But I'm more concerned about what happens to our financial sector at the end of this, what's left of it. I just don't know what's going to emerge after the political system works it over. I hope that we do not throw out the baby with the bathwater. If we rebuild a very statist and inefficient financial sector—as I fear we will—it's hard to imagine that growth won't suffer for years.

Yes, the financial sector needs to shrink. In fact, there's a nice 2007 paper by Thomas Philippon (at NYU) which actually forecast this happening. So some retrenchment is desirable. But I worry we are going to turn back the clock altogether too far. What are needed are (much) greater capital requirements and more transparency, not regulatory strangulation.

But as Greg Ip argues, this time Congress must pay down the debt when the U.S. attains potential growth again (the rest of the article is worth a read) in order to avoid a sovereign default situation:

So what's the moral of the story? The Obama administration should not focus on debt reduction now, which could actually undermine the prospects for a recovery in the real economy. With households and businesses trying to spend less and save more, the federal government must spend more and save less -- that is, borrow more -- in order to prevent a self-feeding downward spiral in economic activity. Once the recession is over, getting our debt burdens down will hinge on Obama's and Congress's willingness to confront the looming cost of Social Security and Medicare benefits for the aging U.S. population.

RW: I tend to think that Congress will pass the massive stimulus, and argue that the new debt will be paid down when the U.S. economy recovers completely; this time is different. But my understanding of Congress is that it can be quite shortsighted, and by the time the U.S. economy is back at potential growth, will probably not pay down the debt until forced to. Case study: the U.S. consumer! So unless there is a specific trigger to pay down debt built into Obama's bill (to my knowledge, the TARP bill doesn't contain such a trigger), I am both skeptical and slightly nervous.

Rebecca Wilder