Monday, January 14, 2008

America: Recession?

Top Economist Says America Could Plunge Into Recession

By Suzy Jagger, New York, London Times | 31 December 2007

Losses arising from America’s housing recession could triple over the next few years and they represent the greatest threat to growth in the United States, one of the world’s leading economists has told The Times. Robert Shiller, Professor of Economics at Yale University, predicted that there was a very real possibility that the US would be plunged into a Japan-style slump, with house prices declining for years. Professor Shiller, co-founder of the respected S&P Case/Shiller house-price index, said: "American real estate values have already lost around $1 trillion [£503 billion]. That could easily increase threefold over the next few years. This is a much bigger issue than sub-prime. We are talking trillions of dollars’ worth of losses."

He said that US futures markets had priced in further declines in house prices in the short term, with contracts on the S&P Shiller index pointing to decreases of up to 14 per cent. "Over the next five years, the futures contracts are pointing to losses of around 35 per cent in some areas, such as Florida, California and Las Vegas. There is a good chance that this housing recession will go on for years," he said. Professor Shiller, author of Irrational Exuberance, a phrase also used by Alan Greenspan, the former Federal Reserve chairman, said: "This is a classic bubble scenario. A few years ago house prices got very high, pushed up because of investor expectations. Americans have fuelled the myth that prices would never fall, that values could only go up. People believed the story. Now there is a very real chance of a big recession."

He pointed out that signs at the beginning of 2007 that had indicated that some states were beginning to experience a recovery in house prices had proved to be false: "States such as Massachusetts had seen some increases at the beginning of the year. Denver also looked like it had a different path. Now all states are falling."

Until two years ago, each of America’s 50 states had experienced a prolonged housing boom, with properties in some— such as Florida, California, Arizona and Nevada— doubling in price, fuelled by cheap credit and lax lending practices to borrowers who ordinarily would not have been able to secure a mortgage. Two years ago, the northeastern states of America became the first to slide into a recession after 17 successive interest-rate rises between June 2004 and August 2006 hit the property market. Numbers from the S&P/Case Shiller index showed that house prices had declined in October at their fastest rate for more than six years, with homes in Miami losing 12 per cent of their value.

Recession Or Not,
Middle America Will Continue To Feel The Pinch In 2008

The decline in the housing market that led to the squeeze on lending is widely expected to carry over into the new year— and it is not the only pressure on the US economy

By Suzy Jagger, New York, London Times | (continued)

A small 1950s bungalow in Stockton, California, is up for sale for $169,950. Sitting off a quiet road dotted with American flags, the Funston Avenue home has two bedrooms, one bathroom and a covered porch.

It was built as part of President Truman’s Fair Deal, a federal promise to guarantee economic opportunity and housing for America’s servicemen returning from World War II. Sixty years on, however, the American Dream has turned into a nightmare. The bungalow’s value has fallen by $110,000 in two years and the family who live in it have fallen so far behind with their rising mortgage repayments that they have been foreclosed by the bank. This family’s story is a common one in the neighbourhood, which houses the bank workers and civil servants who zoom up Highway 205 to commute for two hours each day to and from the pricier city of San Francisco.

According to David Sousa, the real estate broker who is selling the house, the number of properties up for sale in the area has risen from around 1,800 two years ago to about 8,000 now. Most of those properties are in the process of being repossessed by mortgage lenders. Moreover, there is no sign that the residents of Stockton are past the worst. Their lot seems a far cry from the town’s sunny motto: "Stockton’s Great, Take a Look!"

Stockton is one of America’s foreclosure capitals— according to RealtyTrac, in November, one in 99 households had entered the foreclosure process, six times the national average. "One of the biggest challenges we face is that the number of foreclosures have left the market saturated with unsold property," Mr Sousa said. He estimated that prices were falling at "between half and 1 per cent a month" and said that that local mortgage lenders had been so overwhelmed by the number of repossessed homes on their books that they are trying to sell, that real estate brokers— estate agents to you and me— cannot get a decision from them for at least 30 days over whether they will accept an offer price.

So how bad can America’s housing market get? Robert Shiller, of Yale University, one of the world’s leading economists, thinks that the property market could continue to deteriorate "for years", with the estimated $1 trillion-worth of losses in the market, ballooning to "three times" more. Professor Shiller, who famously predicted the top of the dot-com boom, told The Times at the weekend that the likelihood of Americans having to endure a Japan-style recession with property values declining for years is a "realistic scenario. At the same time as this slowdown, the stock market is highly priced and we have high oil prices. There are a lot of negatives. We are facing a substantial possibility of a big recession," he said.

This month, the S&P Case/Shiller house price index showed that property values had fallen in October at their fastest rate for six years, with all 20 of the cities monitored showing a decline. In some states, such as Florida, California and Arizona, property prices have fallen by 40 per cent in the past two years. A world away from the Ivy League office of Professor Shiller, Max Spann, a property auctioneer in New Jersey, told the same story. The bulk of assets that went under Mr Spann’s hammer three years ago used to be agricultural land or government buildings in New York State, New Jersey and Pennsylvania. Now, most of his business is from builders trying to get rid of unsold new homes and banks desperate to remove repossessed homes from their books.

"The situation has really got worse," Mr Spann said. "We are getting calls from the banks. The last thing lenders want to do is take back real estate. All the time that property is on its books, it is accumulating tax demands and is potentially a declining asset. They are using auctions to get out of that position." Mr Spann’s business has doubled each year in revenues for the past three years, and he is expecting sales to triple in 2008. "I think the real estate market will continue to slide at this rate in 2008 and 2009. And that’s all provided that there isn’t a recession. If that happens, all bets are off," he said.

Yet the housing slowdown is not the only risk to America’s economy. One of the biggest threats is neatly expressed in marketing material welcoming visitors to Stockton, "California’s Sunrise Seaport— twinned with Foshan, Guangdong". The closeness between the American town and one of China’s fastest-growing cities underlines America’s growing dependence on an economy that is expected to apply the brakes in 2008.

Carl Weinberg, chief economist at High Frequency Economics, believes that China poses one of the greatest threats to the health of the US economy and could force America to slow next year. "The American and Chinese economies are now inextricably linked," he said. "The US imports a quarter of a trillion dollars-worth of goods a year from China. There is now a new leader on China’s state council and we are expecting them to impose harsh measures next year to slow their economy. They could well introduce fiscal measures with real teeth, like blocking exports of mobile phones, for example. A slowdown in China would have big repercussions for us. The risks could be awful."

Mr Weinberg is still sanguine about America’s prospects next year and insists that its economy is far from facing a catastrophe. "The odds of a recession are still slim," he said, explaining that while growth looks to have slowed sharply since the third quarter of 2007, from 4.9 per cent to about 1 per cent in the fourth quarter, the US Federal Reserve is likely to stave off a sharper slowdown by cutting rates by another 1 per cent to about 3.25 per cent next autumn. He forecasts that even though unemployment will rise next year, he is expecting the percentage of the workforce unable to find a job to rise from 5.0 per cent to about 5.3 per cent in 2008.

While the forecasts of some of Wall Street’s top number-crunchers suggest that America may avoid a nasty recession, it is unlikely to feel that way for many families across the United States. Americans, who for the past two years have spent more than they took home for the first time since 1933, are arguably at their most financially vulnerable for generations. The risk that Americans may be forced to tighten their belts, dampening consumer demand, is a real one, now that they are confronted with a decreasing value of their homes, rising fuel prices and uncomfortably high food costs. The milk price has doubled this year, to keep pace with the soaring cost of maintaining a dairy herd. Corn prices used to feed dairy cattle have doubled because of the rising demand for corn to ferment to make ethanol, the biofuel.

Amy Green, the proprietor of the Ivanna Cone Ice-cream Emporium in Lincoln, Nebraska, has raised her ice cream prices by 37 per cent in the past 18 months. "Everything has gone up. All the raw materials that I need to run my business have risen— the butterfat, the milk, the sugar and the fuel. I had to pass on the rising costs," she said. Ms Green, who at the height of summer makes 600 gallons of ice cream a week, said that the fuel price was so prohibitive that her suppliers would not deliver her goods for an order of less than $500: "We’re a small firm. I have to be really creative at finding ways to get my orders up to $500. I’m only ordering small items like spoons and ice cream cones."

One of her neighbours, Mike Biggs, a third-generation cattle farmer just west of Lincoln, told The Times that business had been very difficult this year. Mr Biggs, who feeds up his 10,000 cows from about 500lb to as much as 1,400lb, explained that the volatility in corn prices and the rising fuel price meant that it had become very challenging to manage the farm’s costs. "The increase in the corn price was not anticipated. The rises meant that a lot of us got caught in the middle," he said. Rising food and fuel costs, increasing health insurance and declining property values have made economists jumpy about whether America’s consumers will continue to drive the economy.

The plight of the swath of struggling Americans has not gone unnoticed.

According to research compiled over the past three years by Harvard University, Middle America is experiencing the most severe financial hardship in more than five decades, and Edward Wolff, Professor of Economics at New York University, predicts that the squeeze on the middle classes will get tighter as banks are expected to tighten their lending criteria in the wake of this summer’s credit crisis.

Professor Wolff said: "These families are just not going to be able to take out additional debt. Credit-card companies and auto-loan groups are just going to start saying no." He said that Americans had not been profligate in their spending— "they’re not expanding consumption, they are just trying to tread water". He said that median household income has nose-dived by 7 per cent between 2000 and 2004, and increased only 6 per cent between 1983 and 2004.

Americans are being delivered a grim New Year warning, Professor Shiller said: "People aren’t scared yet— but once all this unwinds, they will be."

Perils for US: Key risks to America's economy in 2008

  • Rising energy prices

  • Falling housing prices/Increasing defaults

  • Middle East unrest

  • Rising food prices/Rising inflation

  • Rising unemployment

  • Worsening financial markets/Higher credit barriers

  • Slowdown in China/Worldwide slowdown

Source: Carl Weinberg, High Frequency Economics

Wall Street Braces Itself For More Sub-Prime Misery

By Tom Bawden, New York, London Times | (continued)

New year celebrations may not always usher in a better year. As Wall Street reflects on the misery of the past six months— the credit crisis, sub-prime losses, executive sackings and share-price slides— many say that the worst is yet to come. As Goldman Sachs pointed out last week, Citigroup still has an estimated $25 billion (£12.5 billion) of collateralised debt obligations (CDOs) on its books, the bundled packages of sub-prime loans that are now perceived as so risky they are effectively worthless.

Merrill Lynch, which is expected to admit to writedowns of almost $12 billion in the fourth quarter alone, has about $8 billion of CDOs in its portfolio. According to Goldman estimates, JPMorgan is exposed to around $5 billion of the securities. Even though American banks have collectively written off at least $60 billion in combined sub-prime-related securities, James Owers, Professor of Finance at Georgia State University, says that "the worst credit crunch in modern history still has some way to go yet . . . The repercussions will eventually be more widespread than the savings and loan crisis." (This occurred in the 1980s and led to the closure of 1,000 American building societies, with the loss of $150 billion.

Goldman Sachs said that "it will be a couple of quarters before the current credit crisis will be fully digested by the markets" [[or years?: normxxx]]. The bank also thinks that its rivals are unlikely to be able even to hope that they can offset the misery of their sub-prime investments with revenues from investment banking and M&A, both of which GS expects to stagnate in 2008.

Yet while few Americans are likely to feel sympathy with Wall Street bankers, they may worry that banks’ reluctance to take on more risk and extend credit lines to American businesses could push the country into recession. Moody’s Investors Service pointed out to clients last week: "The continued uncertainty of what land-mines remain on bank balance sheets has the potential to spill over into restricted lending to industrial firms." The fallout from the sub-prime mortgage meltdown has already hit other lending. Private equity firms have been hit particularly hard because, typically, they finance about two thirds of each leveraged buyout with debt in high-risk deals that, in this climate, are causing the banks to balk.

The impact on private equity deals has been enormous. Some deals that were agreed before the credit crunch took hold, such as the takeover of Home Depot’s building supplies unit by a consortium including Carlyle, saw their prices cut dramatically— in that case, by $2 billion. Other deals collapsed as the private equity firms were wholly unable to secure financing or were not prepared to complete the transaction [[i.e., they panicked: normxxx]]. In October, Kohlberg Kravis Roberts and Goldman Sachs walked away from their $8 billion takeover of Harman International, the audio speaker maker. JC Flowers’s bid to buy Sallie Mae, the student lender, for $26 billion, fell through.

Risk on Wall Street

  • Citigroup Tipped to cut dividend by 40 per cent and to write off $18.7bn in Q4. Expected to raise up to $10bn of new capital. Sitting in $25bn of CDO investments

  • Merrill Lynch Expected to write off $11.5bn in Q4; still exposed to $8bn in CDOs

  • JPMorgan Expected to write off $3.4bn in Q4; still exposed to $5bn of CDOs

  • Source: Goldman Sachs Note December 26 2007

Recession: Mild Or Severe?

By CalculatedRisk | 7 January 2008

Professor Nouriel Roubini suggests the debate has shifted from whether there will be a recession following the housing bust, to the severity of the recession. Roubini argues the recession will be severe:

“As argued here before, at this point the debate is not about soft land or hard landing; rather it is about how hard the hard landing will be. … This author’s assessment is … of a … severe and painful recession— lasting at least four quarters...

Others think it is still possible for the economy to avoid recession, but even then it will probably feel like one. As Goldman Sachs noted last week:

“the economy [may] skirt a technical recession, but in many respects this distinction may feel like an academic one.”

This raises the question: What is the difference between a mild and a severe recession? Looking back at the last ten recessions, perhaps we can define a severe recession as lasting a year or more, with unemployment rising above 8%, and real GDP falling 2.5% or more from peak to trough.

By that definition, the U.S. has had two severe recessions in the last 60 years:

1) Nov-73 to Mar-75: Duration: 16 months Peak unemployment: 9.0% Real GDP declined 3.1%

2) Jul-81 to Nov-82: Duration: 16 months Peak unemployment: 10.8% Real GDP declined 2.9%

We could use other measures for employment, such as the change in the unemployment rate (from expansion trough to recession peak) or the year-over-year change in total employment.

Click Here, or on the image, to see a larger, undistorted image.

This graph shows the unemployment rate and the year-over-year change in employment vs. recessions for the last 60 years.

Back in the '40s and '50s, it was common for the YoY total employment to decline by significantly more than 2%. This was because of the large swings in manufacturing employment. Now a YoY decline of 2% would be severe.

Also the recession with the highest unemployment rates started from pretty high levels ('70s and early '80s). So maybe the change in unemployment, from expansion trough to contraction peak, would be a better measure to gauge the severity of a recession than the absolute unemployment rate.

Click Here, or on the image, to see a larger, undistorted image.

The second graph shows manufacturing and construction employment as a percent of total employment. The smaller percentage of manufacturing employment— compared to the '40 and '50s— is one of the reasons the economy hasn't experienced the large swings in employment characteristic of recession in those earlier periods.

Construction employment could fall back to 4.5% of total employment, with the loss of over 1 million construction jobs, but manufacturing probably won't see sharp layoffs as in earlier periods. Note that Bernard Markstein, director of forecasting at the National Association of Home Builders, recently suggested the loss of 1 million construction jobs was possible [[probable? and are we counting illegal immigrants?: normxxx]].

If we assume the loss of 1 million construction jobs, 0.5 million retail jobs, and another 0.5 million jobs elsewhere, the unemployment rate would only rise to 6.3% (probably less because the participation rate would fall). And under most definitions that probably isn't a severe recession.

Perhaps other areas of the economy will shed more jobs and Roubini will be proved correct, but my expectation right now is for a recession, but not severe (the unemployment rate will stay below 8%). I also expect that the eventual recovery will be sluggish, especially for employment. For housing related industries, the depression will continue for some time.



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