RAPAPORT... A variety of forces, some that have been on the horizon for months, others more recent, are converging in a way that is creating unease among normally sanguine economists, causing some to revise their forecasts downward, and intensifying the concerns of those already pessimistic.
Among these forces: a stagnant housing market that is seeing plummeting housing prices in key markets, a crisis in credit markets that are increasingly interlinked and therefore more vulnerable to downturns that might otherwise be contained, a seesawing stock market and an unexpected drop in jobs.
Despite a static housing market, high fuel prices and a dropping dollar, the U.S. economy had been holding fairly steady. It’s been in what Michael Niemira, chief economist and director of research for the International Council of Shopping Centers (ICSC), defines as a “growth recession” or, in other words, a minicycle downturn. The economy has been growing, although that growth has been subpar since the summer of 2006.
NEW VARIABLE
This summer, however, a new variable entered the mix: crises in credit markets. Leveraged borrowing by Chrysler and a variety of hedge funds went south. In the past six months, some hedge funds invested heavily in collateralized debt obligations (CDOs), whose losses exceeded expectations, exhausted equity and led to some failures, according to Douglas G. Duncan, chief economist and senior vice president at the Mortgage Bankers Association (MBA). Exacerbating this scenario was the fact that much of the housing boom was financed outside of the traditional banking environment, with higher-risk, variable-rate subprime mortgages offered to homebuyers who might not have qualified under traditional lending parameters. This new subprime mortgage sector linked a variety of financial institutions in a new way and created the opportunity for a chain reaction of foreclosures and financial losses.
The result: turmoil in interbank lending, increased risk premiums and a rising cost of credit, according to Duncan. That has coincided with a stagnant housing market, which has already chilled consumer spending that is usually spurred by home purchases, specifically in the furniture and home-building categories. If people aren’t buying or building new homes, they’re not buying construction materials or a new couch for the living room. The ICSC database shows that home furniture and furnishings chains accounted for the largest proportion — 22 percent — of store closing announcements during the first half of 2007.
The forces behind those store closures are building; a record number of homes started the foreclosure process in the second quarter, the MBA reported in early September. It was the third straight month in which new records for foreclosures were set.
Dean Baker, codirector of the Center for Economic Policy and Research (CEPR) in Washington, D.C., blames these defaults on falling housing prices. “People don’t default if they have equity in their homes,” says Baker, who has long been pessimistic about what a slowing housing market means for the economy. Those holding subprime mortgages are the most vulnerable; that’s why there’s a crisis in that market, he says, but the reason lies in the overall housing market and falling home values, not the subprime market itself.
“You have a number of cities now — and these are formerly hot markets — San Diego, Miami, Las Vegas, Tampa, where house prices are falling at double-digit rates,” Baker says. Falling home prices in many parts of huge state economies such as California and Florida inevitably affect the national economy.
JOB FALLOFFAt the same time, the nation is seeing a continuing falloff in jobs in manufacturing and construction, an unpleasant surprise for Wall Street, which had expected an increase of approximately 100,000 new jobs in August. The U.S. Department of Labor reported in September that 4,000 jobs were lost from July to August, a relatively modest number in the context of national employment until one considers that it was the first employment decline since 2003, when the country was climbing out of the 2001 recession. Hardest hit, according to the Labor Department, is manufacturing employment, which declined by 46,000 in August, bringing the total number of job losses in that segment to 215,000 over the past year. In construction, employment declined by 22,000 in August, bringing total job losses in that segment to 96,000 since the September 2006 peak. Baker believes that construction number is actually higher, because the government data does not include undocumented workers. He sees job losses affecting consumption as well.
In other bad news in its September report, the Labor Department adjusted June and July new job numbers downward to under 70,000 monthly as opposed to initial estimates of more than 100,000 monthly. In comparison, the average monthly job growth in 2005 and 2006 was slightly above 200,000.
Baker also considers the decline in employment significant when put in the context of recent economic history. During the recoveries of the 1980s and 1990s — 1983 to 1989 and 1993 to 1999 — there were just three months that saw a decrease in jobs, and in two of those months, the decrease was due to strikes.
“So there was a grand total of one month of job losses over that whole 12 years,” Baker says. The August numbers could be a fluke, but he believes that a decline in jobs signals a recession. The MBA has revised its own forecasts downward for the next four quarters, according to Duncan, mainly because of existing issues in credit markets that were exacerbated by the subprime mortgage component.
The roller-coaster stock market is not helping either. Its ups and downs breed more uncertainty. “Uncertainty is never good from the perception of the investor or the consumer,” Niemira says. “It rings some cautionary bell that could mean that they spend less and worry more.”
The mid-September move by the Federal Reserve to slash half a percentage point off a key interest rate, the first decrease in four years, immediately rallied the stock market. For consumers, the cut will mean lower rates on loans tied to the prime rate, which could spike consumer spending. But most economists saw the Fed’s move as an indication that it is now more worried about recession than inflation.
Article from the Rapaport Magazine - October 2007. To subscribe click here.