It’s become fashionable in certain circles—primarily among administration types and Wall Street chief executives whose banks are losing gobs of money—to say that the worst is over for the subprime/housing/credit/economic crisis in the US. Whether they express their optimism in baseball terms (“in the eighth inning or maybe the top of the ninth”), as a percentage (“maybe 75-80% over”) or in the form of a timeline (“closer to the end than the beginning”), these faith-based predictions contain the audacity of hope.
I mean, where’s the evidence? Let’s start with public enemy No. 1: housing. For all the false claims of a bottom in the last two years, real residential fixed investment, as it’s called in the gross domestic product (GDP) accounts, keeps registering increasingly larger declines. In the first quarter, residential investment fell at a 26.7% annualized rate, the ninth consecutive quarterly decline and the biggest since 1981.
Home sales and prices continue to plummet. Until buyers step in to absorb the glut of homes on the market, compounded by foreclosed properties dumped on the market at a time when credit availability is constrained, it’s hard to see why home construction should pick up anytime soon.
The deterioration in the value of a household’s main asset has sapped consumer confidence and spending. Spending rose 1% in the first quarter, the smallest increase since the 2001 recession.
Relief, in the form of a tax rebate cheque, is on the way and in the mail, according to the US treasury. If consumers spend half the $117 billion (Rs4.7 trillion) expected to be distributed, mostly in May and June, it would add 0.5 percentage point to 1 percentage point to real GDP in the second and third quarters, according to Joe Carson, director of global economic research at AllianceBernstein.
That estimate assumes “all things equal,” which they never are. Whether consumers who are increasingly delinquent on interest payments on homes, autos and credit cards use their rebate cheque to buy some trifle or pay down debt is a question that will be debated for years. (Even after the statistics are in, conservative and liberal economists view them through their own respective filters and come up with different conclusions.) For what it’s worth, just three in 10 consumers surveyed by the University of Michigan in April said they planned to spend their rebate cheque. Most consumers favoured saving their refund “as a safeguard against worsening future conditions,” according to Richard Curtin, director of the Reuters/University of Michigan Surveys of Consumers.
The Michigan index that gauges consumer expectations plunged to a 17-year low of 53.3 last month, a level consistent with past recessionary periods.
Saved by exports
Without the consumer’s heavy lifting, final domestic demand fell in the first quarter of 2008, the first decline since 1991. The 0.6% increase in real GDP was a function of rising inventories (hardly voluntary) and exports. The Federal Reserve, which has been trying to stimulate demand at home, can’t do much to prod foreign consumers to spend, especially if the weak dollar cuts into their exports.
It is against this backdrop that Friday’s employment report for April was somehow seen as “bullish”. Non-farm payrolls fell 20,000 last month, less than both expectations and the average 80,000 monthly decline in the first quarter.
The difference is statistically insignificant. (Don’t ask me; ask the Bureau of Labor Statistics, which says a change of less than 100,000 is meaningless.) Private payrolls fell for the fifth consecutive month. While the magnitude wasn’t significant—a drop of 29,000—the message was.
“Since World War II, there has never been a five-month decline in private payrolls except during a recession and its immediate aftermath,” says Chris Low, chief economist at FTN Financial.
Financial markets are throwing their hat in with Wall Street CEOs. Stocks have rallied in the last month as bond prices fell, credit spreads narrowed and the lowly dollar found some sponsors. The Fed took out another quarter-point of insurance last week, lowering its benchmark rate to 2% and indicating a preference to pause after a seven-month, 325-basis-point rate-cutting spree.
Yet, the Fed clearly isn’t done with ministering to the financial system. Early on Friday, before the employment report, the Fed announced another step up in the size of its biweekly auction to banks and another step down in the collateral it will accept from bond dealers. AAA-rated asset-backed securities will join the list of AAA-rated mortgage-backed securities and collateralized loan, debt and mortgage obligations that have been added over the months to the existing basket of treasuries, agencies and agency mortgage-backed securities.
So what should we believe the talk or the actions? The spread between the London interbank offered rate and the expected funds rate has remained stubbornly high at about 78 basis points, suggesting an increased preference to hoard dollars rather than lend them. The Fed increased its swap lines with European central banks on Friday, hoping to alleviate the pressure in the interbank market overseas. The financial strains will eventually abate, but the effects from the credit channel will linger, taking their toll on the real economy.
“Phase Two of the crisis is coming from rising unemployment, rising commercial real estate vacancy rates and falling profits,” says Paul Kasriel, chief economist at Northern Trust Corp. in Chicago. “This will precipitate problems in credit card, auto loan, commercial real estate and high-yield corporate debt. We are in the eye of the hurricane right now.”
Even the eye isn’t looking so great. Bloomberg
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