The Friday Stroll Through the Archives

This Friday's look through the archives gives an example of what an economy looks like to observers at the time that it is about to slip into recession. It's extremely difficult to identify the start of a recession, and it usually takes many months after the recession's start to recognize it.

As examples, note that in last week's archive installment we read that Greenspan testified in July 1990 that he thought the chances of the US economy having a recession that year were low (though the US economy was actually sliding into recession that very month); or note that in December 2000, the average forecast for economic growth in the year 2000 was 5.1% and for 2001 was 3.1%, whereas in reality it was just over 2% in 2000 and the economy spent most of 2001 in recession.

So let's take a look at what a contemporaneous reading on the health of the economy looked like as the US economy was just about to move into recession in mid-1990 (the official NBER start data of that recession was July 1990). From US News & World Report, May 14, 1990:

Inflation, jobs and interest rates: Dangerous territory

The job of Federal Reserve chairman is often called the second most powerful in America, but there are times when it hardly seems worth the aggravation. This must be one of those times for Alan Greenspan. Inflationary pressure appears to be building just as the economic expansion, now nearly 8 years old, seems to be reinventing itself once again -- and the Fed is getting unsolicited advice from some quarters to cool things down by raising interest rates. But when the Fed's principal policy group meets next week, the outcome will almost surely be a decision to keep rates more or less at current levels.

Several factors are influencing the nation's money managers. Even though some indicators suggest a sudden new spurt in the expansion, by other measures the rate of economic growth is slowing down. Raising rates now would only increase the risk of recession and add to a federal deficit that already is widening because of a decline in revenues.

Perhaps more important, the financial markets are tightening credit without any help from the Fed. When interest rates rise abroad, as they have lately, rates must rise in U.S. financial markets as well if inflow of foreign capital -- crucial to the financing of the federal deficit -- is to be maintained; in effect, America has lost a fair measure of control over long-term interest rates, which have increased by more than a point from their December trough. The yield on the bellwether 30-year Treasury bond is up to around 9 percent from 7.9 percent. Before squeezing credit even more, the central bank wants time to assess the impact of the rate run-up. As Lyle Gramley, a former Reserve Board member who is now chief economist for the Mortgage Bankers Association of America, puts it, "Why should the Fed risk tightening when the market has already tightened?"

The Fed managers also do not believe that the inflation figures are quite as ominous as they seem. The consumer price index soared at an 8.5 percent annual rate in the first quarter, the swiftest quarterly rise in eight years and nearly double 1989's 4.8 percent rate. But central-bank experts blame much of the price surge on quirky weather patterns and other special factors. December's cold snap destroyed crops and depleted energy supplies, pushing up retail prices for food and fuel in January. The food-price spiral continued into February and March. The early introduction of spring fashions also fanned inflation with expensive price tags, which should be discounted in time. As these transitory factors fade away -- energy prices have dropped already -- inflation should cool to within the Fed's forecast for the year, 4 percent to 4.5 percent.

Since the Fed's anti-inflation strategy is long-term, the central bank does not feel the need to respond to quarterly fluctuations. Rather, the goal is to whittle down inflation to around 2 percent by the mid-1990s. The Fed's preferred weapon involves slowly restricting growth in the checking and savings money supply, or M2, to the midpoint of its target range, 3 percent to 7 percent. After expanding by around 7 percent in the last half of 1989, M2 is growing by about 6 percent this year.

Economic growth, meanwhile, is anything but robust. That suits Greenspan: As he told the House Banking Committee recently, plans to bring inflation down will require a period of holding economic activity "at a rate below (the economy's) potential." Accordingly, the gross national product grew at an annual rate of 2.1 percent during the first three months of the year, below its capacity, and even that was misleading. Just as the weather (much colder than normal) negatively affected the fourth quarter of 1989, so did the weather (much warmer than normal) positively affect the first quarter of 1990.

In fact, underlying conditions indicate considerable weakness in the economy. The nation's overall unemployment rate, 5.4 percent in April, masks an economy that is creating fewer and fewer new jobs -- only 64,000 last month.

Other soft spots

There are other worries as well. January's heat wave sparked a surge in building that analysts say will subtract from this spring's activity. Much of a spurt in orders for manufactured goods this March stems from several big-ticket purchases, notably aircraft. Auto sales remain weak; dealers sold 9 percent fewer cars in April than they did a year earlier. And retail sales are flagging, with net declines for two successive months. In its most recent economic review, the Fed concludes that "activity continues to expand slowly."

Given that assessment, most Open Market Committee members believe that aggressively reining in the money supply would prove more trouble than tonic at the present time. The economy is showing too many fissures that could crack wide open in a downturn.

The real-estate and financial sectors are the most vulnerable. Commercial construction has turned down, and a recent report by the Federal Deposit Insurance Corporation shows that the slide in real-estate values, hitherto concentrated in the Southwest and Northeast, is spreading to other areas of the country. Higher interest rates and a sinking economy would only add to the serious problems that banks, savings and loans, developers and other investors already have in balancing their books.

Commercial banks stand to take the heaviest hit. Profits are taking a shellacking; they plunged by 87.5 percent in the third quarter of 1989 from their level a year earlier and by 59.1 percent in the last quarter, in large part because of soured real-estate loans. After suffering a $ 205 million loss in net income last year, Citicorp, the big New York City money-center bank, reported a stomach-churning 56 percent drop in first-quarter earnings. That prompted Standard & Poor's to mark down the company's credit rating on its senior debt. Tighter money also would make mopping up the S&L mess an even more expensive proposition than the $ 350 billion to $ 500 billion the General Accounting Office now estimates the taxpayers will spend.

A prolonged credit crunch could force many highly leveraged companies into bankruptcy. Interest payments claimed a record 29.8 percent of corporate cash flow last year, and profits, after falling by 10.8 percent in the final quarter of 1989, dropped by another 6 percent from January through March. Consumers, too, are showing the strain of carrying large IOU's: Delinquencies on mortgages spurted by a half point to 5 percent in the last half of 1989 and remain high. Late payments on installment debts also are up. With so many "fragilities in the system," says John LaWare, a Fed governor, "a recession could be more troublesome" now than in the past.

There are some similarities between the state of the US economy today and the economy in May 1990, but also some important differences. If you think that the similarities outweigh the differences, then you might be in the camp that argues that the US is on the brink of recession. Myself, I think that the signs of weakness in the US economy were more obvious in May 1990 than they are today, which suggests to me that we are more than just a month or two away from entering recession.

However... it might be worth checking back in six months to see if this story is starting to sound more familiar...

The Quality of Bank Lending to Businesses

I've written a fair bit in recent weeks about the US banking sector's exposure to losses stemming from bad mortgages. My conclusion: banks are in pretty good shape to handle a good number of mortgage defaults, but if the number of defaults rises significantly beyond current levels, or if the economy starts sliding toward recession in the next year or two, then the damage to the financial health of banks could be very serious.

A related but harder-to-answer question is to what degree banks' loans to businesses could also be susceptible to rising default rates. Calculated Risk took a look at this issue a week or two ago, specifically focusing on bank lending to businesses for real estate development, and today David Weidner of Marketwatch addresses the question of how safe business loans are more generally:

A mortgage crisis of their own
Commentary: Will companies go way of subprime borrowers?

NEW YORK (MarketWatch) -- The subprime credit crisis has been in swing for a few weeks now. As part of the cycle, we've all heard the stories about people drowning in debt. Maybe you know the fellow with the adjustable-rate mortgage who's slapped toward bankruptcy with every reset.

...Unfortunately, Joe America's not alone in experimenting with the dangerous combination of cheap money and supersized amounts. Corporate America may be next.

Much like the consumer-credit cycle, low-interest loans and easy-to-come-by debt fueled economic expansion and a mergers and acquisitions boom in the U.S. market during the last few years. Companies have increasingly been leveraging their balance sheets, putting them at risk of default in the next 12 to 18 months, according to the analysts at Standard & Poor's.

A corporate credit crunch isn't directly linked to the mortgage market, but in the credit cycle the markets tend to move in unison or with one lagging the other. A mortgage-market meltdown would also make it tougher on Main Street and rash of defaults could cause a chain reaction: making it tougher for private equity shops to borrow and buy, slowing mergers and IPOs and shutting down much of Wall Street.

To put a little meat (i.e. data) on these bones, I took a look at some of the statistics that the Fed collects on bank lending to businesses. Four times each year the Fed conducts a survey of bank lending in which they ask banks to categorize the new loans that they've made in terms of riskiness, and to report what fraction of their new loans were backed by collateral (among other things).

The following chart shows the pattern in these measures over the past decade. The light green line shows the percent of new bank loans that were classified as being of "minimal" or "low" riskiness (as opposed to loans that have "moderate", "acceptable", or higher levels of risk). The blue line shows the percent of the least risky loans that were backed up by collateral. The red line shows the percent of higher-risk loans (i.e. loans of "moderate" riskiness, which turns out to be the largest single category of new loans made by banks) that were backed up by collateral.


Note: series show 4-quarter moving averages. Source: Federal Reserve Board Survey of Terms of Business Lending.

By these measures, the quality of bank lending to businesses is not wholly reassuring. Of particular concern is the decrease since 2004 in the collateral that banks are securing for the lending that they do to their riskier clients. In fact, for both low- and high-quality loans, banks are at or near record-low rates of collateralization for the loans they are making.

Now, to some degree this may simply be a function of the types of loans that banks are making, and not an indication that they've been making riskier loans. Loans for businesses to develop real estate are easier for businesses to collateralize than loans for businesses to secure working capital, for example (because the business can promise the real estate itself as collateral). So perhaps banks have simply been making more of the latter type of loan in recent years.

But that explanation seems at odds with the fact that the series began declining over two years ago, when the real estate boom was still in full swing. It's also worth noting that in 2006 real estate development was still considerably above 1999-2000 levels - yet rates of collateralization on bank loans were significantly lower.

Furthermore, the fact that banks have been unable to categorize more of their business loans as being relatively low-risk, despite record corporate profits, suggests the possibility that banks have indeed been increasing the riskiness of the portfolio of loans that they hold, especially since 2004. By comparison, at this phase in the last business cycle (during the expansion of the 1990s) banks were able to classify roughly one-third of their loans as minimal or low-risk loans. For the past few years, on the other hand, the ratio has only been in the range of 20-25%.

Finally, this suggestive evidence that the quality of bank lending to businesses has gone down in recent years is consistent with economic theory. There are good theoretical reasons to think that banks make more risky loans when the economy is doing well. See for example this Richmond Fed paper by economist John Weinbert, "Cycles in Lending Standards?"

My conclusion is that banks' loan portfolios have indeed declined in quality during this business cycle, just as they have in all previous business cycles. So while banks seem to have strong reserves at first glance, they are also exposed to a lot of risk, both from the housing market downturn and from their business lending. Let's hope that any coming economic slowdown remains very mild, because if not, it's easy to see how banks could end up suffering a lot more than most people are now predicting.

Logic Freedom Day

Every year around this time I see news reports about the Tax Foundation's ridiculous "tax freedom day", and this year is no exception. From the Tax Foundation's absurd press release:

Tax Freedom Day® will fall on April 30 in 2007, according to the Tax Foundation's annual calculation using the latest government data on income and taxes.

...The report compares the number of days Americans work to pay taxes to the number of days they work to support themselves.

"Americans will work longer to pay for government (120 days) than they will for food, clothing and housing combined (105 days)," said Hodge. "Since 1986 taxes have cost more than these basic necessities. In fact, Americans will work longer to afford federal taxes alone (79 days) than they will to afford housing (62 days)."

There are just a couple of problems with this type of "report". The first problem is the deeply flawed underlying premise, and the second problem is the profound lack of logic embodied in the comparisons that they make.

The flawed premise: The notion that it makes any sense at all to compare the cost of something without thinking about what one gets in return.

The flawed logic: The categories included in the list above are all categories of goods and services that Americans receive for their spending - except for the one category of "taxes", which is a completely different type of category, since it doesn't represent what people receive for their spending but rather who they pay for it. Otherwise, why not include on a list of outrage the fact that Americans spend 13 days of their year just working to make money to send to Walmart? (Based on ~$9,600 bn in personal outlays in 2006, and ~$350 bn in Walmart sales.)

If you want to go through the stupid exercise of calculating how much of American's working time is spent to pay for government services, then please, at least be consistent. I suppose that I will never convince the Tax Foundation of this point, so let me direct this plea to reporters covering this "news": please do not report this nonsense without noting the profound lack of logic and consistency inherent in it.

As a helpful guide, here's a consistent list of how many days of the year (out of 365) go toward paying for each category, using the Tax Foundation's own numbers along with the breakdown of federal government spending by the CBO:

• housing and household operation: 62 days;
  
• health and medical care: 52 days;
  
• food: 30 days;
  
• transportation: 30 days;
  
• recreation: 22 days;
  
• clothing and accessories: 13 days;
  
• public education for all children through 12th grade, an excellent system of local roads and bridges, a high level of public safety services such as police and fire protection, and other state and local government services: 41 days;
  
• national defense against foreign military power, and the ability to militarily protect and project American interests abroad: 17 days;
  
• income security for all American senior citizens: 16 days;
  
• health care for senior citizens and the impoverished: 17 days;
  
• interest on the US government's debts: 7 days;
  
• a good system of public education, including heavily subsidized college education, an extensive and well-maintained national highway system, lots of pubicly funded basic science research, a safe and well-monitored national air transportation system, safe and regulated food and water, enforced protections for the environment, an extensive and well-functioning legal and judicial system, assistance for and support of veterans, an ambitious space program, and many other publicly provided services: 14 days.

Doesn't seem like such a bad deal to me when you put it that way.

No, government spending is not perfect. And you may not be happy with some of the specific things the government spends its money on (I know I'm certainly not), or how much it spends in general. But any attempt at intellectual honesty has to admit that Americans get a lot of services in exchange for the taxes they pay.


UPDATE: Mark Thoma points me to the Center for Budget Policy and Priorities, who note that the Tax Foundation's data is as flawed as their logic, and significantly misrepresents the true tax burden that average Americans face.

Bad GDP News

Is this good news? The headline of this Reuters coverage sure makes it seem that way:

GDP growth revised up

Gross domestic product, or GDP, which measures total goods and services output within U.S. borders, expanded at a 2.5 percent annual rate instead of 2.2 percent, the department said in its final revision of fourth-quarter economic performance. Economists had expected the final fourth-quarter reading of GDP growth to be unrevised at 2.2 percent.

The final figure was up from a 2 percent rate in the third quarter and meant the economy expanded by a solid 3.3 percent during the whole of 2006. It was the third straight year that GDP expanded at a rate over 3 percent, following growth of 3.2 percent in 2005 and 3.9 percent in 2004.

But when the numbers are parsed, things don't look so good. In fact, they're pretty bad.

The department said companies added to inventories at a $22.4-billion annual rate in the closing quarter of 2006 rather than the $17.3 billion rate it reported a month ago and said that was the main reason for the upward revision in fourth-quarter GDP. Higher inventories were mostly accounted for by larger stocks of motor vehicles. Larger inventories can reflect a backlog of unsold goods or businesses building stocks up in anticipation of better sales ahead.

...[T]he fourth-quarter GDP report showed that investment in new-home building plummeted by 19.8 percent - even steeper than the 19.1 percent fall estimated a month ago - and has declined for five straight quarters. The fourth-quarter drop was the sharpest since a 21.7 percent plunge in the first quarter of 1991 when the economy was on the brink of recession.

There was also a significant revision in spending on equipment and software, which dropped at a 4.8 percent annual rate during the fourth quarter - the largest decline since 4.9 percent in the fourth quarter of 2002 - instead of the 3.2 percent drop reported a month ago. That was a sharp turnaround from the third quarter when equipment and software spending grew at a 7.7 percent rate.

There's really no way to spin this as a good revision.

Bernanke Speaks

Ben Bernanke was on Capitol Hill today. Rex Nutting of Marketwatch reports:

Bernanke expects moderate growth, slower inflation

WASHINGTON (MarketWatch) -- Despite heightened risks from the contraction in housing and the slump in manufacturing, the U.S. economy will most likely achieve moderate growth this year with gradually slowing inflation, Federal Reserve Chairman Ben Bernanke said Wednesday.

"Overall, the economy appears likely to continue to expand at a moderate pace over coming quarters," he said. He doesn't see a recession coming this year.

In prepared testimony to the congressional Joint Economic Committee, Bernanke expanded on the Federal Open Market Committee's statement from last week's meeting, when the committee held interest rates steady.

Bernanke was as explicit as I think it's possible to be about how he views the economy, given that he doesn't know what's going to happen in coming weeks and months. On inflation:

In response to a question, Bernanke explicitly said the committee is still focused more on fighting inflation, even though "risks had increased on both sides." One big risk: "core inflation remains uncomfortably high." However, core inflation "seems likely to moderate gradually over time," he said.

And on the housing market, and slowing economic growth:

"Thus far, the weakness in housing and in some parts of manufacturing does not appear to have spilled over to any significant extent to other sectors of the economy," he said. The Fed chief identified several downside risks to his benign outlook, including the "substantial correction in housing," which could lead to severe financial problems for many individuals.

"The implications for these developments for the housing market as a whole are less clear," he said. "The impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained."

...A slowing in capital spending is another risk, heightened by the February durable-goods orders report, which showed further slowing in capital equipment orders. "Despite the recent weak readings, we expect business investment in equipment and software to grow at a moderate pace this year," he said.

Personally, I think Bernanke really does try to say what he thinks. The only reason that observers might feel differently is that Bernanke doesn't give the markets the information that they really care most about: namely, when will the Fed next raise or lower interest rates? And of course, the reason he doesn't give the markets the answer to that question is primarily because Bernanke himself doesn't know.

The Yield Curve, Bears, and Objectivity

Mark Hulbert of Marketwatch argues that bears are more vocal than bulls:

The not-inverted yield curve

ANNANDALE, Va. (MarketWatch) -- I would be a rich man if I had a dollar for every adviser who, over the past 15 months or so, argued that a recession was imminent because the yield curve had become inverted.

I'd be a very poor man if my wealth were dependent on getting a dollar for every one of those advisers who, since late last week, has even acknowledged that the yield curve has become positive again - much less conceded that, by the logic of their previous argument, a recession has become less likely.

It just goes to show how difficult it is to be truly objective in this business.

This column puzzles me. First of all, I have to disagree with the premise of this piece; when the yield differential is measured as the difference between the 10-year yield and the 3- or 6-month yield, which is much more common than the 2-year yield comparison that Hulbert uses, the yield curve is still firmly inverted. The following picture illustrates.



But on a more fundamental level, I'm puzzled by the implicit accusation of some sort of bias (or at least difficulty being "objective") by economic observers and commentators.

Let me be clear: I'm not puzzled by the possibility that they could be biased, but rather, I'm puzzled by the notion that economic commentators would be systematically bearish in their bias. Some economists are notoriously bearish, and others bullish. Is the right term for that a "lack of objectivity"?

To me, a bias implies some sort of hidden agenda that underlies one's overt actions or statements, leading to an uneven representation of the truth. But I'm not sure what a bearish or bullish economist's hidden agenda might be. (I'm not saying that it's impossible that there might be one - just that I can't think of what it is.)

So I think a bearish "world-view" might be a better description than a "lack of objectivity". After all, is one failing to be objective when one sees the glass as half-full? Call me puzzled.

Some Statistics On Health Care

Mark Thoma has been discussing health care a bit lately, including in yesterday’s post “Striking Health Care Fact?”, in which he responds to comments by Greg Mankiw and Tyler Cowan. Mark points out that the “striking fact” noted by Cowan (namely, that doctor salaries in the US are more than three times higher than salaries in France) accounts for just a tiny fraction of the difference in health care costs between the US and France, and that France actually has better health outcomes than the US.

I thought I’d take this chance to flesh out Mark’s assertion that France’s health care system keeps its people healthier than the American health care system – because, in fact, it’s not just France that does better than the US. It turns out that every industrialized country in the world does at least as well, if not better, than the US when it comes to health care outcomes for its people.

Here is a renewed look at some data that I wrote about a couple of years ago over at Angry Bear, directly comparing the performance of the US health care system with those of other industrialized countries.

First let’s take a look at the very young. How well does the US health care system take care of children and mothers? The following table gives a few indicators:


Notes: Infant and child mortality rates from OECD for 2003; maternal death rate from the WHO for the year 2000.

The US does worst, or tied for worst, in every measure. But what about the elderly? The following table gives details about the length and quality of life that senior citizens enjoy in various rich countries around the world.


Note: Data from year 2001. Source: WHO.

Not only is the US’s life expectancy at or near the bottom of the industrialized world, but Americans spend more of their shorter lives in poor health (as defined by the WHO).

The most striking thing about this data, however, is that Americans spend nearly twice as much as people in other developed countries spend on health care. Our closest competitor for health care costs is Switzerland, which still spends just 65% of what the US spends per capita. (Interestingly, Switzerland is also second to the US in terms of how much health care spending is paid for privately.) And yet all of these countries acheive health outcomes that are as good as or better than the US: longer lives, fewer dead babies and children, and more quality of life for their elderly. Compared dollar for dollar, there’s no contest. The productivity of the US health care system is terrible compared to other developed countries.


Notes: All data for the year 2004 except for Japan and Belgium, which are from 2003. Data from the OECD.

One last point: some have argued that the US’s poor showing on all of these measures is simply an artifact of demographic or other differences between the US and other developed nations, and is not a function of the US’s health care system. But it’s not obvious to me that such demographic differences systematically fall on the side of giving the US’s health care system more health problems to overcome. For example, the US has a higher rate of obesity; but it also has a lower prevalence of other risky behaviors such as smoking, driving without seatbelts, etc.. The US has more people living in poverty due to relatively high income inequality, but has higher overall and average levels of income than most countries.

At any rate, it turns out that this is exactly the type of question that econometric techniques were designed to answer. And the evidence seems to suggest that the US’s relatively poor health outcomes (especially when considered relative to the vast spending that the US does on its health care) are not the result of such demographic-type factors.

One example is given in a 2003 OECD Working Paper titled “The US Health System: An Assessment and Prospective Directions for Reform,” by Elizabeth Docteur, Hannes Suppanz and Jaejoon Woo. They test the influence that various demographic indicators (e.g. income per capita, fertility, education levels, and income distribution) have on infant mortality and life expectancy statistics in a panel of OECD countries. Then they use those results to estimate how much of the US’s poor results simply reflect these demographic characteristics, and how much are unexplained.

They find that such demographic factors do not explain any of the US's bad health statistics. On the other hand, the US's low level of publicly provided health care does explain about one-third of the US's low life expectancy. The conclusion is that there is something idiosyncratic about the US health care system (with some suggestive evidence that the system’s poor productivity is related to low public funding) that yields relatively poor outcomes despite its enormous costs.

In short: the average American receives mediocre-to-bad health care outcomes while paying twice as much as citizens of the rest of the developed world. And the $400 per person that high doctor salaries in the US contributes to the US’s high health care costs (as noted by Mark Thoma yesterday) does little to explain this massive discrepancy.

Housing Market News

This is a data series to keep an eye on:

U.S. Foreclosure Filings Rise 12 Percent in February

March 26 (Bloomberg) -- U.S. foreclosure filings last month jumped 12 percent compared with a year ago as owners struggled with declining home values and higher adjustable mortgage rates.

More than 130,000 homes entered foreclosure last month, according to a report from RealtyTrac, an online listing of foreclosed properties. That's the second-highest since RealtyTrac began collecting data in January 2005.

The worst housing slump in more than a decade is pushing down home prices and hampering the ability of owners to refinance mortgages. Borrowers with poor or incomplete credit are also vulnerable to mortgages that are resetting at higher rates than introductory or so-called teaser rates.

"The rise in foreclosures over the past year probably only marks the beginning of the problem," Jan Hatzius, a Goldman, Sachs & Co. economist, wrote in a March 23 report. "The main reason to expect further deterioration is that house prices are likely to fall significantly in 2007, with further declines possible in subsequent years."

Foreclosures in 2007 may rise by one-third compared with last year should rates continue at the level seen in January and February, RealtyTrac Chief Executive Officer James Saccacio said in a statement today.

One quibble: I think you really need two conditions to have a substantial rise in the number of foreclosures. Declining house prices certainly make foreclosure a more likely outcome (compared to the home-owner simply selling the house, which is what they would do when the real estate market is strong), but some sort of event that leads to the financial difficulty in the first place is also required, like job loss (which is traditionally the most common reason for a mortgage-holder to fall behind on payments) or a rise in adjustable rate mortgage payments.

In our current situation, I think that higher mortgage payments will likely be a catalyst for many foreclosures over the next couple of years. It's only because we can forsee both conditions happening simultaneously - rising mortgage payments for millions of people, combined with stagnant or declining home prices - that people like me are worried about the foreclosure rate rising considerably over the next 1-3 years.

And then there's the nightmare scenario. If we also add an economic recession into the mix - something that is a distinct possibility sometime in the next year or two - then the resulting job losses could really throw the foreclosure rate through the roof. Combine that with my sense that the financial health of banks could be seriously threatened if they have to absorb rising mortgage losses at the same time that they deal with an economic recession, and I feel pretty sure that a recession in the next year would be really, really bad news. The perfect storm.

In other housing market news, the Census Bureau reported this morning that new home sales have dropped by almost 20% over the past year. See Calculated Risk for complete coverage and charts of that very bearish report.

A Friday Stroll Down Memory Lane

I've been hunting around through some newspaper archives for stories about the end of the last housing boom and the subsequent credit crunch of 1990-91, and I've found lots of good stories to read -- some alarming, some prescient, some naive, and some just plain funny.

Many of them are too good to keep to myself, so I've decided to start a regular Friday feature of excerpting an old newspaper or magazine story about the state of the economy at some time in the past. Since I happen to think that today's economy has some important resemblances to the US economy in 1990, I'll initially be focusing on that period. But I'm sure I'll be branching out soon enough.

This isn't just intended as a way to get in cheap shots at people who pontificated about the economy in the past, by the way; by itself, that is an easy but pretty unfulfilling exercise. After all, it's not a revelation that it's hard to predict the future, or that hindsight is 20-20.

But I do think that it can be very instructive to look back when it helps us to correct misperceptions that people have today about what happened in the past; when it contains lessons applicable to today; and when it just generally reminds us how hard it is to guess correctly at what is going to happen, since the street that we're on is, for the most part, so very dark.

I think that today's excerpt does all three of those things. It's from the Boston Globe, July 19, 1990:

Greenspan: Interest rates may ease; Fears credit crunch may fuel recession

Despite a strong surge in inflation, Federal Reserve Board chairman Alan Greenspan said yesterday that the central bank is worried a credit crunch could nudge the nation's economy into recession and is ready to lower interest rates to offset the damage.

Greenspan also said the Fed is ready to lower rates to minimize damaging side effects of any agreement to reduce the federal budget deficit. While such an agreement would slice government overspending, it could hurt the economy by siphoning off money through taxes and reducing government demand through spending cuts.

Greenspan's comments, in testimony before the Senate Banking Committee, were the second time in less than a week that the Fed chairman has said the central bank is prepared to reduce borrowing costs and they signaled the murky state of an economy that, while still growing, is doing so in a patchwork fashion.

They follow by five days the Fed's first major policy change since December: a modest reduction in the federal funds rate - the rate that banks charge on loans to each other - from 8.25 percent to 8 percent.

Both the rate reduction and Greenspan's remarks left analysts baffled. Coming on top of an unexpected surge in inflation during June and Greenspan's previous skepticism about the existence of a credit crunch, the moves left many unsure of where the central bank thinks the economy is headed, and some questioning whether the reserve chairman is bowing to Bush administration demands for lower interest rates.

"I find the timing puzzling and I find the reason puzzling," said Lyle E. Gramley, a former Fed governor who is now chief economist for the Mortgage Bankers Association in Washington.

Greenspan labeled as "low" chances that the economy will slip into recession soon. But he devoted much of his testimony to concerns about the economic damage that a credit crunch could cause.

Template Fiddling

As you may have noticed, I'm fiddling around with the layout of this blog. I'll be experimenting a bit over the next couple of weeks with the layout and incidental content that I might want to include, such as the yahoo economy news feed that I'm trying out today.

The main content of the blog will remain unaffected (and if I do things right, it should always - hopefully - remain in the big, obvious column of information in the center of the blog), but I thought I'd give you fair warning to expect more tweaks in coming days as I play around with what I want to include on the blog. Please feel free to provide feedback or suggestions...

The Prevalence of Negative Equity

This week The Economist adds to the discussions about the dangers that mortgage defaults may pose for the US economy:

Cracks in the façade

On March 13th the Mortgage Bankers Association reported that 13% of subprime borrowers were behind on their payments. Some 30 of America's subprime lenders have closed their doors in the past three months. The cost of insurance against default for the riskiest tranches of subprime debt has soared. The worst effects may not be felt until the mortgage payments of many borrowers with no equity in their homes rise sharply.

Is this a mere irritant in America's vast economy, or the start of something much worse? Opinion on Wall Street is divided. Most argue that the mortgage mess, though a blight on anyone caught up in it, will not spread... [but] growing numbers of pessimists disagree.

What I find most interesting is this bit of data that The Economist then cites, from a new study by economist Christopher Cagan at First American CoreLogic.

...To try to assess who is right, you need to know the share of mortgages potentially at risk. And you need to understand the channels through which subprime defaults could spread to the wider economy.


...The greatest difficulties threaten borrowers whose house is worth less than their mortgage. Just under 7% of all American homeowners had this “negative equity” at the end of December 2006 estimates Mr Cagan, using a sample of 32m houses (see chart 1). Among recent homebuyers, the share is even higher: 18% of all people who took mortgages out in 2006 now have negative equity. A quarter of all mortgages due to reset in 2008 are in the same miserable state (see chart 2).


...The direct damage to Wall Street is likely to be modest. A repossessed property will eventually be sold, albeit at a discount. As a result, Mr Cagan's estimate of $326 billion of repossessed mortgages translates into roughly $112 billion of losses, spread over several years. Even a loss several times larger than that would barely ruffle America's vast financial markets: about $600 billion was wiped out on the stockmarkets as share prices fell on February 27th.

That's where I have to disagree. There's a big difference between the market value of publicly traded US companies fluctuating by a hundred billion dollars, and banks charging losses of a hundred billion dollars directly against their equity capital. When banks have to dig into their capital to cover losses, they have less money left to support lending activities, which they then have to curtail. As my look at bank capitalization showed the other day, it seems plausible that losses of $100-$200 billion on bad mortgages could be enough to have a serious impact on bank behavior -- particularly if the economy is slowing or in recession at the same time.

The sky is not falling (yet); but neither do I take comfort from this type of data.

Health Care and Presidential Politics

I couldn't agree more:

March 22 (Bloomberg) -- John Edwards was the first presidential candidate to get one. Mitt Romney signed a Massachusetts law creating one that he now distances himself from. Barack Obama promises one. Hillary Clinton had one in 1993 and won't talk about it now.

"It" is a plan to revamp U.S. health care, the world's most expensive system and, compared with those of other industrialized countries, not necessarily the best. While candidates for president are reluctant to take on a $2.1 trillion industry that makes up 16 percent of the U.S. economy, surveys show that a majority of Americans want the government to overhaul the system.

The political environment may be right for the first time since former President Bill Clinton took on health care 14 years ago. The puzzle of how to hold down costs while providing health care to 47 million Americans who don't have it has only grown more intractable. The leading Democratic candidates will discuss solutions at a forum this weekend in Las Vegas.

..."Candidates know they have to engage on this issue, and they will," said Chris Jennings, a former senior health-care counsel to President Clinton who is working informally with Senator Clinton of New York.

The candidates must find ways to provide more coverage without making people afraid that they will lose the benefits they already have, he and other advisers say. Another issue is whether to focus on America's uninsured or take on the entire health-care system, from rising costs to the role of insurance companies.

I think that the US's broken system of health insurance is the single biggest policy issue facing the US for at least the next ten years, and that any serious presidential candidate has to make it clear that it will be a priority for them.

The down side to addressing the health care issue, of course, is that fixing the US's health insurance system is almost certainly going to be fiercely resisted by currently entrenched interests, as well as by those Americans who are simply nervous about dramatic changes in general. It is the right thing to do for the country, and will make most Americans far better off in future years, but passing any major health insurance reform is going to be messy, ugly, difficult, and very likely politically costly.

It's kind of like fixing the deficit. Democrats have a choice (about which there's been substantial debate). Do they do the responsible thing, and fix a problem that has just been growing and growing in size during the years of Republican control of the White House, while possibly paying a substantial political price for making the difficult but necessary trade-offs? Or do they just do the minimum necessary to keep the problem from getting out of hand, so that their responsible actions don't hand the keys back over to Republicans in the next election?

My hope is that doing the right thing (in this case, substantially reforming the way health insurance is provided in the US) would yield the positive results that I know it would have quickly enough that those who behaved responsibly would be rewarded at the ballot box. But Democrats do face a very real danger that, as with raising taxes in 1993 to fundamentally improve the federal government's finances, the benefits to Americans may not be felt for a few years, giving Republicans a chance to return to power, possibly undoing some or all of the good done by the responsible party.

Either way, it's something that political candidates need to talk about, and address. I haven't decided whom I will support for President in 2008, but I can guarantee you this: I will definitely not support any candidate - Democrat or Republican - who thinks that the US's health insurance system can continue without major, major reforms.

An Optimistic Reading

The markets today seem to be giving today's FOMC's statement a rather optimistic reading:

March 21 (Bloomberg) -- The Federal Reserve kept the benchmark U.S. interest rate at 5.25 percent and unexpectedly abandoned its tilt toward higher borrowing costs.

"Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth," the Federal Open Market Committee said today in Washington. While inflation is "elevated" and the "predominant" concern, the statement dropped a reference to "additional firming," language used since June, the last time the Fed lifted rates.

Policy makers said recent economic indicators have been "mixed" and acknowledged the persistent downturn in housing. Nevertheless, they repeated that "the economy seems likely to continue to expand at a moderate pace over coming quarters."

Bonds and stocks rallied as some traders read the change as a signal that the Fed will consider cutting rates by the June policy meeting. Other economists said the new wording doesn't necessarily mean a reduction is imminent.

"It does not appear the committee is prepared to consider easing; rather, they are ruling out tightening," said Chris Low, chief economist at FTN Financial in New York. "The FOMC concedes a decidedly gloomier economic picture in March than in January, but continues to worry" about inflation.

I think that Chris Low's reading at the end of this excerpt is spot on: today's statement may indicate that a rate hike is not in the offing, but does nothing to indicate a rate cut any time soon. That's why I think the markets' exuberant reaction (or should that be "irrationally exuberant"?) today will likely be largely undone tomorrow, as a more sober assessment concludes that since we already knew that a rate hike was not likely, this was not really news.

Can Banks Weather the Real Estate Storm?

Next in my series of posts on the potential impact that the housing downturn might have on the health of the US banking sector (see here and here for previous entries on this theme), I'd like to take a look at the question of how well banks are equipped to handle losses due to mortgage defaults.

Banks constantly face the possibilities that the loans they've made might not be repaid by borrowers. That's part of the risk of being a bank, and loan defaults happen to some degree even in the best of economic times. As a result, banks need to have sufficient capital to be able to weather those losses, honor their own committments (the most important of which is to repay people who've deposited their money), and still have something left over to lend out to future borrowers.

At first glance, it looks like banks are in excellent financial shape right now. Due to a series of regulatory and financial changes over the past two decades, banks have substantially increased the amount of capital supporting their activites.



The most recent data (from the Federal Financial Institutions Examination Council, via the excellent St. Louis Fed data site) shows that the US banking system has close to $1 trillion in equity capital to support their activities. Everyone (including me) would agree that banks seem to be very well capitalized right now.

(By the way: does anyone have an explanation for the seemingly discontinuous jump in bank capital between Q2 and Q3 of 2004? I'd be curious to learn the explanation, if there is any.)

The problem is that the amount of money that banks have loaned out for the purposes of buying houses has also risen dramatically in recent years. When we look at the ratio of bank capital to the real estate loans that banks have made (including both direct loans to borrowers, as well as indirect lending through the purchases of mortgage-backed securities), the amount of capital that banks have stockpiled in recent years doesn't look quite as unassailable.



This picture does not make the banking sector look weak, but it does remind us that the huge amounts of capital that banks have at their disposal right now are not that huge compared to their real estate exposure. Furthermore, the ratio has been creeping down in recent years. Banks have less capital supporting the loans they've made for real estate than they have at any time since the early 1990s.

One last point to consider is how many losses it might take to put a real scare into banks, causing them to curtail their lending. It turns out that, based on past experience, those losses may not have to be all that big before banks change their behavior.

The last chart shows that the financial losses (i.e. loan write-offs) suffered by the banking sector during the 1990 housing bust and subsequent credit crunch were only on the order of $10-$15 billion per quarter above and beyond the usual rate of loan write-offs. Yet those losses were enough to trigger a well-documented credit crunch that contributed substantially toward the recession of the early 1990s.



Similar write-offs today (relative to the banking sector's available capital) would be on the order of about $50 billion in extra losses per quarter (pushing total loan write-offs to maybe $70 bn per quarter). That's a lot of money, and would only happen with a truly massive wave of mortgage defaults -- something that may or may not happen, but unfortunately is certainly much more possible than I would like.

The more likely (and dangerous) problem would be if the economy turns sour more generally, so that banks have to absorb losses due to recession (like they did in the early 2000s) on top of a wave of mortgage defaults. Those two forces together could easily push quarterly loan write-offs well into the danger zone. That to me seems to be the biggest potential danger.

My conclusion is this: banks are reasonably healthy, though perhaps not as healthy as you might think; it will take a really big wave of mortgage defaults to hurt them significantly, though, unfortunately, not one that is beyond the realm of possibility given the current state of the housing market and household finances; and if the economy slows down more generally at the same time that the mortgage default rates climb significantly, it seems very possible that banks could be in for a rather rocky period.

Lessons from History

David Callaway of Marketwatch, last week:

In subprime mess, another dumb theory falls

SAN FRANCISCO (MarketWatch) -- It seemed so obvious at the time, back at the peak of the Internet bubble seven years ago this month. Profits no longer mattered.

You see, it was different this time. It was a new paradigm. Internet companies were changing the world and old measurements of success, such as profitability, didn't apply anymore.

Until of course, they did. And we're still living with the fallout from the resulting collapse in Internet stocks and tech stocks in general, seven years later.

The parallel with what's happening in the mortgage market seems eerily familiar. In the media, the general rule of thumb is that the next big crisis in the financial markets will come from something totally unexpected. An earthquake in Japan (Barings collapse); a plunge in Asian and Russian currencies and debt (Long-Term Capital Management); a shell game in the executive suite at one of America's most respected new economy companies (Enron).

The thing about the brewing mortgage debacle, however, is that everyone saw it coming. They just refused to believe it. Questions have been asked about risky mortgage loans going back to 2003. What would happen to all the leverage taken on by home buyers when interest rates started to rise and the market turned around.

I'd just add one thing: the thing that makes the surprise about the end of the housing bubble even more... er... surprising, is that if we look back just one decade before the internet bubble, we can see what happened to the last big housing boom. In other words, we not only have an example from the recent past of an unsustainable bubble, but we specifically have an example from the recent past of an unsustainable housing bubble, and what happens when it's over. I think we can learn a lot about what to expect in the next couple of years by looking back at the early 1990s.

Maybe that's why I love studying history so much...

Recycling the News

Will writers in the business press be able to start helping the environment by recycling some old stories? I'm not sure, but either way, I always find it fun -- and instructive -- to take little walks down memory lane...

Collapsing Housing Market Is Taking an Emotional Toll

Across the metropolitan region, thousands of people who bought homes during the long housing boom... are suffering wrenching emotional and financial hardships as the value of their single largest investment slips away.

...Many two-income families borrowed heavily, spending 40 percent to 50 percent of their income on down payments and mortgages, banking on the seemingly endless rise of real-estate values.

...When Mary Anne and Larry Liesner bought a three-story colonial in Bridgeport, Conn.... they had big plans. Real-estate prices were rocketing; the Liesners figured they would renovate the 75-year-old house, sell it in four years, buy a sailboat with the proceeds and cruise the Caribbean.

...The rudest shock came when the couple finally tried to sell: The house they bought in the boom years [attracted only one bid at three-quarters of the price they paid for it.]

"We feel trapped," said Mr. Liesner, who is 41 years old. "This house consumes every dollar we make. It's a beautiful home, but it's also a huge financial burden."

Like many other first-time home buyers, the Liesners chose a variable-rate mortgage with a low initial interest rate. In four years, the couple's mortgage rate has increased [by] $325 a month for them. In addition, they have to pay back a $50,000 loan they took to cover the down payment and renovation costs.

...The Federal Home Loan Bank of New York said 3.7 percent of the mortgage loans outstanding in New York State were at least 60 days delinquent [this year]. That compares with 2.6 percent [last year]. In New Jersey, delinquencies rose to 4.75 percent from 2.9 percent in the same period, and in Connecticut to 2.3 percent from 1.35 percent.

While still a small fraction of residential real-estate loans, the number of foreclosures is slowly rising. In New York, 0.49 percent of all residential loans ended in foreclosure last year, up from 0.47 percent [the year before]. In New Jersey during the same time, the figures increased to 0.83 percent from 0.74 percent. In Connecticut, they rose to 0.26 percent from 0.18 percent.

"The numbers are a sign of financial stress," said Rae D. Rosen, regional economist for the the Federal Home Loan Bank of New York.

"In the past eight years, most people in Orange County had never seen a foreclosure," said Michele Koebrich, a realt-estate agent in Central Valley, N.Y. "Now they're seeing them again."

Source: The New York Times
April 13, 1990

How Exposed Are Banks to Real Estate?

In my previous post I explained why I think that the quantity of bad mortgages in the US economy may actually be enough to significantly affect the non-performance and write-off rates for the US banking system as a whole. Yesterday, Calculated Risk followed this up with a discussion of why he thinks that the health of commercial real estate loan portfolios may soon suffer the same fate that residential loan portfolios are currently experiencing.

In the comments to both posts there seems to be a lot of confusion about banks' exposure to residential real estate loans. So let me take this chance to provide some data from the Federal Reserve's weekly survey of the assets and liabilities of banks in the US. The following table shows commercial bank assets as of the end of February, 2007, the growth in those assets over the past 12 months, and a comparison of the composition of those assets with the same month ten years ago.



Let me point out a couple of interesting features of this table. First of all, banks have direct exposure to residential real estate loans of close to $2 trillion, plus another $1 trillion in indirect exposure through their holdings of mortgage-backed securities (MBSs). That's not a trivial amount.

Secondly, banks continued to expand their residential real estate lending at an extremely fast pace during 2006, despite the rapidly cooling housing market. This may be worrying (from the banking-sector's point of view), if you think that the loans made most recently are least supported by rising underlying house prices.

Finally, and directly contradicting all of the talk about banks shedding their exposure to real estate, it seems that banks actually have significantly more exposure to real estate loans (both directly and through MBSs) now than they did ten years ago.

It may indeed be the case that banks will dodge any incoming bullets from the growing number of mortgage defaults, as many people argue. But evidence like this tells me that banks have a lot to lose if mortgages go bad.

Bad Loans, Banks, and the Coming Credit Crunch

I've been thinking about the health of the banking sector of the US economy, and pulled together a couple of charts that have gotten me thinking. And worried.

First, take a look at this picture of the total quantity of loans outstanding at commercial banks in the US, broken down by type of loan.



The two things that strike me about this picture are 1) the obvious cyclicality of lending, particularly to businesses (more about that later); and 2) the incredible growth of real-estate lending over the past several years. Note that all series have been deflated by the CPI, and thus reflect real changes. Even after adjusting for inflation, real estate lending has nearly doubled since the start of 2000.

Now consider that the Mortgage Bankers Association (MBA) recently estimated that about 5% of all mortgages are currently in default, and that the delinquency rate that is growing rapidly. Suppose that we use that statistic to infer that 5% of commercial banks' real-estate loans will shortly have to be classified as non-performing. (Since commercial bank real-estate loans also include commercial real estate loans this estimate is a bit high, but since we know that the big growth in real-estate lending over the past several years has been for residential and not commercial property, the 5% figure at least makes a good starting point.)

That would imply about $170 billion in bad loans, or about 3% of the $6.1 trillion in total outstanding loans (real-estate plus non-real estate loans) on the books of commercial banks. Not all of that $170 bn will be lost to banks, since they should be able to foreclose and sell some of the underlying properties, but it seems safe to guess that banks will end up writing off some fraction of that total - probably many tens of billions of dollars worth of loans, or several tenths of a percent of all bank loans.

Now comes the scary part. Consider the following picture, which shows the rates of non-performing loans and loans that banks have had to write off over the past 19 years.



As of December 2006, both ratios were at comfortingly low levels. But the MBA data suggests that -- even if delinquency rate abruptly stops rising today -- we should expect the ratio of non-performing bank loans to rise by a few percentage points, and the portio of bank loans that banks are forced to write off to rise by some tenths of a percentage point. Those developments would quickly move the series in the graph above into the range where they were during the period 1990-92, when bad loans caused the massive Savings and Loan crisis and a widespread recession-causing (or at least recession-exacerbating) credit crunch through the US economy. (At this point, feel free to refer back to the top chart to see the effects of that credit crunch on business lending in the early 1990s.)

I hope it's now clear why I'm in the camp of those who are worried about the financial spillovers that the housing slump will have on the broader US economy.

Life in the Third World

I think that this kind of story is important, but not for the reasons that the reporter (Lisa Mullins of The World, whom I generally like quite a bit) and interviewee think that it is.

Anchor Lisa Mullins speaks with Rochelle Sobel, founder of The Association for Safe International Road Travel -- or ASIRT. Sobel began the non-profit organization after her son, Aron, was killed in a bus crash in Turkey twelve years ago.

As someone who has spent a fair amount of time on the roads in third world countries, I agree completely that developing-world traffic safety is a horrible problem. It can be scary and really, really dangerous to drive in much of the world.

But I don't think that this story captured the degree to which the roots of the problem are economic, and extend to all aspects of life in the developing world. The remark in the interview that most caught my attention was this:

Q: Why haven't [governments in developing countries] done something already?

A: What governments need to realize is that road crashes are preventable... What we need is political will. What we need is the recognition of how immense the issue is, but also that interventions can be put in to place.

That is where I disagree, and where I think the interview missed a crucial point. It does not just take a realization that road crashes are preventable. It does not just take political will to enact the improvements to infrastructure and enforcement of traffic laws that would reduce road accidents. It takes money. A lot of money. And that is something that poor countries don't have much of.

Suppose it would cost $10 million to improve roads and enforce traffic regulations in some city in a poor country. That country's government would have to come up with that $10 million somewhere (which can be difficult for many small, poor countries), and then make the argument that it shouldn't spend that money on more primary schools, or better health care, or more vaccines for children, or stronger enforcement of child labor or environmental laws, or lower taxes.

So this story serves to remind us of an important point: poor countries are well below rich-country standards in many things, including traffic safety, but also including health care, environmental protection, and education. That's because they are poor. And that's why life expectancies are so much shorter in poor countries than rich countries, and why life is still pretty miserable - nasty, brutish, and short - for most people living on this planet.

In other words, the reason why this story sticks in my head is because it is a perfect illustration of one of the many reasons why it sucks to live in a poor country (at least for most people). Unfortunately, the prescription offered by the story (we just need to generate the political will to provide better infrastructure in poor countries) misses the point entirely. Standards of safety will not improve in poor countries until they become less poor. As poor countries become richer, they become better able to provide money for all sorts of things that we in the US take for granted, including safe streets. But as long as they remain in poverty, people living in those countries will continue to suffer daily dangers and discomforts that most people living in a developed country can only imagine.

Bad Mortgage Pains

Didn't someone recently say that we'd soon be seeing more stories like this one?

NEW YORK - Stocks plunged Tuesday, driving the Dow Jones industrials down more than 240 points in their second-biggest drop of the year, as troubles piled up for subprime lenders.

Investors, bracing for a wilting economy, fled the already deflated subprime mortgage sector on more news that lenders New Century Financial Corp., Accredited Home Lenders Holding Co. and General Motors Acceptance Corp.'s residential unit are facing financial problems. Bolstering the belief that the struggles are widespread, the Mortgage Bankers Association said new foreclosures surged to an all-time high in the last quarter of 2006.

As I've argued for some time, if the housing market does put a significant damper on economic growth in the US, the channel is most likely to be by affecting the balance sheets of lenders. These are some early warning signs.

Signs of the End of Easy Money

Okay, so maybe I was wrong when I wrote that no one is quite sure who will feel most of the pain on their balance sheets when mortgages go bad. It seems that recent events are starting to identify some of the big losers:

NEW YORK (CNNMoney.com) -- Embattled mortgage lender New Century Financial Corp. warned Monday of a series of serious financial problems that cast its future in doubt - and cast a pall over much of the nation's financial sector.

The problems at New Century, No. 2 in lending to borrowers with weak credit, could also weigh on the nation's struggling housing market - and home prices - as a major source of mortgage financing dries up. Overall, lenders in the so-called subprime sector made $640 billion in mortgage loans last year, nearly double the amount from 2003.

Irvine, Calif.-based New Century said that all of its own lenders are cutting off financing, that it has been found in default of many of its financial agreements, and that it does not have the funds necessary to meet its obligations, which could reach $8.4 billion. The company's market value has shriveled to only $178 million

...The company's filings said that several of its lenders were now demanding New Century and its subsidiaries repurchase all outstanding mortgage loans, and that its other lenders now have the right to make that demand. It said if each of them do, its total repayment obligations would be about $8.4 billion.

"The company and its subsidiaries do not have sufficient liquidity to satisfy their outstanding repurchase obligations under the company's existing financing arrangements," said the company's filing.

"We know they didn't get their $8 billion by holding a bake sale. We knew it would touch other financial institutions; now we'll see how," said Art Hogan, chief market analyst at Jefferies & Co., about the impact New Century would have on the broader financial sector.

I expect that we'll see quite a few more stories like this in coming months. For some reason, even though it happens at the peak of every business cycle that some firms do more lending than they should, and as a consequence end up running into serious financial trouble when the business cycle turns, it still happens at the peak of every business cycle. This one was no exception.

Interest Rate See-Saw

I love competing news stories. Today, let's have them play with each other. On the first side of the see-saw, we'll put the possible-rate-cut gang:

March 8 -- (Businessweek.com) In light of the weaker economic data of late, investors are once again betting heavily that the Federal Reserve will cut interest rates this year. The ongoing housing recession, concerns about additional fallout from subprime mortgage defaults, a weaker manufacturing sector, and a slower pace of hiring are all helping to revive expectations of lower rates.

On the other side, let's sit the no-cut folks:

March 9 (Bloomberg) -- Treasuries declined the most this year as a stronger-than-forecast government jobs report reduced bets the Federal Reserve will cut interest rates by midyear.

Hmm... the see-saw seems pretty evenly balanced. My conclusion? We need more data to jump on one side of the saw or the other. In the mean time, feel free to take your pick about which story you like more.

February Jobs Report

This morning the BLS released its estimate of job creation for February. It was about as expected:

Nonfarm payroll employment continued to trend up (+97,000), and the unemployment rate (4.5 percent) was essentially unchanged in February, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Employment grew in some service-providing industries but declined sharply in construction. Manufacturing employment continued to trend downward. Average hourly earnings rose by 6 cents, or 0.4 percent, over the month.

The job market has been gradually cooling over the past several months (not that it was ever really hot), and this report is consistent with that trend, illustrated in the following picture.



And what parts of the economy are cooling down the most, you wonder? The next picture tells the story. Unsurprisingly, the construction industry has led the way toward a weaker job market, but nearly all sectors of the economy have seen some slowdown in job creation, with the exception of the government and leisure & hospitality sectors.



Hand-in-hand with weaker job growth comes weak earnings growth by workers, of course. To the $10 per week increase in take-home pay that the average production worker has received since the year 2000, in February they were able to add another $0.30. Unfortunately, that only made up for about half of the fall in average weekly pay that they took home in January.

For more good pictures of the employment situation, see this morning's post by PGL over at Angry Bear, who deserves recognition for getting up well before the sun to get his post up from the West Coast!

Perspective

First, some perspective from recent history.

June 2000:

The forecasters surveyed by the Federal Reserve Bank of Philadelphia for the semi-annual Livingston Survey are projecting much faster economic growth in 2000 than they did six months ago... [F]orecasters now think real GDP will grow 4.9 percent this year, compared with 3.4 percent in the forecast made six months earlier. The forecasters think real output growth in 2001 will slow to 3.0 percent, the same rate they projected six months ago.

December 2000:

Forecasters... who are surveyed by the Federal Reserve Bank of Philadelphia twice a year for the Livingston Survey, are projecting that the economy’s output, which they forecast to have grown 5.1 percent in 2000 (based on the growth rate of the average annual level of real GDP), will slow down to just 3.1 percent growth in 2001 and 3.4 percent in 2002. However, the [forecast] growth rates in both 2000 and 2001 are a bit higher than they were in the last survey, taken six months ago in June 2000.

Actual real GDP growth over the past decade:



Now we're ready for this story from Bloomberg today:

Growth in U.S. to Firm Through 2007, Economists Say

March 8 (Bloomberg) -- The U.S. economy will strengthen during the year, overcoming declines in housing, business investment and stock markets, a survey of economists showed.

The world's largest economy may expand at a 2.4 percent annual rate this quarter, and accelerate to 3 percent by year's end, according to the median estimate of 75 economists surveyed by Bloomberg News from March 1 to March 7. The economy grew at a 2.2 percent pace in the last three months of 2006.

A little perspective is always a good thing. As are grains of salt.

TSA Bargaining Rights

From the Senate today:

WASHINGTON (Reuters) - The Senate on Wednesday backed a Democratic-sponsored measure that would give new labor protections to airport screeners while seeking to address White House concerns that federal authorities have flexibility to respond to security threats.

The arguments that many Republicans have parroted in this debate is that collective bargaining rights for TSA workers would make them unable to respond effectively to emergencies. For example, from the same article:

In a letter to Senate Homeland Security Chairman Joseph Lieberman, a Connecticut independent, Homeland Security Secretary Michael Chertoff said collective bargaining rights are incompatible with the "successful performance" of the U.S. Transportation Security Administration.

"TSA must be able to react nimbly, not only to the ever-evolving security threats that confront our nation, but also to changing air carrier schedules, weather disruptions, and special events that draw large number of passengers to particular airports," he wrote.

I'm not sure that I have a complete handle on all of the pros and cons of this legislation. But this one point, repeated over and over by Senate Republicans over the past 24 hours, makes little sense to me. After all, lots of the nation's police officers and firefighters are unionized.

According to the BLS, close to 40% of workers in Protective Services occupations (which include police, firefighters, corrections officers, and so forth) are unionized. The police officer website officer.com (no, I never knew such a thing existed before today either) lists over 200 separate police officer labor organizations in the US. Is each of those unionized police departments unable to respond to emergencies in their cities? Does each of those cities face problems getting police officers on the street whenever there is bad weather or a special event in their city? Somehow, I just don't think so.

One may have a philosophical objection to letting TSA workers bargain collectively. But the notion that it would make them unable to deal with emergencies seems like a rather ridiculous one to me.

February Job Growth Preview

This Friday the BLS will release its estimate of net new job creation during the month of February. One private-sector forecasting firm is suggesting that the numbers may be quite weak:

WASHINGTON (MarketWatch) -- U.S. private-sector employment grew by 57,000 in February, the weakest job growth since July 2003, according to the revamped ADP national employment index released Wednesday. Job growth in February was about a third of the 167,000 averaged over the previous three months. The ADP index rose by 126,000 in January.

The ADP index, produced by Macroeconomics Advisers LLC for Automatic Data Processing Inc., is considered by many economists to be the single-best indicator of the government's monthly nonfarm payroll report, which will be reported on Friday.

Adding in some 20,000 government jobs created in a typical month, the ADP report would signal payroll growth of about 80,000 in February. Economists are currently projecting job growth of about 100,000 for Friday's report after a 111,000 gain in January.

Job creation has never been particularly strong during this economic expansion, and with the exception of surprisingly strong numbers in November and December of 2006, the data has been indicating for some time that we are in a period of gradually slowing job growth.

It will be interesting to see Friday mornings's numbers...

New Data on House Prices

This morning the Office of Federal Housing Enterprise Oversight (OFHEO) released its latest quarterly estimate of house prices in the US, covering the fourth quarter of 2006. From today's press release (pdf file):

U.S. HOUSE PRICE APPRECIATION RATE STEADIES

WASHINGTON, DC – The rate of home price appreciation in the U.S. remained steady in the fourth quarter of 2006, extending a general trend of deceleration begun earlier in the year. Home prices, based on repeat sales and refinancings, were 1.1 percent higher in the fourth quarter than they were in the third quarter of 2006. This is slightly above the revised growth estimate of 1.0 percent from the second to the third quarter. Prices in the fourth quarter of 2006 were 5.9 percent higher than they were in the same quarter in 2005. Price appreciation in 2006 was substantially smaller than the tremendous price gains of recent years, which ranged from 7.4 percent in 2002 to 13.2 percent in 2005.

The word "steadies" in the context is apparently a euphemism for "moves rapidly toward zero", at least if we look at year-on-year changes in house prices. Today's "House Price Index" (HPI) data basically confirms what we already knew, but it provides some nice extra detail, including good price data by major metropolitan area. Here's a picture of house prices in several major coastal metro areas in the US, including today's newly released data for the end of 2006:


(Note: in all cases the HPI data is deflated by a 6-month moving average of CPI ex. shelter.)

If you prefer seeing the data expressed as the annual rate of appreciation instead of the price level, it looks like this:



One slightly worrying aspect to me about this most recent data is that the fall in appreciation rates (or the move toward real price declines in several cities) is that it is now starting to look like it is not limited to those regions that enjoyed a big house price appreciation episode during 2002-2005. Many interior metro areas in the US missed out on the big house price boom, but are still suffering from a decline in their very modest appreciation rates, as the following picture shows.



One last thing to remember: house prices take a long time to fall, and can fall a long way. During the last downturn in the housing cycle real prices fell by 25-50% in many metropolitan areas over the course of several years. An equivalent fall in this housing market downturn would take these indexes down to around 150 or so by the year 2010.



So be patient. The housing bust has some way to go yet.