No signs yet that economic train heading for crash

If the United States economy is a train wreck, it is the slowest motion train wreck you ever saw. That would be an excellent essay prompt for an Oxbridge macro-economics tutorial and I would love to see the answers it elicited. We are all being given a learning opportunity as spectators of a highly-publicised inflection point in America’s economic growth path. But what exactly are we learning?

It has been eight months since the first cracks in the surface appeared with the Bear Stearns mortgage-asset hedge fund blow-up. The financial crisis has gone from bad to worse, as Bear Stearns’ shareholders would be the first to attest. Yet now the bulls are bellowing that the worst is over.

Some sober commentators are telling us to calm down and realise that no train wreck is going to happen. Despite so much financial chaos, economists are still even debating whether the US is in a recession.

Fact is, we eked out a little growth in the last quarter of 2007: 0.06 per cent to be precise. That is very old news, though it is a measure of how confusing the growth picture tends to be that we still get updates of such ancient history as if we are supposed to find them informative. That is because the statistics are often so subject to revision, though the early estimates for last quarter turned out not to need adjusting. So although growth at the end of 2007 was anaemic, it was growth. No train wreck there, even though finance had been in a down spiral and the housing market had been sick for months.

How about the readings in more recent months? Surely the demise of all those crazy sub-prime lenders and the panic of the investment banks and hedge funds that enabled them would mean that Americans could no longer keep up their consumption binge on borrowed cash? It would be reasonable to expect a serious drop in consumption, especially of discretionary items, and these days almost everything a Western consumer buys is discretionary, when you stop to think about it.

From iPhones to cappuccinos to private-school tuition to ski trips, huge swathes of affluent middle-class spending could be put on hold if the spenders felt truly bothered about their credit card debt, their home equity loans and those hideous adjustable rate mortgages.

So how about it? Has the consumer bandwagon fallen off the rails? Not a bit of it, according to the latest personal consumption figures for February. The bandwagon has slowed to a crawl, with a 0.1 per cent increase for the month, but when you think about how much people could actually have cut back if they had felt the need, that is the most benign train wreck imaginable.

As Robert Samuelson, a University of Texas economics professor and columnist, put it in the Washington Post recently, “Americans are expected to buy about 15 million vehicles in 2008; though down from 16.5 million in 2006, that is still a lot”. Putting off buying a new car for a year or two would seem like an easy economy for American households to make, particularly as the “fleet” is relatively new.

 

If economic doldrums were really here, one might expect maybe half the number of cars to be purchased as were bought while the boom was going on. But in reality it never seems to work like that. Just nine per cent fewer cars being driven off the dealer lots in 2008 does not seem anything like a catastrophe, though if repeated across the entire economy, a nine per cent drop in GDP would count as a severe recession.

It is really only in home building that we see a swingeing cutback in what one can regard as a form of very big ticket consumption. February building permits were 36.5 per cent lower than a year ago and housing starts were 28.4 per cent lower. One of the publicly traded builders, Lennar, posted a 60 per cent drop in first quarter home deliveries and about the same drop in new orders.

RealtyTrac’s index of foreclosure activity for February was slightly better than in January, but still, as the firm pointed out, there were 60 per cent more foreclosures than in the same month of 2007. About 220,000 properties received foreclosure notices in that single month. These kinds of deep reversals make housing look like a train wreck.

Whether all the attempts to open federally-backed credit spigots for mortgages will work to counteract the private bankers’ newly acquired disdain for home loans remains to be seen. Homes are still selling in markets where prices are not out of line with incomes and in segments where there are creditworthy borrowers wanting to finance a house. That leaves places such as parts of California and Florida, where prices went through the roof and still have a long way to fall before being affordable.

 

It also leaves the poor-credit segment, who should never have been buyers in the first place. And then there is the slew of mortgages that are still going to get in trouble as terms re-set, with more homes going on the foreclosure block. All in all, this is no time to be in the home-building industry, which essentially built enough houses in the first six years of this decade to supply legitimate needs for perhaps the entire decade.

By January, the latest month for which there are national figures from Standard and Poor/Case-Shiller, existing house prices had dropped by 12.5 per cent from their July, 2006 peak. The one year drop was 10.7 per cent. That leaves plenty of dropping still to come if one accepts the judgement of economists who are looking for a 25 per cent to 30 per cent drop from peak. Bear in mind that nationally home prices rocketed by 126 per cent from the beginning of this decade to their 2006 peak. Incomes rose at nowhere near that rate, except perhaps for mortgage brokers and asset structuring investment bankers.

Standard and Poor themselves are a bit more sanguine, saying they think a price decline from peak of 20 per cent will be enough to clear the housing market. They expect the slump to hit bottom by early 2009. It is this loss of wealth in the shape of people’s equity in their homes that must be the big dampener on their sense of financial well-being. That and the unending headlines about Wall Street shenanigans and blow-ups.

The Conference Board’s consumer confidence survey is stark evidence of the grim psychology. The consumer expectations index is almost as low as it has ever been since it started in 1967. Consumers only felt worse about the future in 1973, and the stagflation that came next was not the best of economic times, to put it mildly. Yet consumers really are not putting their money where their mouths are.

So let us change tack and look at employment figures. Surely there would be massive job losses with the end of both the housing construction boom and the funny-money tricks played by mortgage brokers and Wall Street?

All those carpenters and masons and all those financial conjurers and jugglers must be in the dole queue by now, right? Well, apparently not. Jobless claims have only inched upwards, not rocketed as they would in an economic train wreck. The last reading on weekly claims was 366,000, up from the low 300,000s a few months ago, but hardly dramatic. 

The unemployment picture cannot be that good can it? We know that the way unemployment is counted is quirky, with people who have given up looking for work being taken out of the figures. The counting of people with jobs is supposed to be more accurate. About 146 million people have been in jobs in the US over the past three quarters, and while the February total of job-holders was down by quarter of a million that does not count as a major spill. Is the jobless picture going to take a turn for the worse, given that economists call it a lagging indicator.

 

For example, are the banks just taking their time in shedding staff, with an avalanche of job losses about to show up? Jamie Dimon is rumoured to be planning to lay off half the 14,000 staff at Bear Stearns, the investment bank that JPMorgan Chase swallowed this month, but those bankers have not hit the streets yet. However, maybe when they do, some of them will find their way on to presidential candidate Barack Obama’s campaign payroll, since the man has to spend the receipts from his record fund-raising somehow. The flippancy is not wholly unjustified.

 

As mortgage banks closed branches or completely closed their doors all last year, bank staff were being laid off, but other jobs grew to take their place, though not necessarily for the same individuals. There are explanations, of course, for this economic train wreck not quite happening.

Although the Fed and other economic policy-makers have rather disgraced themselves in their failure to prevent the housing bubble and the financial panic, they may actually be managing the macro-economy quite well so far. By slashing away at the short-term interest rate and flooding the banks with easy money, the Fed may be succeeding in keeping the nation’s credit cards topped up. In other words, the mayhem in the real economy that looked likely three or four months ago may have been forestalled by dramatic monetary easing.

That $150 billion (Dh550bn) handout that President George W Bush and Congress agreed upon will start to arrive in families’ mail boxes in under two months’ time.

A $600 cheque does not do much for your wealth if your house has lost tens of thousands of dollars in value and wiped out your equity, as the comedian Jon Stewart suggested on The Daily Show the other week.

However, for those not facing a housing wipeout it is a nice little boost and could help prime consumption. The fact that one day America’s creditors might want their money back, and that the handout is all borrowed money that will boost the government deficit, is something that Americans have been blithely willing to ignore for the entire Bush era. Presumably another few months of spending other people’s money will not go amiss and it will help consumption along.

Perhaps we are in for a rolling recession, where the pain hits only a proportion of the consuming public at a time, but it goes on for many quarters.

Is the entire US economy in for the kind of thumping that housing is experiencing?

It certainly has not happened yet.

Nobody can predict the course of overall output very well in times of discontinuity like the housing bust and financial blow-up that we have been witnessing these past few months.

We will not know if we are watching a slow-motion train wreck or just, relatively speaking, watching paint dry, until output either drops off a cliff or simply goes sideways and eventually recovers.