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Eye on the Economy – 01/28/2009
The Economy Is Faltering Badly
The U.S. and global economies downshifted substantially in the final quarter of 2008 and a lot more ground is being lost in the first quarter of this year.
Weâ€™re expecting real GDP in the U.S. to contract at an annual rate of about 5.8% in the fourth quarter of 2008, the weakest reading since the early 1980s. Consumer spending, including the auto market, put a heavy hit on first-quarter GDP growth, and large negatives also came from housing, business capital investment and net exports.
We expect GDP to contract by roughly 4% in the first quarter, reflecting further hits from consumer spending, housing and nonresidential fixed investment, and there is likely to be a rundown in business inventory investment as well.
The job market took very heavy hits during the final quarter of 2008, and weâ€™re expecting a similar degree of damage in the first quarter of this year. Indeed, job losses accumulated throughout 2008 and the national unemployment rate climbed aggressively in the process, reaching 7.2% by December. Furthermore, state unemployment reports released yesterday by the Bureau of Labor Statistics show that labor markets deteriorated markedly across virtually all parts of the country in both November and December.
Housing Demand Still Is Fundamentally Weak
Ordinarily, the new- and existing-home markets work pretty much hand-in-glove, forming different parts of the traditional housing ladder and moving essentially in tandem (aside from the normal time lag between contract and closing). But things are really different now, with record foreclosures putting people out of their homes and dumping those homes onto glutted markets at deeply discounted prices that only make buildersâ€™ lives more difficult.
Indicators of demand in the new-home market have been uniformly weak. The Commerce Departmentâ€™s estimates of new-home sales moved down substantially in both October and November, NAHBâ€™s proprietary survey of large single-family builders showed ongoing weakness of gross and net sales in December, and NAHBâ€™s broad-based Housing Market Index slipped to a record low in January (8) as builders continued to mark down their perceptions of buyer traffic, current sales and expected sales volume.
On the other hand, sales of existing homes have been relatively flat during the past year, at least on a quarterly average basis, and sales of both single-family and condo/co-op units actually bounced up in December â€“ reducing inventory levels as well as monthsâ€™ supplies in both components of the market.
The stark differences from the new-home sales picture obviously are traceable to the rising foreclosure wave that feeds existing-home sales at fire-sale prices while detracting from the new-home sales side. Furthermore, we donâ€™t know how many of the foreclosure sales are to first-time buyers or to investors, or how long the latter category may stay off the market.
Housing Production Downshifts to New Record Lows
Home builders retrenched dramatically in December, faced with abrupt weakening of economic conditions, turmoil in financial markets, flagging consumer confidence, rising competition from foreclosure-related sales and sharply falling house prices.
Total housing starts ran at a record-low seasonally adjusted annual rate of just 550,000 in December, down by 15.5% from November, down by 45% from a year earlier, and down by 76% from the cyclical peak posted at the beginning of 2006. Major declines occurred in both the single-family and multifamily components of the market, and permit issuance also shifted down abruptly â€“particularly for single-family housing.
The December collapse of housing starts and building permits was far worse than â€œconsensusâ€ expectations (including NAHB), and experience tells us that volatility in the governmentâ€™s monthly housing numbers suggests a â€œwait-and-seeâ€ attitude for coming months. But the breadth and depth of this shocking report strongly suggests that buildersâ€™ views of the market and their plans for 2009 deteriorated badly at the end of 2008. The deepening recession, the pervasive tightening of credit conditions and tumbling house prices apparently have taken their toll.
Housing Price Declines Are Accelerating
Weakening home buyer demand and heavy oversupply that continues to be fed by the rising foreclosure wave are combining to put increasingly intense downward pressure on house prices across more and more areas of the country.
Prominent repeat-sales house price measures (controlling for compositional shifts) posted record rates of decline last November (latest data available). The national monthly House Price Index, thatâ€™s produced by the Federal Housing Finance Agency (formerly OFHEO) and based on loans held or securitized by Fannie Mae and Freddie Mac, was down by 8.5% on a year-over-year basis in November and fell at a 19.2% seasonally adjusted annualized rate for the month â€“ well outside the boundaries of recorded experience.
The 20-city composite Home Price Index, produced by S&P/Case-Shiller and based on repeat-sales methodology, fell at a record 18.2% last November on a year-over-year basis and stood 25% below its peak level in mid-2006. This measure fell at a seasonally adjusted annual rate of 20.6% in November, similar to the rapid rates of contraction recorded in September and October.
The median price of existing homes sold (not adjusted for compositional shifts) fell by a record 15.3% in December (year-over-year), as single-family home prices declined by 14.8% and condo/co-op prices were off by 18.3%. The most stunning declines were in the West region, where median sales prices were down by more than 30% in both components of the market.
Thereâ€™s no doubt that house prices now are under strong downward pressure in many parts of the country, and the number of geographic exceptions has been dwindling fast. Distressed foreclosure-related sales at discounted prices are up to nearly half of all existing home sales (according to NAR), and many builders are being forced to drop prices below production cost as they attempt to get some inventory off their hands.
Downward price momentum is bound to continue for quite some time under these extremely difficult and virtually unprecedented market conditions. And although falling prices have boosted standard measures of housing affordability, they also have created expectations of further decline and have helped perpetuate the vicious feedback loop (falling mortgage quality, tighter lending standards, falling house pricesâ€¦) that can easily drive house prices well below sustainable value.
Bring on Economic and Housing Policy
The performance of the economy beyond the first quarter of this year will depend very heavily on economic policy in three critical areas. First, use of unconventional policy tools by the Federal Reserve to strengthen targeted components of the credit markets. Second, use of the remaining TARP funds ($350 billion) by the new Administration to stabilize and strengthen the financial system, possibly supplemented by even more funding and/or by creation of a so-called â€œbad bankâ€ to buy toxic assets from financial institutions. Third, enactment of a huge ($825 billion) and politically contentious fiscal stimulus package now being hammered out by Congress and the Administration.
Measures to support the rapidly deteriorating housing market hopefully will be included in all three policy areas. The Fed earlier identified the mortgage markets as a key area needing support from its unconventional balance-sheet policies, and that message was reiterated in todayâ€™s FOMC statement (see below). With respect to use of TARP funds, the Administration has indicated that high priority should be given to limiting the relentless upswing in mortgage foreclosures. On the fiscal policy front, strong tax credits for home buyers and sizeable federal buydowns of mortgage interest rates by all rights should be part of the mix, although uncertainties on that front currently are considerable.
The Fed Employs New Weapons
The Federal Reserve, led by Chairman Ben Bernanke, has effectively run out of traditional monetary policy ammunition since dropping the federal funds rate target into the 0.0 to 0.25% range at the December 16 FOMC meeting.
At the conclusion of the January 29 FOMC meeting (today), our central bank reaffirmed the 0.0 to 0.25% target range and said that exceptionally low levels of the funds rate are likely to be warranted â€œfor some time.â€ In this regard, the FOMC noted that the economy (including housing) has weakened further since mid-December, that credit conditions for households and firms remain â€œextremely tight,â€ and that inflation may be heading too low for comfort!
The Fed committed to employ â€œall available toolsâ€ to support the functioning of financial markets and stimulate the economy, relying heavily on the power of the central bankâ€™s virtually unlimited balance sheet. In this regard, the Fed reinforced earlier statements regarding support to mortgage and housing markets via purchases of agency debt and mortgage-backed securities, and also noted that the Fed will soon be implementing a new Term Asset-Backed Securities Loan Facility (TALF) to facilitate the extension of credit to households and small businesses.
The FOMC also said itâ€™s â€œpreparedâ€ to purchase longer-term Treasury securities if that would be effective in improving conditions in private credit markets. Such purchases presumably would bring down longer-term private rates, as long as spreads to Treasuries did not widen.
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