15 July 2009

The Bright Side Of The Economy

The economy sucks. But, the economic news isn't unequivocally bad, or at least could be worse. How?

The Stock Market Is Recovering

The stock market is up about 34% from its low five months ago, in what has been a more or less steady climb. Until then, the stock market was declining in value as fast as it had in the Great Depression, now it looking only a little worse than the bear market created by the 1973 oil crisis and the 2000-2002 tech bust. The bottom could fall out again, but each passing month of stock market recovery makes this seem less likely.

A strengthening stock market also greatly reduces the risk that pensions will remain underfunded and potentially unable to meet their obligations.

The Recession Is Nearing Its End

Bank of America Merrill Lynch actually thinks that the recession is over. The consensus isn't that perky, but still expects that the recession will end in late 2009, even if the subsequent recovery may be tepid and could be relatively short lived.

While Serious, This Recession Is Milder Than The Great Depression

Economists use the term "recession" narrowly to describe a decline in gross domestic product. This is on track to fall about 4% in the current recession. While this would make this the deepest recession since the Great Depression, GDP fell 10% in the Great Depression, more than twice as much as it is likely to fall in the current recession.

President Obama is predicting that unemployment will continue to rise for a few months reaching levels above ten percent, before it improves. Other economists predict a peak of 11% sometime in 2010, before declining sometime in the same year. But, there is a consensus that we are not heading towardsd the unemployment levels seen in the Great Depression. Then, unemployment peaked at 25% in 1932-1933; it exceeded 10% in 1930 and stayed above 10% until 1941, when the United States joined World War II. The U.S. is likely to have unemployment above 10% for just three months to fifteen months, depending upon whose talking.

The percentage of jobs lost for the entire recession, likewise, has been serious, the worst of any post-World War II downturn with the exception of 1948, currently 4.7%, and this recession may yet produce a greater precentage of lost jobs than the 1948 recession when 5.2% of jobs were lost. Job losses aren't over yet. But, this is still not nearly so bad as the crushing loss of jobs seen in the Great Depression.

In the current bear market, stocks fell 56.8% from the peak, compared to 89.2% from the peak in the Great Depression.

Inflation Is Under Control

Core inflation for the past year (as measured by the consumer price index) has been 1.7%, which is an economist's dream. By that measure, we are not experiencing deflation, which can cripple an economy, but are not experiencing high inflation, which can also be a problem. Total inflation is negative 1.2% for the year (i.e. modest deflation), but the difference is due almost entirely to the decline in fuel prices from a year ago, which were exceptionally high then. Fuel prices increases account of 80% of the inflation observed in June as they have started to rise.

The worst economic collapses have been accompanied by either deflation or hyperinflation.

Retail Sales Are Stabilizing

Retail sales appear to have stabilized for a couple of months. They were previously plummeting.

In a related trend, consumer sentiment, while not positive, remains well above the low point it reached at the peak of the crisis.

Foreign Trade Is Stabilizing

Both exports and imports are starting to stablize after crashing dramatically from 2008 peaks. The trade deficit meanwhile, is at the lowest level since 2000, and the trade deficit excluding petroleum is at the lowest level since 1998. Net petroleum imports currently account for almost exactly half of the trade deficit, after a decade in which net petroleum imports were a minority of the trade deficit.

In May, 2009, the U.S. had "exports of $123.3 billion and imports of $149.3 billion resulted in a goods and services deficit of $26.0 billion." Of this, $13 billion consisted of net petroleum imports. The U.S. imports about 21% more goods and services than it exports. At its peak, three years ago, the trade deficit was about $40 billion a month larger than it is now.

Major Companies Are Emerging From Bankruptcy

Operational divisions GM and Chrysler have emerged from bankruptcy, locally, Frontier airlines is about to do the same.

The FDIC Worked

The FDIC insured 8,305 commercial banks and savings institutions with a total of $13,847 billion in assets at the end of 2008.

In all of 2008, one of the worst years in the recent history of banking, 98 new FDIC banks were established, while 25 failed and 5 were involved in "assistance transactions." "This is the largest number of failed and assisted institutions in a year since 1993, when there were 50. At year-end, 252 insured institutions with combined assets of $159 billion were on the FDIC’s “Problem List.” These totals are up from . . . 76 institutions with $22 billion in assets at the end of 2007." The average troubled bank at the end of 2008 had about 630 million in assets (1/25,000th of the total assets of insured institutions). The average FDIC insured institution has about $1.5 billion in assets.

Put another way, 99.6% of FDIC commercial banks and savings institutions didn't fail or require FDIC assistance in 2008, and "problem banks" (a much larger category than failed banks) made up just 3% of all banks with less than 1.2% of the assets of FDIC insured banks.

So far in 2009, 53 banks have failed and required FDIC intervention, and those institutions had total assets of roughly $35 billion, more than half of which involved the three largest failed banks (about 0.3% of the assets of all FDIC insured banks).

Historically, there were more than 53 bank failures in every year from 1936-1939 (the Great Depression) and from 1984-1992 (the S&L Crisis).

Most of those banks have been small, and only five states have seen banks with combined assets of more than $2 billion fail, in order of billions of dollars of assets of failed banks: Florida, Georgia, California, Illinois and Colorado. Six of the banks closed in Illinois were owned by the same family. Just three of the banks, one in Florida, one in Georgia and one in Colorado has $2 billion or more of assets.

In contrast, the vast majority of independent mortgage finance companies making subprime loans, many doing hundreds of millions or billions of dollars of business each year, are no longer in business, and all of the free standing investment banks in the U.S. have gone out of business or been acquired by other types of institutions as more highly regulated divisions.

Risk Premiums For Big Business Loans Have Returned To Normal

The genuine financial panic of late 2008, evidenced by a phenomenal surge in interest rates for all but the safest investments, is essentially over.

At its worst, the interest rate spread between high grade and low grade 30 day non-financial commercial paper (i.e. short term loans) was 5.00 percentage points. It is now 0.59 percentage points, which while considerably higher than it was before the financial crisis, is still almost back to normal. Thus, fear of default on short term loans to less creditworthy large non-financial businesses has declined by a factor of ten.

The TED spread, which is the difference between the interbank rate for three month loans and the three month Treasury has dropped to 0.339 percentage points from a peak of 4.63 percentage points. This is within the normal range of under 0.5 percentage points and represents the fear banks have that fellow banks will default.

The interest rate spread between Aaa and Baa rated thirty year bonds and thirty year Treasury bonds has also dropped back into the high end of the normal range, about 1 percentage poinits of the Aaa rated bonds and 3 percentage points for the Baa rated bonds. At the peak of the financial crisis in 2008, the spread was almost 3 percentage points for Aaa rated bonds and more than 6 percentage points for Baa rated bonds. These speads are quite direct market based risk premiums that reflect the market assessment of the likelihood that these bonds will default.

The financial markets are no longer assigning outrageous risk premiums to relatively safe loans. A few months of utter panic in the financial markets has been replaced by business as usual with a slightly elevate concern that less credit worth big businesses may default on their obligations.

The return to normalcy has allowed the Federal Reserve to reduce the short term loans it made to banks, and to non-financial companies that couldn't find commercial paper lenders.

Housing Is More Affordable

Housing affordability, which is a product of median housing prices, mortgage interest rates and median family incomes, was greater in April 2009 than in any time since records were first kept in 1971. Housing affordability remains very high, although not quite at the peak reached in April. The median family has more than 170% of the income needed to afford a median home nationally, and more than double the income needed to afford a median home in the Midwest.

A year ago, the median family in the West could not afford a mortgage payment on a medium priced home. Now, the median family in the West has 151% of the income needed to do so.

The flip sides, of course, are that many families are too worried about unemployment to buy a home, and that mortgages are harder to obtain now that underwriting standards for mortgage lending have tightened. Loans with low down payments and loans for people who have irregular incomes or subprime credit are now much harder to secure. Still, with housing prices down, it takes less money down to make a reasonably large down payment.

Those not interesting in buying homes are finding that it is easier to find an affordable apartment as vacancy rates rise, and that rents are falling.

Office Space Is More Affordable

Households looking for a place to live aren't the only beneficiaries of the collapse of the housing bubble. Office space is also easier to find, and rent for office space is declining, often dramatically. This takes economic pressure off a wide variety of businesses.

Savings Rates Are Up; Consumer Debt Is Down

Personal savings as a percentage of disposable income are at 6.9% as of May, 2009, the highest it has been since December 1992 (with the one month exception of December 1993 when it reached 7.6%) and about the same as the fifty year average. See also here.

Consumer debt levels meanwhile have declined about $100 billion nationally from a peak of $13.9 trillion in 2008. This is still almost double the amount in 2000, however, so it isn't wonderful. "Household debt peaked at 133% of disposable income in 2007 vs. 65% in the mid-1980s."

While these are baby steps, the was a growing consensus before the financial crisis that people were saving too little and borrowing too much for consumer spending. This wasn't necessarily irrational on the part of the consumers. It was in part due to a perception of real estate and stock market wealth that, in the end, disappeared before it was realized. But, a return to more normal savings levels and a decline in consumer debt levels are positive trends.

1 comment:

Jamie said...

A strengthening stock market also greatly reduces the risk that pensions will remain underfunded and potentially unable to meet their obligations.