Thought Theater

Keeping A Watchful Eye On The Economy genre: Econ-Recon

Despite assurances from the Bush administration, the factors for instability in the economy continue to provide evidence that a recession...or at the minimum...a significant slowdown in Gross Domestic Product is just around the corner.

The following three excerpts provide a quick review of the numerous issues that will undoubtedly exert influence on the degree and the depth of any such occurrence.

From The New York Times:

Keep Your Eyes On Adjustable-Rate Mortgages

In fact, the mortgage meltdown has arrived at something of a turning point. So far, most of the loans gone bad were among the worst of the worst. Some were based on outright fraud, either by the lender or the borrower.

But the pool of people falling behind on their house payments is starting to widen beyond this initial group, and adjustable-rate mortgages are the main reason. Starting in the spring of 2005, these mortgages began to get a lot more popular, largely because regular mortgages no longer allowed many buyers to afford the house they wanted.

They turned instead to a mortgage that had an artificially low interest rate for an initial period, before resetting to a higher rate. When the higher rate kicks in, the monthly mortgage bill typically jumps by hundreds of dollars. The initial period often lasted two years, and two plus 2005 equals right about now.

The peak month for the resetting of mortgages will come this October, according to Credit Suisse, when more than $50 billion in mortgages will switch to a new rate for the first time. The level will remain above $30 billion a month through September 2008. In all, the interest rates on about $1 trillion worth of mortgages, or 12 percent of the nation’s total, will reset for the first time this year or next.

So all the carnage in the mortgage market thus far has come even before the bulk of mortgages have reset. “The worst is not over in the subprime mortgage market," analysts at JPMorgan recently wrote to the firm’s clients. “The reason for our pessimism is that loans originated in late 2005 and all of 2006, the period that saw peak origination volumes and sharply decreased underwriting quality, are only now starting to reset in large numbers."

So while we hear the apologists suggesting that the sub-prime lending crisis will not be broad enough to push the larger economy into a recession, we rarely hear discussions of the pending adjustable-rate fiasco. While these loans haven't begun to reset in large numbers, the out of sight, out of mind mentality won't prevent the inevitable surge in loan failures that will accompany this significant event.

Further, even those borrowers who don't default will have to constrain their spending...and that will further slow an economy that many, myself included, believe has been largely built upon equity lending fueled by rising home values. Lastly, it may also lead to lower home prices as homeowners unable to sustain the higher payments feel forced to sell.

Imagine the convergence of events...higher interest rates on new loans and adjustable rate loans, slowing home sales and a glut of existing homes for sale as well as declining prices, a tightening of available capital and more stringent lending standards, and the shrinking equity available to fuel spending and the associated economic growth. That's not a very pretty picture.

From The Denver Post:

Is Recession Already With Us?

U.S. Bank regional economist Tucker Hart Adams, a.k.a. "The Duchess of Doom," put a high probability of a recession in her 2007 forecast at the beginning of the year. She did not think it would hit until the fourth quarter.

"Now, I'm wondering if it is going to hit us sooner," she said.

It's almost impossible to tell what's going on. The market has grown too complex, and all the signals are mixed.

"I don't think the unemployment numbers are telling us anything," said Adams. "If you lose your job in construction and a hospital needs 600 nurses, does it matter?"

Adams also thinks illegal immigration is affecting the numbers. When illegal workers lose their jobs, they don't show up in the unemployment lines.

And inflation?

"If you don't drive a car, or eat, or heat or cool a house, that's a real good indicator," Adams said.

I often wonder how much of the recovery from the last recession (which officially ended in November 2001) was borrowed.

It seems we collectively lost our jobs at Internet companies and took out home-equity loans to keep spending.

With interest rates at historic lows, this made sense. But now, interest rates are higher and borrowers are increasingly defaulting. A spate of home foreclosures is finally wreaking havoc on Wall Street.

Adams has been a mainstay in providing information on the economic conditions in the region and few would question her ability to reasonably forecast the future. Never one to sugar coat her thoughts, everything Adams states in this article seems not only plausible, but straight forward and consistent with the thoughts of a number of other economists who are anticipating a significant slowdown.

Her insights into unemployment and inflation caught my attention. All too often the numbers provided by the government mask factors that will ultimately drive the situation. In the last few years, adjustments in how these statistics are being compiled have arguably made them less reliable indicators of what has happened, is happening, or will happen in the market. Add to that the growing complexity which Adams points to and it leaves one even more suspect of those who argue all is well with the economy.

From The New York Times:

Job Growth Slowest In Months

The job market lost some of its punch last month as employers added 92,000 jobs — the fewest number in five months, the Labor Department said today.

In a further sign that hiring has slackened somewhat, the government also reported that job growth in May and June was slower than first estimated and that the unemployment rate edged up last month to 4.6 percent from 4.5 percent.

Wage growth in the current economic recovery has been unusually weak. The real average wage for rank-and-file workers actually fell from the start of 2002 to late 2006, despite solid economic growth. As job growth picked up, wages surged in the second half of last year, before falling back this year.

One cannot overemphasize the meaning of the last paragraph in the above excerpt. The fact that real wages have actually declined in the last four years supports the theory that much of the economic growth in this recent period of expansion has been fueled by debt and the low interest rate housing bubble.

This means that the poor performance in wage growth and an apparent stagnation in the upward mobility one would expect to accompany job growth hasn't materialized...which, in my opinion, suggests that the margin or cushion one might expect to accompany a period of economic growth is going to be much smaller than otherwise expected.

In other words, this recent run of expansion has lacked the depth found in prior periods of growth making it much more vulnerable should we experience a measurable and sustained period of decline. That would suggest that a recession could also last longer and be far deeper than anticipated.

Predicting the economy is a daunting task but this current merger of ominous factors is reason for concern...and we haven't even discussed the huge costs of prosecuting the war in Iraq, the expanding national debt, the huge trade deficit, and the infrastructure deficiencies being brought to light by the bridge collapse in Minneapolis.