As the steepest downturn since the Depression begins to yield, slowly, to signs of recovery, economists, who had been focusing on whether the downturn has ended, are now debating how the recovery will unfold: Will it be a “normal,” robust, v-shaped recovery, with an upward trajectory almost as steep as the downturn? Or are we facing what some are calling a “new normal” — a recovery redefined by prolonged, persistent unemployment and reshaped by a profound, long-term shift in consumer psychology?
Economists who question those proclaiming the end of the world as we’ve known it say they have history on their side. “Whenever we have plunged off a cliff and fallen into a deep hole for a while in the past, the economy has a tendency to bounce back very quickly,” James Glassman, senior economist at J.P. Morgan Chase, told Bloomberg News. Glassman thinks predictions that economic growth will jump from below zero to 4 percent may be too conservative. Pent-up demand created by long-deferred discretionary purchases will soon lure consumer from their new-found frugality, Glassman believes.
Tobias Levkovich, Citigroup’s chief U.S. equity strategist, agrees. After a prolonged period of deferred consumer spending, he told Bloomberg News, “some reasonable bounce is to be expected.” Levkovich also doubts that recent consumer behavior, driven by the economic downturn, will create the “new normal” that some analysts say will replace the old one. The recent shift from spending to saving, although dramatic, is temporary, Levkovich believes. There is no reason to expect that “the frivolous consumer will turn into the frugal buyer,” he argues.
Of course, a rebound in consumer spending assumes a strong recovery in the labor market, or at least the expectation that a recovery is in the making, and on that score, recent employment statistics paint a mixed picture. The pre-Labor Day report that employers had shed fewer jobs than expected certainly cheered the stock market. But the jump in the unemployment rate to 9.7 percent, sent a cold chill through retailers, already reporting dismal back-to-school shopping results and now looking ahead to what could be an even bleaker make-or-break Christmas season.
The 217,000 jobs lost in August represented the fewest cuts in more than a year and that counts as good news, according to Automatic Data Processing (ADP), which tracks employment trends. “It shows there’s a gradual improvement in labor markets under way,” a company spokesman told CNN-Money. But the statistics also indicate that “we have several more months to go of job losses,” and that is “disappointing,” the ADP official acknowledged.
A Jobless Recovery
The employment outlook grows a shade or two darker for analysts who point out that adding part-time workers, who want full-time jobs but can’t find them, boosts the “real” unemployment rate to 16 percent. And even the most optimistic analysts, who are convinced that the economy is beginning to recover, are also talking about a largely jobless recovery. The result — a prolonged period of unemployment —would have a devastating impact on the incomes of millions of workers, who won’t find jobs comparable to those they have lost, and on the confidence of employees whose jobs haven’t been affected, but who will remain uncertain about the stability of their income.
A recent Gallup poll found that while consumers are becoming more upbeat about the economy, they remain cautious about their spending plans, and that caution persists in virtually all income and age categories. “The fact that all…generations seem to be pulling back strongly on spending, even as optimism about the future of the U.S. economy has increased, does not bode well for a strong economic recovery in the near term,” Jeffrey Jones, a Gallup analysts, said in his analysis of the survey results.
Nouriel Roubini, one of the few economists to predict the current downturn, is also one of the few warning that a sluggish recovery could turn into a double-dip recession. An economist at New York University’s Stern School of Business, Roubini emphasizes the “wealth shock” on his list of reasons to expect, at best, a U-shaped rather than V-shaped recovery. In a reverse of the “wealth effect” — the bubble in home prices and investment income that drove consumer spending for much of the past decade – Roubini suggests that the staggering decline in home prices and the erosion of retirement portfolios, combined with a jobless, or near-jobless, economic recovery, will depress spending and impede economic growth for the foreseeable future.
Bill Goss, co-chief investment officer of PIMCO (whose analysts are credited with coining the “new normal” term), agrees. “If you are a child of the bull market, it’s time to grow up and become a chastened adult,” Goss wrote in his September investment outlook. “It’s time to recognize that things have changed and that they will continue to change [for the next 10 to 20 years].”
Don’t Count on Housing
Although housing dragged the economy into a recession, Goss argues, it will not lead the way out of the economic wilderness, as it has done in the past, “no matter what the recent Case-Shiller home price numbers suggest.”
The most recent reading of that closely-watched housing market gauge seems to support a somewhat brighter assessment of the housing market and the economy than Goss and other proponents of the “new normal” theory perceive. In the 20-city index, prices increased nearly 3 percent in the second quarter compared with the first three months of the year, the first quarterly increase in more than three years. Prices were down 15.4 percent year-over-year, but that is the smallest annual decline since April of last year.
Both Robert Shiller and Karl Case, the co-founders of the index, think the recent statistics are significant and encouraging. Case told the New York Times that he “danced a jig” after seeing the most recent numbers. “It appears the housing market is stabilizing quicker than people thought it would,” he said.
A bit more restrained, but no less optimistic, Shiller noted “the sense that something is changing is definitely in the air. After three years of decline, “he told the Times, “we might be seeing a turnaround across a broad spectrum of the market. “
Home sales activity has also been encouraging, with both existing and new home sales in June notching consecutive increases of four and eight months, respectively. For existing homes, the annual sales pace of 5.24 million homes in June was the strongest in more than two years; the 7.2 percent month-over month gain was the largest recorded since the National Association of Realtors began tracking these numbers in 1999. The pending sales index, an indicator of future sales, rose 32 percent to 97.6 in July — up nearly 12 percent year-over year and the highest reading since June of 2007.
The new home sales figures were equally encouraging. Sales for July posted the largest month-over-month gain in four years (9.6 percent), reducing the inventory of unsold homes to 7.5 months – 35 percent below the year-ago level and the smallest inventory of unsold new homes in more than two years. Although housing starts were down overall in July, reflecting a steep drop in multi-family activity, single family home starts increased by 1.7 percent, and single-family permits increased by 5.8 percent, reaching their highest leave since October of 2008.
The National Association of Home Builders’ (NAHB’s) monthly gauge of builder optimism reflected those trends, reaching its highest level since June of 2008. Perhaps the best indicator of the improving mood – builders are beginning to purchase raw land again. According to a recent Bloomberg News report, “Home builders that spent the past three years selling off land and writing down the value of property buildings are now scouring the markets in Sacramento, Phoenix, Denver and Orlando,” looking for attractive deals in markets representing ground zero in the real estate downturn.
Ambiguous Signals
While signs of improvement in the housing market are welcome, they are also ambiguous. Industry analysts attribute increased sales partly to the first-time buyer tax credit (which expires in November) and partly to improved “affordability” – a euphemism for declining prices that have also left 15.2 million homeowners with mortgages exceeding the value of their homes. First American CoreLogic estimates that 25 million more owners may join that list if prices decline by another 5 percent.
Mortgage delinquency and foreclosure rates, meanwhile, continue to rise, despite intensive government efforts to help struggling homeowners. Most disturbing to analysts is the increase in foreclosures involving prime borrowers, accounting for one-third of all foreclosures in the first quarter compared with one in five a year ago.
“It’s certainly a problem with employment, but it’s also a function of how far home prices have fallen,” Jay Brinkmann, senior chief economist for the NAHB, noted recently. The percentage of all residential mortgage loans past due or in foreclosure rose to 13.16 percent at the end of the second quarter, the highest level since 1979, according to the NAHB report.
Worse than it Looks
Those statistics may actually understate the foreclosure problem, according to some analysts, who note that lenders and servicers are delaying foreclosures as long as possible in order to defer losses for as long as they can. RealtyTrac reported recently that of 2.3 million homes receiving foreclosure notices last year, only one-third had been repossessed by year-end. “No one is encouraging banks to quickly book $75 million in losses and then take the heat for it, since they wouldn’t have a job for very long if they did,” Robert Simpson, president of Investors Mortgage Asset Recovery Company, told American Banker.
Echoing that concern in a recent note to investors, Morgan Stanley analysts noted that the much-touted improvement in home prices has been concentrated in areas where foreclosures have declined. “But this drop-off has nothing to do with fewer people becoming delinquent,” the analysts pointed out. “Instead, it has to do with banks and servicers reducing the rate at which they are taking back properties.”
Morgan Stanley analysts aren’t alone in warning that the lenders who are delaying foreclosures are simply setting themselves and the economy up for an even harder fall. “One of the oldest lessons in banking is, ‘the first loss is the best loss,’” Fred Cannon, co-director of Research at Keefe, Bruyette & Woods, Inc. told American Banker recently. “That’s what most lenders believe,” Cannon added. “The question is, are they abiding by their own rule.”
