An abnormal recovery

July 30, 2009

jamessaft1 (James Saft is a Reuters columnist. The opinions expressed are his own)

Things in the U.S. economy are moving in the right direction, but the pace will be slow, frustrating and very likely to disappoint investors betting on a rip roaring old-fashioned recovery.

News that the Standard & Poor’s Case-Shiller 20 City house price index rose for the first time in almost three years in the three months to May was greeted with much rejoicing.
The Case-Shiller data is important and encouraging but not nearly as positive as it looks at first glance.

For one thing, house prices are supposed to rise in the spring; when looked at on a more meaningful seasonally adjusted basis prices are still falling, though at a slower rate than before.

For another, the relative improvement coincides with foreclosure moratoriums which are delaying but not eliminating the flood of repossessed houses.  One way or another these houses will need to clear the market and be a continued source of downward price pressure.

Rather than a recovery we are probably facing an extended slow descent in house prices. Compared to how things looked in February this is good news.

Inventories of unsold houses are declining, though they are still unusually high, and housing starts actually rose in June, though again from historically very low levels.
All in, it looks like a tentative recovery in housing activity, which will feel very good indeed after the past two years.

In combination with a bit of inventory restocking, after all there is some final demand in the economy, you might even call it a recovery.

But rather than springing out of bed and hurtling back to work, the U.S. economy will be like a recovering swine flu victim with little energy and very susceptible to a relapse.

“The normal cyclical dynamic in which housing, consumer durable goods purchases, and investment spending rebound in response to monetary easing is unlikely to be as powerful in this episode as during a typical economic recovery,” New York Federal Reserve President William Dudley said in a speech on Wednesday.

“There are a number of factors which suggest that the pace of recovery will be considerably slower than usual,” he said.

America is still “long” housing, its just that too many of the houses are not in the right places and too many are owned by people who’d be better off renting.

We’ve seen the homeowner vacancy rate decline, but the rental vacancy rate rise to record highs. Even if we believed that the price adjustment was over, it would be hard to underwrite a strong economic rebound on the back of housing in the current circumstances.


The key to any recovery is consumption, which at 70 percent of the U.S economy may well be at a generational high.

Even if house prices don’t fall very far from here, they, along with stock prices, are down enough to have dealt a very serious blow to the average household’s balance sheet. Quite sensibly, if a bit surprisingly, people are attempting to fill that hole by saving.

According to U.S. Commerce Department data the savings rate rose to 6.9 percent in May, the highest since the end of 1993 and up from just over zero in early 2008. Who’s to say too that Americans don’t continue to increase their savings from here, perhaps back up to 8.0 percent or more.

Unemployment is rising and will take some time to fall and there is a growing realization that given growing life expectancy people’s pensions are woefully underfunded.

Income growth is not going to rescue consumption either.  The New York Fed’s Dudley pointed out that despite cuts in hours worked and lousy wage gains, incomes in the first half of the year were boosted by a number of one-time factors, such as falling energy prices and a one-off payment to Social Security recipients.

A higher savings rate and poor income growth add up to a really profound check on consumption spending, something that will make earnings growth for many companies difficult despite savage cost cutting.

I’d bet too that income growth recovers long before the savings rate falls. Business plans or investments strategies based on growing consumption in the U.S. are going to be losing ones for quite some time.

And of course there is commercial real estate, which is not only the single biggest landmine for banks but will be a source of further outright contraction as current projects are completed and developers, businesses and their banks shorten their sails.

Construction, once begun is carried through but who will be breaking ground on new projects?

None of this is necessarily bad, and again, is actually pretty good compared to where we were just a few short months ago. But a world in which Americans save and pay down debt and where banks lend cautiously while rebuilding balance sheets may not be one where current stock market values are validated.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)


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I find it worrying that the implied measure of improvement in the economic outlook in this article seems to hinge on house prices and consumption, savings or over-doing credit. Where’s the productivity? Where’s real growth?
What worries me even more is that the measures of improvement implied in this article is exactly what our “leaders” consider to be the priority… after making sure their buddies in the banks have enough freshly printed money for their remuneration.

Posted by Peter H | Report as abusive

The moratorium on foreclosures is such a disaster looming, for the exact reason highlighted in this column. Companies are cleaing their balance sheet by cutting costs. Jobs are costs, so the moratorium was made with the hope that once the stock market rebounded and companies were healthy, they would rehire and we’d be humming along again.

As Bank of America is showing by announcing a closure of 10% of its branches, companies are realizing that we may have been a bit outsized over the last few years. The real estate related jobs (mortgage, agents, builders, contractors, Home Depot, Lowes, etc.) are not going to come bounding back. The money pulled from inflated homes to live lavishly is now gone, and not coming back, and probably not going to be let out by wary banks.

It is more likely that the Case-Shiller report is the eye of the hurricane than a reassuring red sky at the end of the recession.

Posted by George | Report as abusive

Given the suspension of mark to market, large unreported shadow inventories, notice of defaults clearly inconsistent with delinquencies, foreclosures at record levels, and a population that can only be described as unemployed, underemployed, or underpaid, I am unconvinced that we’ve experienced anything other than the fugitive ad hoc measures of a desperate government playing kick the can. Wait until the Alt-A and Option Arm mortgages recast near the end of this year. Good article by the way.

Posted by jb | Report as abusive

The simple truth that stimulus package doesn’t work. Banks got credits but there is no strings attached to make them lend these money to real economy.
Secondary mortgage (MBS/CMOS etc) market is dead and will be dead until banks are forced to accept marked-to-market price.

CRE disaster is unfolding. Many businesses cannot refinance/roll their commercial mortgages. Banks also own a lot of CRE.

Banks suppose to be source of financial stability in society. Today banks are introducing a lot of instability. We should be less concern about capitalism and more about making banks carry out their main function – financing real economy.

Posted by sergey | Report as abusive

It always strikes me as peculiar, when someone refers to bank lending as a necessary element of economic activity. Until very recently, industrial expansion and new products were funded primarily from retained earnings (profits) – not bank lending. If General Motors wanted to introduce a new model, they had cash to invest in styling and marketing.

Bankers lent a portion of residential construction cost, if you had a steady job and a hefty down payment – until Congress chartered the GSEs who “securitized” mortgages. No private lender would have dared lent to NINJAs.

Now government decrees that we can spend our way out of a bad financial hole. Unemployment in Ohio is officially 12%, effectively 20% and no sign of recovery.

Posted by Alan von Altendorf | Report as abusive

What if..

To many jobs have left the U.S. by the way of pretty much everything made in china. Including cars soon, say byebye U.S car makers.

So bubbles are the only way to keep us going now? The government most likly knows this and now we are left with printing money as the latest bubble. Till the other super powers say hey ok your money is junk. Then what, we must have teams of people whos jobs are to assure other governments that our printing of money is nothing to worry about.

Posted by henry | Report as abusive

Well said JB! There is just way too much negative news out there! The recent market move up looks like a good old fashioned “pump and dump” scheme all based on a federal government that says the worst is over now. It sounds like ENRON all over again as all is NOT okay!

Posted by Lou | Report as abusive

Inventories of unsold houses are declining, but is there more to this story? What percentage of these sales are from investors buying properties at depressed prices?

Posted by Ken Slank | Report as abusive

Commercial banks have gone back to the old conservative methods of credit underwriting. No longer will there be a massive push for loan totals fueled by mortgage brokers and internal lending officers stimulated by huge bonuses based on loan production only and not loan quality. Lending officer performance will now be based on loan quality and not on generated loan volumes and loan fees. Bankers that want to stay employed until retirement will now have to demonstrate their credit skills and loan service skills and not just their ability to generate sales.

Posted by Bighorn | Report as abusive

To Alan von Altendorf –
“It always strikes me as peculiar, when someone refers to bank lending as a necessary element of economic activity.
Until very recently, industrial expansion and new products were funded primarily from retained earnings”

On contrary money accumulated from retained earnings tend to be wasted by greedy managers.

Since Middle Ages every significant project was financed with credit. From Great Explorations to Wars to Constructions.

Credit is just like oil that lubricates economy. Unfortunately today banks are disconnected from real economy they became destabilizing speculative force.

Posted by Sergey | Report as abusive

There will be a number of forces that in the end will be good for getting Americans to save, banks to be more conservative lenders, etc., and that is part of the roller coaster of the economy that I do not fear–that’s just the annoying part when I look at my 401K balance in the short run.

Henry points to the part that we all fear–that we spend huge amounts of money developing an idea, then ship off the production to the Orient. They then produce it cheaply, steal the idea, stop producing our stuff, then produce their own versions at a fraction of the price. They don’t pay for the R&D, pay very little for labor, ignore environmental and humanitarian concerns and send it back to us for our consumption. Not sure how any of the clever consumption schemes in America will dig us out if we’re just consuming.

Posted by Al | Report as abusive

I view the economy as an automobile engine. We ran it out of oil and then we tried to make it to the next gas station. Now we have to rebuild the cripple and it is a major undertaking. We tried filling it up with oil and driving it, but the bearings and rings are scored and it only will run on two cylinders(not 6). Even when it gets rebuilt it will have to be carefully driven as we have stressed the engine block and has cracks that may or may not crack further. People will have to start owning houses and cars, and businesses will have to expand using profits rather than borrowed money. Companies will also have to be allowed to have protected reserves to weather dips in the economy. Takeover people will have to have very specific rules to protect the shareholders. I think the leveraged takeover is dead.

Posted by f belz | Report as abusive

How can there be a recovery? These houses that are being “moved” are most likely people buying foreclosures with the hope of making money on them somehow eventually.

But with no jobs, how can people afford to pay their rent, especially if on a 30 year loan?

Who has money to play on the market? That 4.7 trillion that the Financial Industry got, that disappeared, think that would be enough for Goldman Sachs, J.P. Morgan, and all their clients, friendly nations (who have Ex-Goldmanites) and their shell companies using high frequency computerized trading techniques to keep the market moving? Who needs the common investor when the computerized market makes money for the “Big Banks” plugged into the market using computerized trading?

Posted by C.D. Walker | Report as abusive