Monday, August 22, 2011

Hopeful for the Future

It’s easy to react to every economic statistic that is released each morning. Good or bad, emotions take over. The spate of bad statistics lately combined with little meaningful movement here and abroad on addressing government debt levels and high unemployment has overwhelmed markets.

The uncertainty and confusion increase worries that we are on the verge of another recession. Certainly, the odds of another recession have risen -- to 1 out of 3 and perhaps higher as uncertainty breeds inaction. In the face of all the day-to-day changes, it’s useful to step back and look at the picture across many months and years. Some important observations emerge -- both positive and negative.

First, it’s not a repeat of 2008. Things are slow and tough, but they’re better than they were. Financial market conditions are much better now -- even with the current problems -- than in 2008. Risk spreads are much lower and liquidity is vastly better. For example, risk spreads are under 50 basis points now -- the norm for a functioning market -- compared to over 450 basis points during the height of the crisis.

Second, while unemployment is still very high, consumer debt levels have fallen fast and savings rates have risen considerably. For example, the Fed’s Consumer Financial Obligation (debt service) ratio is at its lowest point since 1994. Nominal personal income has risen and regained what it lost during the recession.

The private sector has had 17 straight months of positive job growth. It’s not strong enough to reduce the unemployment rate (particularly with public sector payrolls falling), but it’s a far better picture than the 8.5 million jobs that were lost in the recession. Hiring today, while at low levels, is absorbing the current level of layoffs and the voluntary quits.

Third, businesses are more conservative and many are stockpiling cash and lowering debt levels. Tens of thousands of businesses have failed throughout the recession, but the survivors are by-and-large positioning themselves for a slow recovery and to expand when things improve. Lack of confidence is freezing current expansion plans.

And fourth, U.S. banks continue to improve. Banks have added $238 billion in capital since 2008 and pushed the industry’s capital-to-assets ratio to a record high of 11.3 percent. Asset quality is improving. Banks have ample liquidity (excess reserves at the Fed now exceed $1.6 trillion) and borrowing from the Fed has practically disappeared (from $700 billion during the crisis to about $12 billion today). U.S. banks are seeing large inflows of deposits -- $100 billion in the second quarter alone and before the current flight to quality. FDIC-insured bank deposits are the safest thing around.

These positive trends are critically important and it reflects the continued healing from the recession. But I’m a realist as well. It will be a long and winding road to recovery. There is no straight line going upward. The high level of unemployment and the overhang of housing will take many years to resolve. The time horizon is five or six years, not one or two.

For example, past recessions suggest that the unemployment rate comes down very slowly. It took 76 months for the unemployment rate to return to “normal” levels following the 1980-81 recession when unemployment peaked at 10.8 percent. The same pace of improvement was seen following the 1991 recession and there’s little to suggest that today will be any different. If anything, that six-year timeframe of the 1980s will be even longer this time. A 6 percent unemployment rate by 2016 requires GDP to grow at about 4 percent per year.

Housing problems will also take years to resolve. With a shadow inventory of about 1.7 million units, it will take years to eliminate the overhang at the current pace of sales. The most stunning chart that I’ve seen is housing starts over the last half-century (you can see this, and many other charts, in the link below). Housing starts are near historic lows, running at about 600,000 a year compared to the 50-year annual average of 1.5 million. Even more troubling is the demand for new homes doesn’t appear strong enough to absorb the record low levels of new homes being built.

Sovereign debt issues in Europe are adding enormous volatility to markets. Losses on debt of Greece, Portugal and Ireland have yet to be recognized and dealt with. Each day, there is more talk and no resolution. The sovereign debt struggles in the Eurozone are a constant reminder that the U.S. may not deal well with our own debt problems. It’s a global economy, and worries in one corner are instantly transmitted to all of them.

Despite all of the headwinds that we face, it’s useful to remember these points: The United States remains the most productive nation, with the strongest banking system and the currency of choice. It is second only to China in manufacturing and has businesses that remain extremely attractive to foreign investors. The United States is also the world leader in technology and innovation.

It will not be a straight road to recovery and the daily grind of economic statistics will darken our mood, but there is good reason to be hopeful for the future.

See more charts on the economy.

-James Chessen, ABA Chief Economist

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