Review Saperston's Economic Research fresh each Saturday Morning. It is specially prepared by Stone & McCarthy Research of New York City. Go To : www.saperston.com
WEEKLY ECONOMIC COMMENTARY -- WEEK OF MARCH 12, 2010
It will take a painfully long time before the damage from the Great Recession is fully repaired, but the healing process is definitely underway. The financial system is mending, as the capital markets are eagerly swallowing up record volumes of corporate bonds and Treasury issues, mergers and acquisition activity is coming back to life, the Fed has closed down virtually all of its emergency lending facilities aimed at propping up financial institutions, and credit availability is improving for households, albeit the demand for loans remains constrained. Financial flows are the lifeblood of the U.S. economy and their resuscitation is key to sustaining the recovery.
The deep wounds on the real side of the economy are also on the mend, although the pace of improvement is lagging the financial side. That's not surprising, given the lopsided benefits that the financial system reaped from government support relative to what Main Street received. Moreover, there is the time-honored recognition lag that is now playing out. The financial system may be functioning more normally and an array of economic data may indicate that the nation has exited the recession; but the vast majority of households and businesses remain highly skeptical of the strength and durability of the recovery. Until the all-important job-creating engine revs up, fattening paychecks and enabling households to rebuild decimated balance sheets, that skepticism will linger and suppress growth.
That said, the vicious cycle of massive layoffs, plunging asset values, sinking confidence and financial turmoil that led the economy into a pernicious nosedive has been broken. Slowly but surely, a virtuous cycle is settling in and underpinning the recovery; job openings are increasing, layoffs have receded, incomes are rising and confidence is returning, nurtured by rising asset values and more favorable credit conditions. Absent the unusually harsh weather last month, job growth would likely have turned positive in February and is poised to do so in March, in large part due to an upsurge in Census hiring. Notwithstanding the temporary nature of the Census jobs, they will provide a much-needed jolt to wages that will boost purchasing power and spending. That, in turn, will act as the functional equivalent of another fiscal stimulus, with multiplier effects on orders, production and more jobs.
It will take awhile before decimated paychecks wrought by the 8.4 million jobs lost since the onset of the recession in December 2007 are made whole again, which will restrain the spending propensity of households. According to most estimates, those lost jobs plus the number needed to accommodate the increase in the labor force will not be recovered at least for another three years. The unemployment rate, at 9.7 percent, will stay high over the foreseeable future, and the new "norm" for full employment is viewed as being closer to 5 ½ percent than the 4 ½ percent seen earlier in the decade and in the 1990s. Part of that upward adjustment can be attributed to slower growth and part due to structural changes in the economy that has increased the mismatch between skills companies want and the skills available among job seekers.
But it now seems that the unemployment rate is peaking out earlier and at a lower level than thought a few months ago. What's more, the vast damage to household balance sheets associated with the plunge in asset values and the debt run-up prior to the recession is being gradually repaired. The Federal Reserve provided further evidence of the latter in its latest flow of funds report, released this week, which provides a comprehensive snapshot of financial flows and balance sheet changes for households, businesses and the various levels of government. In the critical household sector, the transformation from an ambulatory victim struck by a perfect storm of financial thunderclaps to a recovering patient that is able to reclaim some semblance of normal functioning continued apace in the fourth quarter.
From late 2007 through the first quarter of 2009, households suffered a devastating $17.4 trillion loss in net worth, wiping out more than 25 percent of the total held in the third quarter of 2007. That wealth destruction reinforced the recession's negative impact on spending, and left a big financial hole for households to climb out of. But the climb received a big assist from the astonishing 60 percent stock market rally that began precisely a year ago this week, boosting the value of direct stock holdings by more than $2.5 trillion alone. Households also increased savings and paid down debt and even saw a modest increase in housing values last year. Hence, after hitting a low of $48.5 trillion in last year's first quarter, net worth rebounded to $54.2 trillion at the end of the fourth quarter.
To be sure, there's still a ways to go before net worth climbs back to its bubble-inflated $65.9 trillion peak reached in mid-2007, before the housing bust and stock market collapse vaporized asset values. Absent the unlikely event that another asset bubble suddenly reappears, those riches are not likely to be recaptured any time soon. Indeed, households have reverted to a healthier mind-set that trumpets the virtue of living within their means as a guiding principle, which foreshadows a long slog of higher savings, less leverage and more rational spending decisions. That may not satisfy the rapid-growth crowd, but it is a far cry from the panic mentality that prevailed at the height of the recession, which evoked fears of another Great Depression. Nor, for that matter, is it necessary for households to regain all of the final $11 trillion lost during the recession to keep their wallets open. Relative to disposable incomes and economic output, net worth has already returned to the high end of the range prevailing throughout the post-war period.
That's not to say that Americans are fully comfortable with their financial condition. The Fed's flow of funds data, which show the brighter balance sheet picture, encompasses a wide range of households in different income classes. Obviously, the ones who derived the most benefit from the stock market rally are those with a large stock portfolio, who are generally higher up the income ladder. For the most part, these are also the biggest savers, so their improving wealth will have less of an impact on aggregate spending than was the case in earlier years, when the housing boom encouraged the less well-off to borrow extensively against their homes to finance spending. Those overextended borrowers who are now struggling with huge debt loads and facing foreclosure are not likely to step up spending in any meaningful way until their income prospects show more improvement.
Indeed, the flow of funds data provide striking evidence of how heavily households relied on their housing equity to sustain their life styles. Throughout most of the post-war period until the early 1990s, homeowners retained well over a 60 percent equity stake in their homes, averaging 69.6 percent from 1952 through 1989. Even as they started to extract more equity through borrowing in the 1990s because of easier access to mortgage credit in its various forms, the equity share averaged 60 percent from 1990 through 2006. One reason: appreciating home values just about offset the increase in mortgage borrowing. But with the housing bust and plunge in property values since then, the equity stake of homeowners has declined precipitously, plunging to an all-time low of 33.5 percent in the first quarter of 2009. Keep in mind too that about one-third of homeowners paid off their mortgages, which means that those with mortgages have a much smaller equity stake in their homes than the averages indicate.
However, over the last three quarters, homeowners have rebuilt some of their equity stake. By the end of last year, equity as a percent of property values had risen to 38.1 percent - still very low by historical standards but measurably off the bottom of a year ago. The improvement reflects a blend of forces that are likely to continue going forward. On one side of the ledger, housing values are starting to slowly recover, although obviously not in every region of the nation. On the other side is the repayment of mortgage debt, which lifts equity as directly as does a rise in home values. The decline in mortgage debt is a particularly compelling story that reflects both positive and negative trends. To the extent that paydowns are voluntary, reflecting a deliberate effort to lighten debt burdens as part of the balance-sheet repair process, the trend is positive. Unfortunately, some portion of the paydowns is involuntary, reflecting foreclosures and distressed sales that may have more of a negative than positive impact on household finances.
But despite the unequal nature of the balance sheet improvement, households in the aggregate are in a better place than they were last year. That is showing up in their spending habits, which are anything but robust but are nonetheless steadily reviving. According to this week's retail sales report, consumers rang up more cash registers in February than forecast. An expected decline in auto sales (the Toyota effect) held back the total, which rose by a still-solid 0.3 percent, with virtually all major categories participating in the gain. Most encouraging was the rise in sales excluding the volatile auto and gasoline purchases, which is more representative of underlying trends. These purchases rose by 0.9 percent in February, following a solid 0.5 percent increase in January - the strongest two-month gain in a year.
To be sure, the federally funded cash for appliances program gave sales a boost, as evidenced by the sizeable 3.7 percent jump in revenues at electronics and appliance stores (although the Super Bowl may have juiced sales of plasma TVs as well). But the modest recovery in consumer spending is consistent with other barometers of an economy that is moving ever more firmly on a growth track. Hardly anyone expects a vigorous rebound from the recession, one that resembles a V-shaped recovery. There are still too many scars that have yet to heal, particularly the deep wound in the housing sector that continues to impair a broad swath of the population. With each passing month, however, the economy seems to gain more vigor, even as the headwinds suppressing growth are beginning to fade. There remains the question of whether the recovery can be sustained without the formidable support provided by government steroids. The latter are scheduled to phase out in coming quarters, so the economy will be put to the test. We believe it is