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Thursday, 23 September 2010

Recovery Evident Mainly to Statisticians

by Randall W. Forsyth

Balance-sheet drags remain deterrent to economic rebound.

THE GREAT RECESSION IS OVER, and it's news because, except for the stock market, it's far from obvious.

The National Bureau of Economic Research Monday declared the recession that began in December 2007 ended in June 2009, making it the longest since the Great Depression. It also was the deepest, slashing gross domestic product by over 4%, nearly twice as much as the 1981-82 contraction, which had held the distinction of being the worst since the 1930s.

As the seasons change with the arrival of the autumnal equinox in the Northern Hemisphere, it's useful to think of economic cycles in the same way. The end of a recession may be likened to the winter solstice, the shortest day of the year; after that, the days get longer, but that's not apparent during the short, cold days of January.

As with the seasons, the springtime of recovery is nowhere in sight at recessions' end. But in past cycles, 30 months after the peak of economic activity (analogous to the summer solstice), the recovery was in bloom. We're still in the February of this recovery; past the low point but the sun remains low in the sky, occasionally shining but bringing little warmth.

This cycle is different because it was the result of a plunge in wealth, which is ongoing. According to the Federal Reserve's latest flow of funds data, households' wealth contracted by $1.5 trillion in the second quarter owing to the stock market's decline. More importantly, Americans' wealth remains nearly $10 trillion, or 15%, below the yearly peak reached in 2006.

A number of commentators have noted in the second quarter's data an increase in households' real estate assets, to $18.8 trillion from $18.7 trillion in the preceding quarter. Notwithstanding their skepticism, the rise is possible given the federal government's tax credit to qualifying home buyers that expired during the second quarter, which goosed prices and sales volumes temporarily.

Not noticed was the sharp upward revision in the Fed's tally of residential real estate values in the latest flow of funds report. The level of housing assets increased by some $4 trillion, retroactively back through 2009. That statistical revisionism no doubt is as gratifying to homeowners as the news that the recession ended last year is to the ranks of the unemployed.

Another revelation is that much of the reduction of Americans' liabilities—a bigger factor in the improvement in their balance sheets than growth in their assets—has been the rising tide of defaults. WSJ.com's Real Time Economics blog put numbers to that observation () made here previously.

In this column late last year ("Middle Class Money Angst Visible in Dry Fed Data," Dec. 11), I contended the contraction in household debt in the third quarter of 2009 "wasn't just because of Jane and John Q. Public's pledge to get their financial houses in order after having tapped their houses as automatic teller machines. Their debt also was extinguished in the rising tide of mortgage defaults and home foreclosures, not exactly a wealth-enhancing trend."

Three months later, this trend was still apparent in the fourth-quarter report. At the time ("Middle Class Money Angst Still Apparent in Data," March 12), the second part of the headline explained: "Fed's Flow of Funds numbers again show average Americans' net worth gaining more by mortgage defaults than asset appreciation."

And three months ago, the same phenomenon continued ("No Champagne Wishes or Caviar Dreams," June 10) So-called strategic defaults—where homeowners determined it wasn't worth continuing to pay a mortgage worth more than the property—helped push foreclosures to a record at the time.

No respite is in sight, however. With foreclosures surging, spirits of homebuilders remain at rock bottom. The National Association of Home Builders/Wells Fargo reported Monday its confidence index remained at a cyclical nadir of 13. Index readings under 50 indicate conditions are poor. RealtyTrac reported last week that evictions under foreclosure were at a record in August.

Foreclosures may slow, albeit for non-economic reasons. GMAC Mortgage, a unit of recently rebranded Ally Bank (the one heavily advertised in commercials saying even kids know it's not fair to screw you, the customer) Monday said it halted foreclosures in 23 states for procedural reasons.

That doesn't change the doleful reality that, according to Institutional Risk Analytics, "we are less than one-quarter through the total corpus of bad loans and foreclosed properties in the U.S." Citing a presentation by Laurie Goodman of Amherst Securities, one-third of U.S. households have negative equity—owing more than the asset is worth—in their homes, which means one-fifth of them is vulnerable to foreclosure. So massive is the backlog of foreclosures that it takes 18-24 months from a borrower being in default and until they are evicted, according to Goodman.

IRA's Chris Whalen contends loan-to-value ratios in excess of 100% are less problematic that the loss of jobs by one or more of the breadwinners of the household. Whether it's the inability or unwillingness to pay that's more important, defaults and foreclosures have become so numerous that there's a backlog.

Regardless of the declaration of the end of the recession issued from some ivory tower, saying it won't make it so.

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