Archive for the ‘Economy’ Category
For the Seattle-ites out there
The latest issue of the Conway-Pedersen Economic Forecaster just hit my desk today. It’s a “must read” for anyone doing business in the Pacific Northwest. Their lead article is titled “Are We There Yet” and asks if the recession is over.
Of course, “recession” is more than just a feeling, it’s defined by a set of numbers (technically, two consecutive quarters of negative GDP growth). However, as they so aptly put it, “At the end of a recession, when the economy is in flux, numbers can get squirrely.”
We concur. The Blue Chip Economic Indicators rofecast a positive GDP growth for the US of 3.1% this year. However, employment growth for the State of Washington — normally one of the economic leaders — is forecasted for a negative half percent. Ouch. (Actually, national employment is also forecasted at -0.5% this year, since employment growth and GDP growth are not linked at the waist.)
They conclude with the observation that, “While the recession may be over, there is much work to be done before the economy recoups its losses…Our projections indicate that Puget Sound employment will not return to its pre-recession level until the end of 2012.”
For more information, or to subscribe to their very valuable newsletter, visit their web site, www.conwaypedersen.com.
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Billconnerly.com
Just a quick note — just got my regularly scheduled e-mail newsletter from Dr. Bill Conerly (www.billconerly.com). If you have any interest at all in Washington/Oregon economy issues, he’s a must-read.
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Dallas Fed Econ Letter
The February issue of the Dallas Fed’s Economic Letter hit my desk this week. The economic research staffs at various Federal Reserve Banks don’t directly compete with one another, but instead take very different slices of the same issues. As such, I try to glance at most of them from time to time. Dallas does a great job at the nuts-and-bolts of what makes up the economy.
The focus this month is on the way the world-wide recession has hit global trade, particularly durable goods. I won’t bore you with the whole thing — look it up yourself at http://www.dallasfed.org. However, they DO tend to assume that the reader is fully versed on how things work, and as such leave out a few details we would normally need to explain to Econ 101.
From an average persons perspective, world trade begins — and ends — with consumption. People want to buy stuff, and so other people somewhere else make it and ship it to them. If demand falls off, so does supply. Since one person’s consumption is another person’s income, a fall-off in demand creates a downward spiral that needs to be kick-started. It’s one reason why the Chinese are so apoplectic right now — they tend to be in the “supply” biz and Americans and Europeans are in the “consumption” biz. Ergo, if things get really bad, Chinese workers have too much spare time on their hands. Very few things frighten the Chinese leadership more than that.
And yes, trade REALLY got hit hard by this recession. On an annualized basis, U.S. imports fell about 15% in 4Q08 and another 35% in 1Q09 (U.S. exports fell by comparable percentages). Those are huge, but mild compare this to Japan’s experience. Remember — Japan is very much a trading hub. They import a huge share of their food and consumption and make a big chunk of their income by exporting stuff. Japan’s exports fell at an annual rate of about 45% in 4Q08 and a whopping 60% in 1Q09. Their imports fell as well, but not as badly because, let’s face it, if they don’t import stuff, they starve. (If the U.S. doesn’t import food, we end up having to eat domestic lettuce rather than Chilean arugula. It’s just not the same.)
Two things are missing from this equation, though, and need to be understood for a fuller appreciation of the trade problems. First, even if demand picks up (or for that matter, never fell off in the first place), world trade was going to get hit badly due to the almost total collapse of trade capital. Banks in free-fall were cutting lines of credit, and since import/export activities are among the riskiest (and require hedging, which was also in a tailspin), those lines got cut badly. If you were a major player, like Boeing or GE, you could finance yourself. However, if you were Joe’s Apple Orchard, you were out of business.
Second, this is interesting to the real estate community because the huge array of trade means a huge array of logistics — transportation, storage, port facilities, and associated properties dedicated to moving and storing stuff. If arugula needs to be imported from Chile, then consider all of the real estate devoted to getting a serving of it from the farm to a salad plate in middle-America.
Until credit is restored, the import-export game will continue to suffer, and the real estate devoted to serving that game will be “on hold”.
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Seattle Mortgage Bankers
I don’t get to visit with these folks as often as I’d like (maybe…. twice in… forever?), but they had a great luncheon meeting yesterday on HUD multi-family and health care finance. As dull as that topic sounds, HUD lenders are almost the only game in town for these sectors, and as such the “deal” volume at HUD has exploded.
Also, unfortunately, the “bad deal” flow has dramatically increased. HUD is seeing a rapid increase bad loans — not the same sort of levels we see in the sub-prime housing market or even in the conventional commercial market, but given the high degree of underwriting on these projects, HUD usually expects a loan-loss problem in the fraction-of-a-percent range. Thus, when loan losses start approaching 2%, it’s time for a lot of serious soul searching.
We had heard some vicious rumors out of the east coast that HUD was “shutting down assisted living lending”. Well, that’s apparently not true. However, there are a few obvious problems in the “New Normal” (I’m increasing stealing that phrase to describe the post-recession financial reality). Based on what I heard yesterday, I think HUD multi-family borrowers are going to see three significant issues:
1. The pipeline is a LOT longer. They haven’t done this on purpose, but the volume of deals coming thru the door at HUD is disproportionately large compared to the number of underwriters. (I saw this in the residential FHA/VA market back in the early 1980’s, when FHA money was the only game in town for start-up homebuyers, and it took longer to process a loan than it did to build the house!)
2. Underwriting criteria will be more subjective, and borrowers with little track record will face significant scrutiny.
3. Terms will be more severe. In the case of assisted living, the LTV went from 90% to 75% (although the Loan-to-Cost is still 90%) and DSCR is now 1.45, up from 1.1. This is mainly reflective of the significant problems in the assisted living market.
On the positive side, some programs are being slightly liberalized (232 program, for example). All in all, though, HUD multi-family borrowers will have a somewhat tougher time in the future than they had in the immediate past. Will this change down the road? Probably. I would expect that eventually we’ll see a return to somewhat easier money, but not until HUD works through the loan-loss problems and the conventional market becomes competitive again.
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Seattle CFA Society
Tomorrow we’ll send out the latest issue of The Greenfield Advisor, our periodic e-mail newsletter. Back “in the day….” when we were called Mundy Associates, the firm’s newsletter was entirely printed and called The Mundy Insider. In deference to the trees we’re saving (the subscription list now runs in the thousands), our current newsletter is entirely via e-mail. If you’d like a subscription — and they’re free — just drop us an e-mail to info@greenfieldadvisors.com. You’ll be added to the list. You can also simply download a .pdf of the file from our website, www.greenfieldadvisors.com.
The current issue focuses mainly on this year’s Economic Forecast dinner, held this month by the Seattle CFA Society. I make it a point to attend every year, and we generally take a few folks with us. The speakers are top-flight, and the information was terrific. For more details and my “take” on what they had to say, please check out the newsletter.
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Where does everyone live?
It’s an interesting question for a couple of reasons. First, I’m in the real estate analysis biz, and since housing is a b-i-g chunk of real estate, it’s interesting from a purely academic perspective.
Second, though, there is a fair argument that at the apex of the recent housing bubble, we got the mix wrong. Congress, in their infinite (cough… cough….) wisdom, encouraged home ownership for all. It sounds like a noble idea, but one without too much economic sense. Simply put, even though the United States is LARGELY a nation of homeowners, we are not ALL homeowners. There are a lot of important economic reasons for this, w-a-a-a-a-y behond the scope of this blog. That having been said, over a reasonably long period of time, (say, a few years), the supply side of the equation can more-or-less match demand, and an equilibrium of sorts can emerge.
The problem arises when non-economic forces enter into the equation (such as artificial government stimuli) and home ownership is foisted off on market participants who really should be renters. There are plenty of ways to do this — mostly through artificially high levels of liquidity.
It’s hard to say exactly WHEN the recent housing bubble crested, but a quick glance at the Census Bureau’s American Housing Survey as of the end of 2007 is probably pretty close. (Anything closer than that would be pure conjecture anyway). We had 124.4 million housing units in the U.S., both rental and owner-occupied, of which 110.7 million were occupied. The different — a vacancy rate of about 11% — is pretty normal. This number includes new construction and actual vacancies, and there is a fairl amount of economic literature showing that a very low vacancy rate is not efficient in a healthy market, particularly among rental units.
Here’s where life gets interesting. Of the total number of occupied units, 75.6 million were owner-occupied, or about 68%. Many economists now agree that this proportion was too high — that the ownership rate in America was artificially propped-up by Congressional direction toward “easy” mortgage money. Since it was those “easy” borrowers who got in trouble first, one of the important questions being asked now is, “What is the best level of owner-occupancy for the market?” In a free market economy, “best” is what emerges at equilibrium without any external artificial interference.
We don’t really know where the market will level out, but discussions suggest the owner occupancy level should be closer to 60% than 68%. If this is the case, then in a static no-growth model, we would have about 66.4 million occupied dwellings. That’s a shift of about 9.2 million homes. Naturaly, many of these will be absorbed in the rental side of the equation, and that’s what we’ve seen lately — it’s why the fundamentals on new apartments has looked rugged for a while. That ruggedness won’t last long — much if not most new construction built for owner-occupancy is not suitable for rental, at least in the long-term. Luxury homes, luxury condos, and vacation “second” homes are either the wrong housing product or in the wrong place for such an easy shift to be accomodated. As such, we should see the apartment fundamentals get back to normal before the owner-occupied side of the market does.
Our natural “equilibrium” absorbtion of new housing in America is about 1.9 million units per year (about 1/3 rental and about 2/3 owner-occupied), so a big chunk of any excess will be eaten up by new demand as we come out of the recession. Nonetheless, it will take a while for the excess supply to be absorbed and for things to get back to normal in the new housing sector.
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Gawd, I’ve been busy….
Seriously busy, on serious stuff. I mean it. I’m not complaining, mind you. Nothing wrong with busy, in the right doses. It keeps me off the street and out of trouble. AND…. It pays the bills. None of us are as rich as we thought we were, right? I commented last evening over drinks, “I’m sure every now and then, Bill Gates turns to Melissa to fuss about money, and says, ‘Who do you think I am? Warren Buffett????’ ”
But, I digress. My ever vigilent and underpaid team has been encouraging me to climb out of my shell once and a while and deliver some of my economic rants and ramblings to random unsuspecting Rotary and Kiwanis Clubs. For those of you lucky enough to miss these, I’ll spend the next few blog entries sharing a few thoughts with you. As always, my lawyer(s) ask(s) that I tell you that these ramblings do not constitute investment advise or the official or even unofficial opinions of Greenfield Advisors, your experience may vary, subject to credit approval, if you suffer anything lasting more than four hours contact a physician, not valid in Wisconsin, etc., etc., etc.
Today’s rambling is about INFLATION. In nearly every talk I’ve given recently, someone asks why neither I nor any of the economists I’m surveying are forecasting inflation. After all, the gov’t has been “running the printing presses night and day, right?” Well, haven’t they been? And surely such a flood of money coming out of Washington (well, technically a whole bunch of it has come from the NY Fed, but who’s counting, right?
And while I’m on the subject, Paul Kruegman thinks a little inflation may be good for the nation’s soul. I won’t elaborate on his theories, but with all deference to his recent Nobel Prize, while most of us of a certain age WISH we couldn’t remember the 70’s, apparently Paul actually CAN’T. Fortunately for all of us, one of the few things both the Bush administration and the Obama administration could agree on is to NOT spend very much time listening to Paul Kruegman.
(Digression — I met my wife in the 1970’s — proof that the decade wasn’t ALL bad. However, the list of good things to come out of that decade is short.)
Clearly, the actions of the Treasury and the FED in the past year-and-a-half have had the effect of pumping enormous amounts of liquidity into the system. In a ceteris parabus world, this would stimulate demand, which without commensurate increases in production (which is highly fixed in the short-run) would lead inexorably to inflation. Yes, yes, you… the student in the back of the room…. you’re wondering if households and businesses wouldn’t do the rational thing and simply save the extra money? Well, the problem is that actions which may be good for society as a WHOLE may not be good for INDIVIDUALS acting atomistically. This is part of the whole “moral hazard” body of research. Households and businesses ANTICIPATING that liquidity would stimulate inflation would go out and spend today (rather than see the value of their wealth dissipate tomorrow). Thus, inflation becomes a self-fulfilling prophesy. However, even if they DID save, the banks would be flush with cash and be forced to lower borrowing terms until savings simply made no economic sense, and then businesses would borrow if for no other reason because the marginal cost of production would have been lowered… etc…. etc… etc…
So anyway, we’re back to the question, if the gov’t has pumped zillions of dollars into the economy, why hasn’t this translated into inflation yet, and when will it?
The answer is, probably never. Why not, you ask? Because the liquidity that has been pumped into the system in response to the banking crisis (indeed, near-collapse) has served not to increase the money supply, but to replace a massive, sudden shrinkage in “off-book” liquidity that households and businesses were drawing from pre-2008. Think about household budgets which could be “balanced” every month on the back of credit cards and home equity lines. Was this a good thing to do, economically? Heck no, but it was a souce of liquidity in the economy, and had the same effect as M-1 money for all practical purporses. The same was true with small business lines of credit, easy home loans, etc. When the credit dam broke in the summer/fall of 2008, it carried with it trillions of dollars in off-balance-sheet liquidity. Had the “gov’t” not reacted the way it did, we would have…. well…. both Christina Romer, the Chair of the President’s Council of Economic Advisors, and Ben Bernake are students of the history of the Great Depression. They are both well aware that PRECEEDING the stock market crash, for a period of a couple of years, there was a huge shrinkage in the supply of money in the U.S. When the damn broke in 2008, they were well aware of what history tells us could happen.
We can debate for days the roots of this problem — easy money, lack of financial controls, lack of credit market oversight come quickly to mind. Clearly, there will need to be changes. Sadly, most of the solutions are in the hands of politicians…. many of the loudest voices are pointing fingers in the wrong directions. Re-regulation of the system in the coming years must take care not to kill the various geese which lay the golden eggs.
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It’s been a busy month!
Sorry about the lack of posts. Things have been terrifically busy around Greenfield, and I’ve been traveling almost constantly.
Two quick pieces of news, then on to my regularly scheduled prattle. First, the May issue of The Greenfield Advisor just went to press. If you’re not on the e-mailing list, please let me know. We just send out an e-mail once per month with a link to the .pdf file, which you can read on-line or download and print. The newsletter format allows us a little more lattitude than a blog for including graphics, etc.
Second, I’ll be speaking at the Chinese Drywall litigation conference in New Orleans on June 18th. If you’d like more information, either e-mail us here at Greenfield or check out the Litigation Conferences website.
You’ve probably heard today’s jobs report by now — unemployment is up to 9.4% but the rate of job decline is slowing. The stock market is reading this as relatively good news (the 9.4% was already discounted in the market, and the slow-down of decline is good news). In our most recent Greenfield Advisor, we present a more detailed analysis from the Philadelphia FED, along with the implications for real estate. The current consensus thinking is that umemployment will get worse (up to 9.8%), but it will get from here to there slowly, probably peaking in early 2010.
In general, the residential real estate market has probably already bottomed, but we’ll need the credit markets to straighten out before we see strong price growth again. A LOT of personal wealth was wiped out with the market declines, and until this is restored — which could be a few years — we won’t see sales volumes like we saw at the recent peak.
The commercial market is a mixed bag. Some parts have already bottomed, and will slowly recover as the market comes around. Some parts — notably retail (except existing community shopping centers) — will be dark for quite some time.
Anyway, that’s it for today. If you have any questions, don’t hesitate to contact me.
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4/27/09 — The Death of Efficiency?
I was trying to explain to a lawyer why AIG was “too big to fail”.
While I let that sink in, I’ll tell you a little story. Back when I was an academic, every summer our Finance department would have a little private, in-house, self-edification symposium we jokingly called “Finance Camp”. Usually running 4 to 6 weeks, it would consist mainly of a weekly, afternoon session of 1 – 2 hours, in which each of us would take turns making a presentation on some aspect of that summer’s theme. One summer it was bond portfolio duration. Etc. You get the picture?
Anyway, one summer, we decided that the theme would be “bankruptcy”. While planning for the sessions, we realized that the Law School also taught “bankruptcy”, so we should invite the 3 or 4 law professors who taught that subject. We planned for a big “round robin” intro meeting, followed by alternating weeks of presentations from finance and law. Good idea, right?
Sigh… as it happened, not only were we talking about two different SUBJECTS, we were frankly talking about two different LANGUAGES. Case in point — from a finance perspective, if bankruptcy is properly priced ex ante, then the event of bankruptcy is irrelevant. From a legal perspective, the very concept of such irrelevance is inconceivable.
So, back to AIG. Everyone, I guess, seems to bemoan the fact that we have (or had) companies in America that were “too big to fail”. Because what they do is so clouded in mystery, it’s hard for the person on the street to grasp how badly the economic machinery would suffer if AIG failed. Imagine, instead, if Boeing and Airbus were one company, and they suddently went out of business, taking with them all the expertise not only to build new planes but also all the expertise to repair, maintain, and service all the existing airplanes. In short, air-transport in the world would grind to a halt by 8am t. Yeah… THAT big.
So, why are Boeing and Airbus so big? After all, these companies are fairly new to the game — Boeing didn’t even get into commercial aviation until the jetliner days, and Airbus is a fairly recent amalgamation. What ever happened to venerable names, like Douglas, de Havilland, and Lockheed?
In short, they were victims of efficiency. Monopoly theory suggests that as firms become more-and-more efficient, the “also-rans” drop out. One big mistake and a firm ceases to exist. Think about automobiles — the U.S. alone used to have dozens of auto manufacturers. Today, we’re down to three domestic producers (not counting off-shore headquartered labels which are actually made here). Indeed, world-wide, the number of profitable auto makers may be just a hand-full after this recession is over.
It might surprise the lay person to read that financial services is actually a fairly low-profit business, compared to making automobiles or airplanes. Car makers can easily knock a few thousand dollars off the list price and still make money. Boeing is currently making millions of dollars in concessions on airplanes. On the other hand, margins on financial instruments are extraordinarly thin. If so, then how are the AIGs and Merrill Lynchs of the world able to pay seven- and eight-figure salaries? Simple — a one percent margin on a billion dollars worth of business is still $10 million.
In a world like that, where financial houses constantly trade with other financial houses, we end up with razor-thin margins, which leads inexorably to monopolies. Add to it the fact that these financial houses are massively intertwined, and we end up with houses of cards that could completely collapse if a major, key-stone player falls down.
How do we fix it? The first question is should we fix it? Is the cost of having to pick up all of Humpty-Dumpty’s pieces every few years greater than the cost of inefficiency? Of course, this question probably doesn’t matter, since the regulators in the U.S. and most everywhere else seem inexorably headed toward new rules which will add significant inefficiency to the process. Is that a bad thing? Probably not — it would be nice to go back to the day when there were 10,000 mortgage lenders in the U.S. rather than just a hand full, when there were dozens of major stock brokerage firms rather than just a few, and when AIG didn’t completely own the insurance business (and a few other businesses that may surprise you, like airplane leasing). The price of this — and let’s call it an insurance premium — will be significant inefficiencies in the financial marketplace.
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4/21/09 — From a Seattle Perspective
Ironically, I’m writing this sitting in a hotel room in Baltimore.
As many of you know, the Seattle Post-Intelligencer newspaper is one of this year’s recession casualties. However, many of their staff, with much help from their loyal followers, have created a very good on-line news source for Seattle-ites. We wish it well, along with many more like it around the world.
My good friend, Chuck Wolfe, contributed an editorial today. Whether you’re from Seattle or not, I encourage you to read it here. His comments can be generalized to any community facing a changing development dynamic.
From a small northwestern observatory... 