by Calculated Risk on 11/10/2009 09:23:00 AM

From Atlanta Fed President Dennis Lockhart: Economic Recovery, Small Business, and the Challenge of Commercial Real Estate

[H]ow serious is the CRE problem for the financial system and the broad economy?

First, let me provide some overview comments: While the CRE problem is serious for parts of the banking industry, I don't believe it poses a broad risk to the financial system. Compared with residential real estate, the size of the CRE debt market is smaller, and the exposure is more concentrated in smaller banks.

However, I am concerned about the potential impact of CRE on the broader economy. Unlike residential real estate, there is not the same direct linkage from CRE to household wealth—and therefore consumption—caused by erosion of home equity. However, there could be an impact resulting from small banks' impaired ability to support the small business sector—a sector I expect will be critically important to job creation.

To add some detail: At the end of June 2009 there was approximately $3.5 trillion of outstanding debt associated with CRE. This figure compares with about $11 trillion of residential debt outstanding.

About 40 percent of the CRE debt is held on commercial bank balance sheets in the form of whole loans. A lot of the CRE exposure is concentrated at smaller institutions (banks with total assets under $10 billion). These smaller banks account for only 20 percent of total commercial banking assets in the United States but carry almost half of total CRE loans (based on Bank Call Report data).

Many small businesses rely on these smaller banks for credit. Small banks account for almost half of all small business loans (loans under $1 million). Moreover, small firms' reliance on banks with heavy CRE exposure is substantial. Banks with the highest CRE exposure (CRE loan books that are more than three times their tier 1 capital) account for almost 40 percent of all small business loans.

To repeat my current assessment, while the CRE problem is very worrisome for parts of the banking industry, I don't see it posing a broad risk to the financial system. Nonetheless, CRE could be a factor that suppresses the pace of recovery. As the recovery develops, the CRE problem will be a headwind, but not a show stopper, in my view.

It's appropriate to be a bit tentative in the assessment of CRE risk to the financial system, however. In 2007, many underestimated the scale and contagion potential of the subprime residential mortgage-backed securities problem. With this experience in mind, my assessment should continue to be refined.

As Lockhart noted earlier in the speech, small business employment has been especially hard hit during the current employment recession. (Note: this is probably one of the key reasons that the BLS birth/death model has overestimated new job creation).

Many of the banks in trouble because of CRE lending are also key lenders to small businesses. Therefore this might limit small business financing, and further inhibit small business job creation.

by Calculated Risk on 11/10/2009 08:43:00 AM

According to an article in the LA Times, it appears the 2009 holiday season will be worse than 2008 for the travel industry: Airlines, hotels face bleak holidays

According to the Auto Club, 46% of those surveyed said they planned to spend the same amount on holiday travel as they did last year, while 36% planned to spend less. Only 18% planned to spend more.

The article also mentions a forecast for air travel: ATA Expects 4 Percent Decline in Air Travel Over 12-Day Thanksgiving Holiday Period

The Air Transport Association of America (ATA), the industry trade association for the leading U.S. airlines, today said that it expects a 4 percent year-over-year decrease in the number of passengers traveling on U.S. airlines during the 2009 Thanksgiving holiday season, despite deep discounting over the past several months.

“It is increasingly apparent that the economic head winds facing the airlines and their customers are anything but behind us. ...” said ATA President and CEO James C. May.

... Carriers have cut back their schedules in response to economic pressures, with 2009 capacity reductions the deepest since 1942. In addition, recently released government data show that average domestic airfares in the second quarter of 2009 fell to their lowest level since 1998, dropping 13 percent from the second quarter of 2008 – the largest year-to-year decline on record.
emphasis added

And of course this will be a very difficult holiday season for hotels.

by Calculated Risk on 11/10/2009 12:19:00 AM

Floyd Norris at the NY Times asks: Did Unemployment Really Rise?

The economic reactions over the weekend to Friday’s employment report all started from the assumption that things grew much worse in October. The unemployment rate leaped to 10.2 percent from 9.8 percent. Another 190,000 jobs vanished.

Actually, none of that happened.

In reality, the government report says unemployment rates remained steady at 9.5 percent. And the number of jobs actually rose, by 80,000. ...

The adjustments are for seasonality. ... All this may be very reasonable, and there is no way I can think of to test whether the seasonal adjustments are reliable. But I suspect seasonal factors are less important this year, when the economy may be changing directions, than they normally are.

I'm not sure where the 80,000 number came from - the not seasonally adjusted (NSA) payroll employment increased by 641,000 in October - but the BLS did report a 9.5% NSA unemployment rate.

However there is a strong and consistent seasonal pattern for employment, and I think the seasonal adjusted numbers are the ones to use. I wrote about this earlier this year (excerpt with an updated graph):

What if I wrote that U.S. payroll employment increased by 383 thousand jobs in May 2009 following an increase of 259 thousand jobs in April 2009?

Some readers would suspect CR had been captured by aliens or had visited crazytown.

But, in fact, those numbers are exactly what the BLS reported as the actual change in payroll employment in April and May. The economy added 643 thousand jobs over those two months. However no one reports those numbers because there is a strong seasonal pattern to employment.

Even in the best of years, 2.5 to 3.0 million people lose their jobs in January. It happens every year for a number of reasons such as retail cutting back on holiday hires. And just about every July the economy loses over 1 million jobs for seasonal reasons too.

The following graph shows this seasonal pattern:

Click on graph for larger image in new window.

The blue line is the seasonally adjusted (SA) change in net jobs as reported by the BLS, and the red columns are the actual not seasonally adjusted (NSA) data.

No one reports the NSA data because the swings are so wild and the pattern very consistent. Unless you follow the data closely, the NSA numbers are meaningless.

There may be problems with the BLS numbers - as an example the birth/death model has consistently overestimated new job creation during the current employment recession, possibly because small businesses have been impacted more than larger companies. But the model used by the BLS for seasonal adjustments is very good, and the SA number is still the one to use.

by Calculated Risk on 11/09/2009 09:24:00 PM

Former Fed Governor Frederic Mishkin writes in the Financial Times: Not all bubbles present a risk to the economy

There is increasing concern that we may be experiencing another round of asset-price bubbles that could pose great danger to the economy. Does this danger provide a case for the US Federal Reserve to exit from its zero-interest-rate policy sooner rather than later, as many commentators have suggested? The answer is no.
excerpted with permission

Mishkin outlines two different types of bubbles, and argues a "credit boom bubble" poses a risk to the economy, but a "pure irrational exuberance bubble" does not.

For more excerpts, see EconomistView: "Not All Bubbles Present a Risk to the Economy"

by Calculated Risk on 11/09/2009 06:10:00 PM

From the NY Times: Paterson Paints Grim Picture of N.Y. Budget Crisis

"We stand on the brink of a financial challenge of unprecedented magnitude in the history of this state,” Mr. Paterson told lawmakers as he warned that New York was rapidly running out of cash ...

While the state faces a deficit of more than $3 billion for the remaining four and a half months of this fiscal year, the greater worry among state officials are the unprecedented deficits the state faces in 2011 and 2012, after federal stimulus financing and a temporary tax increase on the wealthy expire.

“We’re going to fall off a cliff unless we get our revenues and our expenditures in true sync,” said Lt. Gov. Richard Ravitch ...

The Rockefeller Institure recently released a report showing most states have seen a precipitous decline in revenues.

Total state tax collections as well as collections from two major sources — sales tax and personal income — all declined for the third consecutive quarter. Overall state tax collections in the April-June quarter of 2009, as reported by the Census Bureau, declined by 16.6 percent from the same quarter of the previous year. We have compiled historical data from the Census Bureau Web site going back to 1962. Both nominal and inflation adjusted figures indicate that the second quarter of 2009 marked the largest decline in state tax collections at least since 1963. The same is true for combined state and local tax collections, which declined by 12.2 percent in nominal terms.
emphasis added

by Calculated Risk on 11/09/2009 03:19:00 PM

Note: The Sacramento Association of REALTORS® is now breaking out monthly resales by equity sales (conventional resales), and distressed sales (Short sales and REO sales). I'm following this series as an example to see changes in the mix in a former bubble area.

Click on graph for larger image in new window.

UPDATE: percentages corrected.

Here is the October data.

They started breaking out REO sales last year, but this is only the fifth monthly report with short sales. About 63.2 percent of all resales (single family homes and condos) were distressed sales in October.

The second graph shows the mix for the last four months. REO sales declined, but short sales and conventional sales were up. It will be interesting to see if foreclosure resales pick up later this year - or early next year - when the early trial modifications period is over.

Total sales in October were off 17.5% compared to October 2008; the fifth month in a row with declining YoY sales.

On financing, over half the sales were either all cash (24.6%) or FHA loans (28.9%), suggesting most of the activity in distressed former bubble areas like Sacramento is first-time home buyers using government-insured FHA loans (and taking advantage of the tax credit), and investors paying cash.

This is a local market still in distress.

by Calculated Risk on 11/09/2009 02:00:00 PM

From the Fed: The October 2009 Senior Loan Officer Opinion Survey on Bank Lending Practices

In the October survey, domestic banks indicated that they continued to tighten standards and terms over the past three months on all major types of loans to businesses and households. However, the net percentages of banks that tightened standards and terms for most loan categories continued to decline from the peaks reached late last year. The exceptions were prime residential mortgages and revolving home equity lines of credit, for which there were only small changes in the net fractions of banks that had tightened standards. A small net fraction of branches and agencies of foreign banks eased standards on C&I loans, whereas a significant net fraction continued to tighten standards on CRE loans. Demand for most major categories of loans at domestic banks reportedly continued to weaken, on balance, over the past three months.
emphasis added

The banks are still tightening lending standards and demand continues to weaken.

And a special question on maturing CRE loans:

The October survey included a special question on the status of CRE loans on banks' books that, at the beginning of 2009, were scheduled to mature by September of this year. Among the domestic respondents that reported having such loans, about 75 percent indicated that they had extended more than one-fourth of maturing construction and land development loans, and 70 percent reported extending more than one-fourth of maturing loans secured by nonfarm nonresidential real estate. In contrast, only 15 to 20 percent of domestic banks reported that they had refinanced more than one-fourth of each of the two types of maturing CRE loans.

Extend and ... hope.

by Calculated Risk on 11/09/2009 11:11:00 AM

The following graph shows the maximum number of net jobs lost after the end of several official recessions (both in numbers and as a percent of peak employment prior to the start of the recession).

Note: The last two columns assume the 2007 recession officially ended in June 2009 or in July 2009. Recessions are labled by starting year.

Click on graph for larger image in new window.

Even if the economy started adding jobs in November (very unlikely), the 2009 recovery would already be one of weakest for job creation.

The recovery following the 2001 recession was the worst for job creation, with the bottom for employment happening in August 2003, twenty one months after the official end of the recession.

This graph shows the job losses from the start of the employment recession, in percentage terms.

Look at the brown line for the 2001 recession. According to NBER, the 2001 recession lasted 8 months, but the job losses continued for another 21 months (the brown line bottoms in month 29) - and employment didn't reach the pre-recession level for 46 months.

In terms of jobs lost, the 2009 "recovery" might be even worse than the 2001 recovery.

Maybe we should call this a "job loss" recovery?

by Calculated Risk on 11/09/2009 08:39:00 AM

St. Louis Fed President James Bullard told the Financial Times that uncertainty about the inflation outlook is the most since 1980.

From the Financial Times: Uncertainty ‘high’ over inflation outlook

“For 2009, in particular, and maybe a little bit into 2010, you have to worry about getting out of the recession, establishing your recovery, making sure the recovery has really taken hold. And then, at the appropriate time, when things are all going forward, you have to switch gears and watch whether the inflation rate is coming up.” [Bullard said]
excerpted with permission

Bullard noted that the first step would not be raising the Fed Funds rate, and unwinding some of the unconventional policy. Bullard also added the Fed is concerned about asset bubbles this time:

What is different this time is that the argument about staying too low for too long is going to weigh pretty heavily on the committee. It is more than just: ‘What does the output gap look like; what does inflation look like?’ ”

He said it was also the issue of whether “you are generating the conditions that might foster a bubble that really might come back to hurt you later? I think this will be a big issue for the committee.”

My comment: historically the Fed does not raise rates until well after the unemployment rate peaks. And the Fed plans on buying MBS through the first quarter of 2010 - so Bullard's comment about starting to switch gears "a little bit into 2010" is probably way too early.

by Calculated Risk on 11/08/2009 11:58:00 PM

A quote from a conference this weekend, from the NY Times:

"There are families not eating at the end of the month,” said Stephen Quinn, executive vice president and chief marketing officer at Wal-Mart Stores, and “literally lining up at midnight” at Wal-Mart stores waiting to buy food when paychecks or government checks land in their accounts.