by Calculated Risk on 1/11/2010 02:21:00 PM

From Reuven Glick and Kevin J. Lansing at the San Francisco Fed: Global Household Leverage, House Prices, and Consumption (ht Amir)

"[O]ver-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money." —Irving Fisher (1933)

In the United States and many other industrial countries, the recent financial crisis contributed to the longest and most severe economic contraction since the Great Depression. The rapid expansion in the use of borrowed money, or leverage, by households in recent years, is one factor that may help account for the virulence of the downturn.

In the years leading up to the crisis, a combination of factors, including low interest rates, lax lending standards, a proliferation of exotic mortgage products, and the growth of a global market for securitized loans fueled a rapid increase in household borrowing. An influx of new and often speculative homebuyers with access to easy credit helped bid up U.S. house prices to unprecedented levels relative to rents or disposable income. U.S. household leverage, as measured by the ratio of debt to personal disposable income, reached an all-time high, exceeding 130% in 2007 (see Glick and Lansing 2009). National house prices peaked in 2006 and have since dropped by about 30%. The bursting of the housing bubble set off a chain of events that pushed the U.S. economy into a severe recession that started in December 2007.

This Economic Letter shows that the recent U.S. experience is by no means unique. Household leverage in many industrial countries increased dramatically in the years prior to 2007. Countries with the largest increases in household leverage tended to experience the fastest rise in house prices over the same period. Moreover, these same countries tended to experience the most severe declines in consumption once house prices started falling. The common patterns observed across countries suggest that, as in the United States, the unwinding of excess household leverage via increased saving or increased default rates could be a significant drag on consumption and bank lending going forward, possibly muting the vigor of the economic recovery.

And a couple of graphs from the paper. The first graph plots the change in house prices vs. the change in household leverage.

Note: this is on a national basis. Professors Atif Mian and Amir Sufi (both University of Chicago Booth School of Business and NBER) published a paper last year showing the same result across U.S. counties), see: The Household Leverage-Driven Recession of 2007 to 2009 or my post last September for excerpts and graphs: MEW and the Wealth Effect

Click on graph for larger image in new window.

Figure 3 ... shows that countries exhibiting the largest increases in household leverage from 1997 to 2007 also tended to experience the fastest rise in house prices over same period. The pattern suggests that the link between easy mortgage credit and rising house prices held on a global scale.

The second graph shows the change in consumption following the financial crisis vs. the change in household leverage prior to the crisis:

Figure 4 shows that countries experiencing the largest increases in household leverage before the crisis tended to experience the most severe recessions, where severity is measured by the percentage decline in real consumption from the second quarter of 2008 to the first quarter of 2009. Consumption fell most sharply in Ireland (-6.7%) and Denmark (-6.3%), both of which saw huge increases in household leverage prior to the crisis. Consumption was flat or fell only slightly in Germany, Austria, Belgium, and France, which were among the countries that saw the smallest increases in household leverage before the crisis. Overall, the data suggest that recession severity in a given country reflects the degree to which prior growth was driven by an unsustainable borrowing trend.

Not a surprise, but this suggests growth will be sluggish in the U.S., and regulators should be alert to rapid increases in household leverage.

by Calculated Risk on 1/11/2010 12:18:00 PM

The following graph is from a forthcoming paper by Natalia Cohen, a senior at Barnard College.

Note: the price-earnings and price-rent portion is based on a graph by Paul Krugman, "The Return of Depression Economics and the Crisis of 2008", pg. 145

The graph shows the 10 year stock price-earnings ratio as calculated by Robert Shiller (see here for data and an explanation).

The price-rent ratio is based on work by Fed economist John Krainer and researcher Chishen Wei: "House Prices and Fundamental Value". This calculation uses the American CoreLogic LoanPerformance House Price Index and Owners' Equivalent Rent (Jan 2000 = 25 for convenience).

The unemployment rate is from the BLS.

Click on graph for larger image.

The graph clearly shows the recent stock and house price bubbles. The smaller late '80s housing bubble is also evident.

The overlay of the unemployment rate on the graph (green) suggests that asset bubbles push down the unemployment rate, and then when the bubbles burst, the unemployment rate increases significantly. There are other factors too, but the bursting of the bubble probably leads to higher sustained unemployment because many workers have non-transferable skills and need to acquire a new skill set.

A good example of this would be construction employment in the recent bubble.

The second graph shows residential building construction employment and the price-rent ratio. The increase in residential construction employment in the late '90s was probably due to the stock bubble, but there was a clear increase in employment related to the housing bubble in the late '80s, and the also during the more recent housing bubble.

Note: Scales do not start at zero to better show the change. Also this is just residential building construction employment - unfortunately the BLS didn't track residential speciality construction employment separately until 2001.

The third graph compares total construction employment and the price-rent ratio. Some of the increase in the late '90s was due to non-residential construction.

As we know, there were bubble in both residential and non-residential investment. This pushed up both key categories of construction employment.

Since the recovery in residential construction will probably be sluggish, and private non-residential construction spending is declining rapidly - construction employment will probably continue to decline even with more public spending.

A construction industry group is now arguing that almost one-in-four construction workers is unemployed. But that reality is many of these jobs are not coming back any time soon because the bubbles in residential and non-residential investment pushed construction employment up way too high - and now many of these "unemployed" construction workers will need to develop new skill sets and find alternative employment.

This wasn't the workers fault - they were just responding to the market demand, and construction employment was probably the highest paying job available. However this does suggest that the Fed needs to consider asset bubbles when trying to follow their dual mandate of price stability and maximum sustainable employment. Asset bubbles play a key role in employment, and trying to clean up after the bubble is short term thinking and is not promoting sustainable employment.

by Calculated Risk on 1/11/2010 09:53:00 AM

Press Release: Fitch: U.S. CMBS Delinquencies up 42bps; Peak Not Until 2012 (ht ron at Wallstreetpit)

Rising defaults among all property types led to a 42 basis point (bp) increase in U.S. CMBS delinquencies to close out 2009 at 4.71%, according to the latest Loan Delinquency Index results from Fitch Ratings.

'Though delinquencies have increased approximately five times from a year ago, they may not peak until 2012', said Managing Director Mary MacNeill. 'An increased amount of loans are coming due over the next two years that will result in delinquencies possibly peaking at 12%.' Fitch's surveillance criteria reflect a forward looking view of performance. Therefore, the current ratings on CMBS transactions recently reviewed by Fitch incorporate significantly higher delinquency rates.

Of the five main property types, each has seen an increase in delinquencies of over 195% since December 2008, ranging from multifamily with 196% increase, to hotel, with a 1,175% increase. Delinquency rates for these properties are as follows (along with total dollars delinquent versus total dollars delinquent as of December 2008):

--Office: 2.66% ($3.9 billion vs. $603.5 million);
--Hotel: 9.13% ($4.6 billion vs. $363.7 million);
--Retail: 4.25% ($5.7 billion vs. $1.2 billion);
--Multifamily: 7.54% ($5 billion vs. $1.6 billion);
--Industrial: 3.57% ($851.3 million vs. $186.2 million).

With rising vacancy rates and falling rents, the CMBS delinquency rates will keep rising; Fitch estimates the rate will rise until 2012.

This is related to these recent commercial real estate stories:

On offices from Reuters: At 17 pct, US office vacancy rate hits 15-year high

On apartments from Reuters: U.S. apartment vacancy rate hits 30-year high

On malls from Reuters: US shopping center vacancies hit records - report

For hotels, the occupancy rate has fallen to the lowest level since the Great Depression.

by Calculated Risk on 1/11/2010 09:00:00 AM

From Bloomberg: Dubai’s First Foreclosure May Open Floodgates in Worst Market (ht Nanoo-Nanoo, Steve)

Dubai’s housing rout sent prices down 52 percent in the past year, prompting some homeowners to abandon their cars and mortgage payments and flee the country. Not one received a foreclosure notice.

Until now.

Barclays Plc won the sheikdom’s first foreclosure cases in court, clearing the way for lenders holding about $16 billion of Dubai home loans to take action when borrowers don’t pay.
...
Moody’s estimated in September that 12 percent of the 27,000 residential mortgages in the sheikdom would default within 12 to 18 months.

Banks and developers until now have avoided the process of reclaiming homes through the courts, barred by tradition and an arcane legal process that few understood. The Barclays and Tamweel cases may change that ...

It is amazing that this is the first foreclosure given all the skips (expats fleeing the country to avoid debtor prison). But Dubai has lacked a clear legal process to handle foreclosures. As reader Steve joked, it is not so much "walk away" in Dubai but "fly away" defaults.

by Calculated Risk on 1/11/2010 12:15:00 AM

From Bloomberg: Fed’s Bullard Says Asset-Purchase Adjustments Main Policy Issue (ht MrM)

[St. Louis Fed President] James Bullard said the main challenge for U.S. policy makers will be to adjust the asset-purchase program ...

The Fed should retain flexibility by adopting a “state- contingent” policy that would allow for the adjustment of such purchases as new information becomes available ... He said it was “disappointing” that markets focus more on interest rates instead of the Fed’s quantitative monetary policy.
...
“Markets are still thinking of monetary policy strictly as changes in interest rates even though the Fed has been conducting successful policy this past year through quantitative easing,” Bullard said. “Markets should be focusing on quantitative monetary policy rather than interest rate policy.”

It is pretty clear that the Fed will not raise rates any time soon.

by Calculated Risk on 1/10/2010 09:28:00 PM

Note: Here is a weekly summary and look ahead.

Evelyn Nieves at HuffingtonPost has an update on Stockton, CA: Stockton, California Is Foreclosureville, USA, Has One Of The Worst Foreclosure Rates In The United Sates. A short excerpt:

Stockton is a changed place. Whole neighborhoods have been decimated by the mortgage disaster. The tax base has shrunken. City services and municipal jobs have been cut. Unemployment hovers at about 16 percent. Economists predict it will take years for Stockton to recover from the housing bust.
...
Housing developments built for commuters have been hit the hardest, since they were the ones to attract newcomers fleeing the huge spike in prices closer to the Bay area. Those whose livelihoods depend on a healthy housing environment – real estate brokers, contractors, day laborers – are barely holding on here.
...
The heart of Foreclosureville, U.S.A. – the Stockton subdivision that had more bank repossessions than any other place in the country for much of the last two years – is starting to look like its old self again.

The "For Sale" signs that overwhelmed Weston Ranch are mostly gone, and the lawns where weeds grew like corn stalks are shorn.

Foreclosure businesses that sprang up, including one that spray-painted brown lawns green and another that offered a foreclosure bus tour, have folded. Every time a foreclosure hits the market, bargain hunters snap it up.

But looks are deceiving. In Weston Ranch, financial devastation struck like a natural disaster and the ground has not yet settled. Speculators are buying houses to rent out. On streets where everyone knew everyone, no one knows anyone.

A long way from normal ...

by Calculated Risk on 1/10/2010 06:28:00 PM

Note: Here is a weekly summary and look ahead.

The Hartford Courant quoted Boston Fed President Eric S. Rosengren as saying he expects mortgage rates to rise 50 to 75 bps when the Fed MBS purchase program ends.

And that is an excuse to update the status of the program. From the Atlanta Fed weekly Financial Highlights:

Click on graph for larger image.

From the Atlanta Fed:

[T]he agency-backed MBS purchase program is ... on
schedule, with more than $1.1 trillion purchased by year-end.

The Fed purchased a net total of $9.3 billion of agency-backed MBS through the week of December 30. This brings its total purchases up to $1.115 trillion, and by the end of the first quarter 2010 the Fed will purchase $1.25 trillion (thus, it is 89% complete).

The Fed purchased an additional $12 billion net in MBS over the last week, bringing the total to $1.127 trillion or just over 90% complete.

by Calculated Risk on 1/10/2010 01:59:00 PM

Economic news this week includes the trade report for November on Tuesday (consensus is for an increase in the trade deficit from $32.9 billion in October to around $35 billion in November). Retail sales for December will be released on Thursday (consensus is for 0.2% increase ex-auto), and CPI and Industrial Production / Capacity Utilization (for December) on Friday.

I expect the AAR rail traffic report, DOT's vehicle miles, and West coast port traffic data all to be released this week too.

And a summary of last week ...

Employment Report: 85K Jobs Lost, 10% Unemployment Rate

Here are couple of graphs based on the employment report this week:

Click on graph for larger image.

This graph shows the job losses from the start of the employment recession, in percentage terms (as opposed to the number of jobs lost). The current employment recession is the worst recession since WWII in percentage terms, and 2nd worst in terms of the unemployment rate (only early '80s recession with a peak of 10.8 percent was worse).

Note: The total jobs lost does not include the annual benchmark payroll revision that will be announced on February 5, 2010. The preliminary estimate is for a downward revision of 824,000 jobs - pushing the total jobs lost over 8 million.

The second graph (blue line) is the number of workers unemployed for 27 weeks or more. The red line is the same data as a percent of the civilian workforce.

According to the BLS, there are a record 6.13 million workers who have been unemployed for more than 26 weeks (and still want a job). This is a record 4.0% of the civilian workforce. (note: records started in 1948).

For more on the employment report:
-> Employment Report: 85K Jobs Lost, 10% Unemployment Rate
-> Employment-Population Ratio, Part Time Workers, Temporary Workers
-> Unemployed over 26 Weeks, Diffusion Index, Seasonal Retail Hiring

Commercial Real Estate Vacancy Rates Rise Sharply, Rents Fall

This graph shows the office vacancy rate starting in 1991.

Reis is reporting the vacancy rate rose to 17.0% in Q4, from 16.6% in Q3 and from 14.5% in Q4 2008. The peak following the previous recession was 16.9%.

-> On offices from Reuters: At 17 pct, US office vacancy rate hits 15-year high
-> On apartments from Reuters: U.S. apartment vacancy rate hits 30-year high
-> On malls from Reuters: US shopping center vacancies hit records - report

Construction Spending Declines in November

Residential construction spending was off slightly in November, and is now only 5.8% above the bottom earlier in 2009. Non-residential appeared flat in November, but that was only because of a downward revision to October spending. The collapse in non-residential construction spending continues ...

This graph shows private residential and nonresidential construction spending since 1993. Note: nominal dollars, not inflation adjusted.

Private residential construction spending is now 62.9% below the peak of early 2006.

Private non-residential construction spending is 22.5% below the peak of October 2008.

U.S. Light Vehicle Sales 11.25 Million SAAR in December

This graph shows the historical light vehicle sales (seasonally adjusted annual rate) from the BEA (blue) and an estimate for December (red, light vehicle sales of 11.25 million SAAR from AutoData Corp).

Excluding August (sales driven by "Cash-for-clunkers"), December was the strongest month since September 2008 (12.5 million SAAR) before sales fell off the final cliff.

The current level of sales are still very low, and are still below the lowest point for the '90/'91 recession (even with a larger population). On an annual basis, 2009 sales were probably just above the level of 1982 (10.357 million light vehicles).

Other Economic Stories ...

From the Institute for Supply Management: December 2009 Manufacturing ISM Report On Business® PMI increased to 55.9% in December from 53.6 in November.

Oil Prices Push Above $81 per Barrel

The WSJ reports: Personal Bankruptcy Filings Rising Fast

From the NAR: Pending Home Sales Decrease Sharply in November

From the FDIC: FDIC Issues Interest Rate Risk Advisory

Consumer Credit Declines for Record 10th Straight Month

Guest post from Albrt: HAMP Loan Modifications and Due Process

Unofficial Problem Bank List Increases to 576

Best wishes to all.

by Calculated Risk on 1/10/2010 11:44:00 AM

From Patti Waldmeir in the Financial Times: China’s exports rise as economy picks up

Exports climbed 17.7 per cent last month from a year earlier and imports shot up 55.9 per cent, according to official figures released on Sunday. ...

Andy Rothman, CLSA’s chief China economist, predicted ... that if the export recovery continues, that would give China’s leaders the political cover they need to resume renminbi appreciation by mid-year, with a possible increase of 3 per cent for 2010.
excerpted with permission

This was an easy comparison because exports collapsed last year.

The article quotes Rothman arguing that the Chinese government has been waiting for three things before resuming appreciation of the renminbi: 1) economic recovery in China, 2) stabilization in Europe and the U.S., and 3) sustained Chinese export growth (for several months). Rothman thinks the first two have happened, and that if export growth continues, the Chinese will allow the renminbi to appreciate later this year.

by Calculated Risk on 1/10/2010 08:39:00 AM

From Kenneth Gosselin and Dan Harr at The Hartford Courant: Boston Fed Chief Expects Mortgage Rates To Rise This Spring (ht MrM)

Eric S. Rosengren, president and chief executive of the Boston Fed, said in an interview at The Courant that he expects [mortgage] rates to rise when the [Fed MBS purchase] program ends — or before, as the end approaches.

"Actually, I've been surprised that we haven't seen more of a backing up already," Rosengren said. "You maybe would have thought you would have seen rates move up more quickly than they have, but nonetheless that is a concern."
...
The mortgage rate increase of one-half to three-fourths of a percentage point from the end of the Fed program would happen regardless of any Fed action in interest rates, Rosengren said.
...
Rosengren said the Fed could choose to extend the mortgage buying program if the economy deteriorated dramatically.

"That's not in our forecast," Rosengren said. "That's not what we're expecting."

So Rosengren is expecting a 50 to 75 bps increase when the Fed MBS purchase program ends. That is slightly higher than my forecast of 35 to 50 bps.