by Calculated Risk on 11/10/2009 10:53:00 AM

Lately I’ve been leaning against the view of a “V shaped” recovery. I think that growth will be decent in the second half of 2009, but growth will be sluggish in 2010.

San Francisco Fed President Dr. Yellen has a similar view – from her speech this morning: The Outlook for the Economy and Real Estate

The big issue is how strong the upturn will be. With such enormous reservoirs of slack in the form of high unemployment and idle productive capacity, we need a strong rebound to put unemployed people back to work and get underutilized factories, offices, and stores humming again. Unfortunately, my own forecast envisions a less-than-robust recovery for several reasons. As the impetus from government programs and inventories diminishes in the quarters ahead, private final demand will have to fill the breach. The danger is that demand may grow at too anemic a pace to support vigorous expansion.

First, it may take quite a while for financial institutions to heal to the point that normal credit flows are restored. The credit crunch hasn’t entirely gone away. In the face of massive loan losses, banks have clamped down on underwriting and credit terms for both businesses and consumers. Smaller businesses without direct access to capital markets are particularly feeling the pinch. Lenders have had to run hard just to stay in place: Rising unemployment, business failures, and delinquencies in real estate markets have fed additional credit losses and made it more difficult for financial institutions to get their balance sheets in good order.

Second, households have been pummeled and prospects for consumer spending are cloudy. Consumers have surprised us in the past with their free-spending ways and it’s not out of the question that they will do so again. But I wouldn’t count on them leading a strong recovery. They face high and rising unemployment, stagnant wages, and heavy debt burdens. Their nest eggs have shrunk dramatically as house and stock prices have fallen, and their access to credit has been squeezed.

It may be that we are witnessing the start of a new era for consumers following the harsh financial blows they have endured. ...

Weakness in the labor market is another factor that may keep the recovery sluggish for quite some time. Payroll employment has been plummeting for more than a year and a half, and, even though the pace of the decline has slowed, unemployment now stands at its highest level since 1983. In addition, many workers have seen their hours cut or are experiencing involuntary furloughs. ... my business contacts say they will be reluctant to hire again until they see clear evidence of a sustained recovery. High unemployment, weak job growth, and paltry wage increases are a recipe for sluggish consumer spending growth and a tepid recovery.

... the outlook for housing has turned up in response to favorable mortgage rates, lower house prices, and a lower overhang of unsold houses. And growth in this sector should contribute to the overall economic recovery. These developments represent real gains, but it’s important not to get carried away. Some of the advance reflects temporary government support in the form of tax credits for first-time home buyers, and the impact of loan modification programs and foreclosure moratoriums that reduced the pace of distressed sales. Moreover, foreclosure notices surged earlier this year and distressed property sales may rise once again in the months ahead. If so, we could see renewed pressure on house prices. Of course, continuing high unemployment will also fuel additional foreclosures. And the supply of credit for nonconforming mortgages remains extremely tight. Financial institutions are reluctant to place them on their books when they are trying to reduce leverage and we have yet to see any revival of the market for private mortgage-backed securities.

When we turn to commercial real estate, the prospects are worrisome. ...

When the weakness of the commercial property market is combined with the muted outlook for housing and consumer spending, you can see why I believe that the overall economic recovery is likely to be gradual and remain vulnerable to shocks. It’s popular to pick a letter of the alphabet to describe the likely course of the economy. The letter I would choose doesn’t exist in our alphabet, but if I were to describe it, it would look something like an “L” with a gradual upward tilt of the base. With such a slow rebound, unemployment could well stay high for several years to come. In other words, our recovery is likely to feel like something well short of good times.
emphasis added

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"