Bounceback: On Econbrowser, Menzie Chinn weighs in on a brewing debate in the blogosphere over whether recessions are followed by strong growth. “Given that output is trending upwards (at about 3% per annum, in log terms) in a deterministic fashion, then the argument that big drops in output are accompanied by faster growth rates makes sense. That being said, I think that additional information is always useful. And in this case, I stressed (in my last discussion of this graph) that the overpredicted growth rates were for the recoveries associated with financial system problems, such as a credit crunch. This means (in my opinion) that it is essential to fix the banking system in order for the faster growth to be realized.â€
Policy Confusion:Simon Johnson on the Baseline Scenario warns about policy confusion. “Policy confusion is rampant. Did the government effectively sort-of nationalize Citigroup last Thursday when it said Vikram Pandit will stay on as CEO? If that wasn’t a nationalization moment (i.e., an assertion that the government is now the dominant shareholder), what legal authority does the Treasury have to decide who is and is not running a private company? Will debtholders be forced to take losses and, if so, how much and for whom? As part of last week’s Citigroup deal, preferred shareholders – whose claims had debt-like characteristics – were pressed into converting to common stock. You may or may not like forced debt-for-equity swaps, but be aware of what the prospect of these will do to the credit market. Junior subordinated Citigroup debt (securities underlying enhanced trust preferred shares) were yesterday yielding 26%… Confusion in policy breeds disorder in companies, and disorder leads to the loss of value. This is the reality of severe crises wherever they unfold; we have not yet reached the worst moment. And, of course, there are many more shocks heading our way – mostly from Europe, but also potentially from Asia.â€
Troubling Housing Proposal: On the naked capitalism blog, Yves Smith looks at some troublesome aspects in the Obama administration’s housing proposal. “Something sensible, likely to work, but possibly damaging to the fragile banking establishment is to be avoided at all costs (Larry Summers apparently does not subscribe to the widely held economic precept that the highest and best use of a market is to set clearing prices, and in this case, letting prices drop to clearing levels is necessary and ultimately unavoidable. The goal of policy should be to prevent an overshoot on the downside, not to impede the correction). I have read the Treasury mortgage mod program, and it’s a bit fuzzy on certain details, but there was enough that was troubling without being clear on all the program wrinkles. First, it appears the program is a five year payment reduction program. While the guidelines are silent here, reasonable people would infer that the payment relief will be added to principal (particularly since the monthly borrower incentive for keeping current, is paid the servicer on behalf of the borrower to reduce principal, which suggests it is to offset principal increases).â€
Claims do have some tendency to rise during the week containing the Presidents Day holiday, but the latest increase looks too large to be due purely to seasonal adjustment problems… The latest round of claims data signal that the February employment report will show another large payroll loss; indeed, the February payroll loss should be greater than in previous months. Over the last three months payrolls fell at an average of 591,000, but in February they will likely drop at least 650,000. The unemployment rate should increase in around 8.0%. –Abiel Reinhart, J.P. Morgan
The labor market looks even worse than our already weak read. Initial jobless claims increased to 667,000, easily the high for the cycle, and a break higher from the 630,000 range they had sat in for the past three weeks. This substantial increase indicates that the employment situation continues to get even worse, which means that the vicious cycle downward between the labor market and demand continues. Along with this, continuing claims moved over 5 million, also the high for the cycle, as laid off workers have a difficult time finding new jobs. –Goldman Sachs
The trend in claims is sharply upwards , reflecting the depth of the recession, and we see no reason for it to peak anytime soon. Indeed, adjusted for population growth claims are still well short of the peaks seen in the mid-70s and early 80s; to match them now would require the weekly numbers to breach the 1 million mark. We fervently hope that does not happen but we are not confident. Companies are throwing in the towel as they recognize that no sector is safe. On the back of these data we have to expect the rate of fall of payrolls to rise further; 750,000 monthly declines are looming. –Ian Shepherdson, High Frequency Economics
Continuing claims leaped by 114,000 on a seasonally adjusted basis in the week ended February 14 to 5,112,000 after having jumped by 4,998,000 in the preceding week (this series is reported with a one-week lag vis-à -vis initial claims). Measured on a four-week moving average basis, continuing claims are 2,186,000 (80%) higher than they were a year ago, which points to considerably weaker labor market conditions because it indicates that those who are unemployed are finding it increasingly difficult to get re-employed. –Joshua Shapiro, MFR Inc.
New-Home Sales
Sales declined for the sixth month in a row as builders continued to reduce construction and work off inventory. We expect sales activity will remain constrained over the coming months as buyers struggle with access to credit and worry about their income prospects and the U.S. economy. Sales in the hard-hit bubble markets in the West continue to struggle. –Adam G. York, Wachovia Economics Group
New home sales very likely remained weak in February, as mortgage purchase applications are down, the homebuilder survey remained extremely low, and the economy continued to contract at a rapid pace. It is true that affordability has increased, but the economy may have to stabilize some before buyers feel comfortable re-entering the market. Of course, even when the economy does eventually recover, there will be a large stock of existing properties competing with the new home market. –Abiel Reinhart, J.P. Morgan
A key problem homebuilders have pointed to recently is that they are unable to compete with the flood of foreclosed homes hitting the market at fire sale prices, so even with housing affordability surging, efforts to stem foreclosures remain key to stabilizing the housing market. In the mean time, there is just about no floor for how far housing starts can fall from already record low levels with inventories this out of control. –Ted Wieseman, Morgan Stanley
With demand still trending down, the inventory of unsold new homes is still too high, and the months’ supply at the current sales rate is a huge 13.3 months. This suggests that prices need to fall further to stimulate sufficient demand to begin to balance the market. Until prices reach market-clearing levels, sales will remain weak and housing starts are going to stay under downward pressure. –Joshua Shapiro, MFR Inc.
We thought December’s rise in mortgage applications and the uptick in buyer traffic reported by the NAHB survey might be reflected in a modest rise in sales, but alas not. We do think, though, that sales are now very close to their floor. Activity … can’t fall much further; sales will not drop to zero. The absolute level of inventory continues to fall, down 29.9% y/y, but because sales are falling even faster the months supply is still rising, up to 13.3 in January from 12.2 in December. This will keep prices falling for the rest of this year at least. –Ian Shepherdson, High Frequency Economics
Note that the unadjusted data show that just 23,000 new homes were sold in U.S. in January and only 4,000 in the West Census region, which includes Alaska, Arizona, California, Colorado, Hawaii, Idaho, Montana, Nevada, New Mexico, Oregon, Utah, Washington, and Wyoming! –RDQ Economics
The new home sales numbers are an unreliable measure of the state of this market, because they are based on small samples. Thus, they are volatile, and most of the reported numbers are not statistically significant. For example, the Census Bureau’s press release shows new home sales in the Northeast increasing 12.5% in January. This estimate should not be taken at face value, because just below it in the press release is its standard deviation, a plus or minus 93.0%! –Patrick Newport, IHS Global Insight
Durable-Goods Orders
Yet another extremely weak durable goods report, pointing to intense weakness in business capital spending. Overall orders plunged 5.2% in January, and the key core gauge, nondefense capital goods ex aircraft, plummeted 5.4% on top of a downwardly revised 5.8% drop in December. Over the past six months, core capital goods orders have now collapsed at an unprecedented 37% annual rate. Capital goods shipments also showed extreme weakness, leading us to cut our first quarter GDP forecast to -6.0% from -5.0%… We also now see the fourth quarter being revised down to -5.5% from – 3.8%… Other than a surge in the volatile civilian aircraft component, every major category of orders was down sharply in January. –Ted Wieseman, Morgan Stanley
There is a tendency for the seasonally adjusted January durables number to print weak, but the magnitude of the decline makes it hard to dismiss this morning’s report as a seasonal quirk. The weakness in the durables report was broad-based, with non-defense aircraft orders and shipments being one of the only bright spots. –Michael Feroli, J.P. Morgan Chase
The durable goods report shows demand evaporating both domestically and globally for big-ticket capital equipment investments. The decline in orders was severe and almost across the board… The only thing even resembling a chink of light was that companies did manage to reduce their inventories, the first decline in this cycle. But sales are still falling so fast that the inventory reduction wasn’t enough to keep the inventory/sales ratio from rising yet again. So companies have much more work to do before their inventory levels will be comfortable. –Nigel Gault, IHS Global Insight
Durable goods orders fell more than expected in January, continuing the recent streak of worse than expected industrial sector activity reports. Tight credit conditions and the highly uncertain outlook for growth appear to be weighing heavily on businesses’ capital spending plans. –Zach Pandl, Nomura Global Economics
The decline in durable goods orders in January was immense and broad based. The capital goods shipments data have started the year on an extremely weak note, pointing to another sharp decline in business equipment investment in the first quarter. –RDQ Economics
Businesses are cutting back drastically to survive the recession. Declining for a record sixth consecutive month, durable goods orders were led lower by significant declines in defense spending and computer & electronics orders. After inventories piled higher for 16 straight months, we finally saw a drawdown in January. If this continues, we could see the pace of decline in orders diminish. –Tim Quinlan, Wachovia Economics Group
Bernanke Rally: On the Econbrowser blog, James Hamilton is skeptical of the ties between Ben Bernanke’s comments yesterday and the stock market rally. “Tuesday’s stock market rally was pretty impressive. But can the mere words of the Federal Reserve Chair actually produce a 4% increase in the value of the U.S. capital stock? … OK, so if it wasn’t reassurances from Bernanke, do I have a better explanation for what could have produced such a big move in stock prices? No I don’t, other than to suggest that perhaps we were in pretty much the same situation Tuesday afternoon as we had been on Friday morning.†In the post, Hamilton references an item on Paul Krugman’s Conscience of a Liberal blog, where Krugman is critical of Treasury plans. “What we want to do is clean up the bank’s balance sheet, so that it no longer has to be a ward of the state. When the FDIC confronts a bank like this, it seizes the thing, cleans out the stockholders, pays off some of the debt, and reprivatizes. What Treasury now seems to be proposing is converting some of the green equity to blue equity — converting preferred to common. It’s true that preferred stock has some debt-like qualities — there are required dividend payments, etc.. But does anyone think that the reason banks are crippled is that they are tied down by their obligations to preferred stockholders, as opposed to having too much plain vanilla debt? I just don’t get it. And my sinking feeling that the administration plan is to rearrange the deck chairs and hope the iceberg melts just keeps getting stronger.â€
Explaining Common Equity: Writing for the Baseline Scenario blog, James Kwak aims to offer an updated overview of the differences between common and preferred shares. “I still don’t understand why people care so much about whether the government owns more or less than 50% of the common shares. This just seems like a fig leaf. The more important issue which people can argue about is whether government is controlling Citigroup’s day-to-day operations. (Some say that’s good, some say it’s bad.) According to The New York Times, this is already happening. Alternatively, if you want to minimize government control, the government could tie its own hands; for example, no matter what its percentage ownership, the government’s stock purchase agreement could say that it has the right to appoint a minority of the board of directors but no more than that.â€
Lesson From Sweden: On the Peterson Institute’s RealTime Economic Issues Watch blog, Anders Aslund looks at what the U.S. can learn from the Swedish model. “The common American idea that the Swedish bank resolution involved major nationalization is a sheer misunderstanding. Only one failing private bank, Gota Banken, was merged with an equally bankrupt state bank. Sweden avoided private-public partnerships, of which Fannie Mae and Freddie Mac are the most telling and repulsive example, because, as Larry Summers so memorably has stated, public-private partnerships usually means that profits are privatized and losses nationalized. In sum, in Sweden bad debts were not taken over by the state or transferred to any aggregator state bank; but each bank, private or state-owned, established its own bad bank. The Swedish model avoided the trading of depressed assets in the midst of the crisis, while they were internally valued at their low market value. If nobody can assess the value of an asset, it is probably not worth much. Only one bankrupt bank was nationalized.â€
Fixing Banks: Writing for voxeu, Salvatore Rossi looks at what’s needed to fix the banking industry. “There are two schools of thought on how to get credit flowing again. One suggests buying the toxic assets, the other says to recapitalize banks. This column says that both approaches are necessary, though the right balance will vary across nations. The real difficulty is aligning incentives – in both pricing assets and recapitalizing banks, bank managers’ interests may thwart governments’ objectives.â€
Nice Work if You Can Get It: In the New Yorker, James Surowiecki looks at sticky wages during the current recession. “For the employed, then, this recession may be less than awful — if, that is, you can forget about the value of your home and your 401(k). But the very factors that benefit people with jobs — higher productivity and sticky wages—make prospects bleaker for those without them. That’s one reason that it was important for the stimulus package to extend and increase unemployment benefits, as well as create jobs. We’re a more productive, more efficient economy than ever, but that’s cold comfort when you’re on the dole.â€
Need for Stable Policies: Writing for Scientific American, Jeffrey Sachs says stable policies are more important than stimulus. “We need to avoid reckless short-term swings in policy. Massive deficits and zero interest rates might temporarily perk up spending but at the risk of a collapsing currency, loss of confidence in the government and growing anxieties about the government’s ability to pay its debts. That outcome could frustrate rather than speed the recovery of private consumption and investment. Deficit spending in a recession makes sense, but the deficits should remain limited (less than 5 percent of GNP) and our interest rates should be kept far enough above zero to avoid wild future swings. We should also avoid further gutting the government’s revenues with more rounds of tax cuts. Tax revenues are already too low to cover the government’s bills, especially when we take into account the unmet and growing needs for outlays on health, education, state and local government, clean energy and infrastructure. We will in fact need a trajectory of rising tax revenues to balance the budget within a few years. Most important, we should stop panicking. One of the reasons we got into this mess was the Fed’s exaggerated fear in 2002 and 2003 that the U.S. was following Japan into a decade of stagnation caused by deflation (falling prices). To avoid a deflation the Fed created a bubble. Now the bubble has burst, and we’ve ended up with the deflation we feared! Panics end badly, even panics of policy; more moderate policies will be safer in the medium term.â€
New Depression?: On his blog, Jeff Frankel takes a critical look at some of the reassurances given for why this recession won’t be as bad as the Great Depression. “How do we really know for sure that this recession won’t reach the league of the economic disaster that was the 1930s? After all, Japan in the 1990s endured a period of essentially zero growth that lasted as long as the Great Depression. Over the last year, forecasters have already marked down their growth forecasts over and over again, both in the U.S. and globally. When the sub-prime mortgage crisis first hit, in the summer of 2007, the Fed and White House said it was “contained.†When instead it spread, freezing up liquidity throughout the financial system, they said that Wall Street was not Main Street. When it became increasingly evident that the entire U.S. economy was in recession, most emphatically including Main Street, many talked of “decoupling:†under which other major economies would remain centers of global growth. Yet this optimistic hope, like the others, soon crumbled away to nothing.â€
Can’t Pay or Won’t Pay: The Economist says that the success of President Obama’s housing plan will depend on what is driving foreclosures. “Obama’s chances of being any more successful depend on whether his team has correctly diagnosed what is driving the wave of foreclosures. Is it that homeowners cannot afford to pay; or is it that they are declining to do so, because their homes are now worth less than their mortgages, the phenomenon known as negative equity? Both factors play a part, but economists are divided on their relative importance.â€
Spending TARP II:Barry Ritholtz of the Big Picture has a consumer focused idea for the second trance of TARP. “My plan is very simple: Take 175 million taxpaying households — the bottom 80% or so of all taxpayers. They each get a Debt Reduction check for $2,000 each from Uncle Sam. The twist is it can only be used to pay a pre-existing debt (February 1, 2009 or older) — Mortgages, auto lease/loans, student loans, and revolving credit (MC, V, AMEX) or any retail credit card (Sears, Macys, etc.). The check must be used within 90 days — or its forfeited.
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Stimulus Effects: The congressional budget office released an analysis of the macroeconomic effects of Senate’s version of the stimulus bill. “CBO estimates that the Senate legislation would raise output by between 1.4 percent and 4.1 percent by the fourth quarter of 2009; by between 1.2 percent and 3.6 percent by the fourth quarter of 2010; and by between 0.4 percent and 1.2 percent by the fourth quarter of 2011. CBO estimates that the legislation would raise employment by 0.9 million to 2.5 million at the end of 2009; 1.3 million to 3.9 million at the end of 2010; and 0.6 million to 1.9 million at the end of 2011. Those estimated effects are slightly greater than those of H.R. 1 (as introduced) in 2009 and 2010 (particularly in 2009), but lower in 2011, because more of the overall rise in spending and fall in revenues occurs in the first two years under the Senate legislation.â€
Big Bad Bank: On voxeu, Daniel Gros says any bad bank must be big and mandatory. “Uncertainty over losses from toxic assets is blocking the resumption of bank lending – thus prolonging and deepening the recession. Governments should take over these assets to kick-start credit markets, but to avoid the “market for lemons†problem, the bad bank should be big, and banks should be forced to transfer their entire portfolio of toxic assets.â€
Bank of America’s Deal: Writing on his Basline Scenario blog, Simon Johnson looks at the government’s deal to aid Bank of America and remains critical of the government’s approach. “This is more of the same incoherent Policy By Deal that has failed to stabilize the financial system, while also greatly annoying pretty much everyone on Capitol Hill. Hopefully, it is the last gasp of the Paulson strategy and the Obama team will shortly unveil a more systematic approach to bank recapitalization; it would be a major mistake to continue in the Citi II/BoA II vein.†Separately, the Journal’s David Wessel discusses how well TARP is working on NPR.
Tax Cuts and Stimulus: Writing for the Financial Times, Joseph Stiglitz says tax cuts shouldn’t be part of the stimulus. “We are in uncharted territory in this crisis. But household tax cuts, except for possibly the poorest, should have no place in the stimulus. Nor should business tax breaks, except when closely linked with additional investment. The one tax cut that should be included is a temporary incremental investment tax credit; it provides a big bang for the buck, encouraging companies to invest now when the economy needs the spending. Increased investments in infrastructure, education and technology, relief to states, and help to the unemployed need pride of place.â€
More Than Stimulus:Martin Wolf of the Financial Times writes that stimulus alone won’t save the U.S. economy. “First, there must be a credible program for what Americans call “deleveragingâ€. The U.S. cannot afford years of painful debt reduction in the private sector — a process that has still barely begun. The alternative is forced write-downs of bad assets in the financial sector and either more fiscal recapitalization or debt-for-equity swaps. It also means the mass bankruptcy of insolvent households and forced write-downs of mortgages. All this would also lead to big one-off increases in public debt. But those increases would probably be much smaller than those generated by a decade of huge fiscal deficits. The aim is to have a slimmer and better-capitalized financial system and a healthier non-financial private-sector balance sheet, sooner rather than later. The troubled asset relief program should be used for these purposes. It will need to be bigger. Second and most important, the structural current account deficit has to diminish. The US private sector is no longer in a position to run huge financial deficits as an offset to the demand-draining external deficits. The public sector can do so only for a few years. In the long run, the world economy must be sustainably and healthily rebalanced. This is a huge challenge for international economic diplomacy. It is also an essential element of sound domestic policy.â€
Fed Balance Sheet: Writing on the Econbrowser blog, James Hamilton looks a Fed Chairman Ben Bernanke’s speech yesterday and wonders about the risks the central bank is taking on. “That sounds to me like an exit strategy for how to get out of this if everything works out just right and the problems all go away. And what’s the exit strategy if it doesn’t work? I suppose more lending facilities.†Separately, on the Atlanta Fed’s macroblog, David Altig plays down the inflationary implications of the expansion of the Fed’s balance sheet.
