Eye on the Economy - 01/23/2008 (Plain Text Version)

By David F. Seiders, NAHB Chief Economist

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The employment report for December was a real downer, as was the Institute for Supply Management (ISM) report on the manufacturing sector for that month. We’ve also gotten reports of weaker-than-expected retail sales in December, and some regional economic reports have been quite troublesome.

The December report on housing starts and building permits was fundamentally weak — showing that the housing sector exerted a strong drag on economic growth throughout the final quarter of 2007.

NAHB’s recent builder survey measures also are quite weak, and housing production (Residential Fixed Investment) is bound to be a major drag on GDP growth in the first quarter of this year.

The recent proliferation of weak economic news has led some prominent forecasters, including former Federal Reserve Chairman Alan Greenspan, to put better-than-even chances on near-term economic recession. And some analysts are declaring that the U.S. economy already is in recession.

NAHB believes that the economy still is in the black, and we believe that recession will be narrowly averted in 2008 ― our recession probability is 40%.

However, our baseline (most probable) forecasts for housing and the economy are grounded on some key assumptions regarding monetary and fiscal policy as well as prospective housing policy adjustments.

The Credit Crunch Still Weighs Heavily on the Economy

The wide-ranging credit crunch that was triggered by revelations of deep problems in the U.S. subprime mortgage market last year still stacks up as a substantial problem for the U.S. and global economies.

On the positive side, the severe liquidity problems in short-term credit markets have eased since the end of 2007. Libor spreads have narrowed and the Fed’s latest auction of discount window credit — the new Term Auction Facility procedures — shows less demand for liquidity by U.S. commercial banks.

There also have been improvements in commercial paper markets, particularly the beleaguered asset-backed market where rates have come down and the amount of paper outstanding has edged upward.

However, some financial markets are struggling badly. Equity values have been tumbling, particularly in recent days, and quality spreads in corporate bond markets remain at or near the elevated levels of late 2007.

In home mortgage markets, the spread of prime fixed-rate conventional conforming loans salable to Fannie Mae and Freddie Mac over 10-year Treasury yields is holding at an elevated level ― about 200 basis points. And the spread of prime conventional jumbo mortgage rates over the prime conventional conforming yield still is around 100 basis points. [return to top]

The Fed Shifts Gears and Hits the Accelerator

On Jan. 10, Fed Chairman Ben Bernanke delivered a comprehensive speech on cyclical risks to the economy and pressures in financial markets. He emphasized downside risks to the economy and strains in financial markets that remained quite serious.

With respect to Fed policy, Bernanke said that “additional policy easing may well be necessary,” adding that “we stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.”

Bernanke repeated those messages in testimony before the House Budget Committee on Jan. 17. He also said that “the FOMC (Federal Open Market Committee) must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability.”

“Adverse dynamics” certainly emerged on Jan. 21 as foreign stock markets tumbled, racked by fears of recession in the U.S., and futures markets signaled impending damage to U.S. equity markets (U.S. financial markets were closed on Jan. 21). So early in the morning on Jan. 22, the Fed announced 75 basis point cuts to both the federal funds rate and the discount rate — to 3.50% and 4.00%, respectively. These definitely were “emergency” cuts, enacted only eight days before the next regularly scheduled FOMC meeting.

The Jan. 22 FOMC statement cited a weakening economic outlook ― including deepening of the housing contraction ― and deterioration of financial market conditions (other than short-term funding markets), and noted that appreciable downside risks to growth remain ― even after the 75 basis point cuts. The statement also moved earlier inflation concerns well off to the sidelines.

The Fed presumably will enact additional cuts in short-term rates at the Jan. 30 FOMC meeting (we’re currently assuming half-point reductions), and further pressure on the monetary policy accelerator is likely down the line.

We’re looking for a 2.75% funds rate by the March 18 FOMC meeting, translating into a highly stimulative real (inflation-adjusted) rate, and even stronger monetary stimulus will be delivered if conditions warrant. [return to top]

The Fed, Congress and the Administration Favor Short-Term Fiscal Stimulus

The recent downshift in economic activity has quickly captured the attention of the Federal Reserve, Congress, the Administration and virtually all the Republican and Democratic Presidential candidates competing in the primaries and caucuses. The groundswell of interest and an apparent agreement among major players on some basic principles make design and implementation of a short-term fiscal stimulus package likely in the near term.

The Democratic leaders of the House and the Senate, Nancy Pelosi and Harry Reid, sent a letter to President Bush on Jan. 11 outlining some basic principles of a timely, targeted and temporary fiscal stimulus package and requesting a bipartisan meeting with congressional leadership and the President following his return from the Middle East.

Bernanke entered the fray on Jan. 17 when he told the House Budget Committee that “fiscal action could be helpful in principle, as fiscal and monetary stimulus together may provide broader support for the economy than monetary policy actions alone.”

Bernanke stressed that a fiscal stimulus package should be implemented quickly, be temporary and be efficient in terms of the amount of near-term stimulus per dollar of increased federal spending or foregone tax revenue.

On Jan. 18, President Bush voiced his support for a short-term fiscal stimulus package that would amount to about 1% of GDP, or roughly $150 billion.

The President stressed that stimulus measures should include assistance for both households and businesses and he did not tie his support to extension of his 2001/2003 tax cuts.

With that big stumbling block out of the way, timely bipartisan agreement on a stimulus package may very well be reached in the near term.

Broad fiscal options (i.e., not sector-specific) that would appear to meet the President’s criteria, as well as the principles laid out by the congressional leadership and Bernanke, presumably include: a quick and targeted rebate of personal income tax; a temporary increase and extension of unemployment insurance benefits; a temporary increase in food stamp benefits; and reinstitution of bonus depreciation allowances for businesses. [return to top]

The Housing Sector Needs Temporary Stimulus and Longer-Term Policy Support

In view of the heavy impact of the ongoing housing downswing on the economy, it certainly makes sense to include targeted housing provisions as part of a short-term fiscal stimulus package. Temporary tax credits for home buyers would quickly bolster home sales and reduce inventory overhangs of homes that promise to weigh on house prices and home building for some time.

The President made reference to housing in his Jan. 18 address, stressing the need to keep the housing contraction from “infecting” other parts of the economy. In this context, the President pointed out that the Administration already was working to keep people in their homes through the FHA-Secure and Hope Now initiatives and the temporary elimination of taxes on forgiven mortgage debt that were a barrier to mortgage restructuring.

The Administration also is calling on Congress to allow states to increase issuance of tax-exempt mortgage revenue bonds and to use these funds for innovative refinancing programs.

In addition, the President called on Congress to send FHA modernization legislation to his desk as soon as possible, so that FHA can fill more of the gap that has been left by the decline of the subprime mortgage market. The Administration also supports timely enactment of comprehensive GSE reform legislation, including an increase in the conforming loan limit that would allow Fannie Mae and Freddie Mac to support the jumbo mortgage market ― providing support to high-priced housing markets in places like California. [return to top]

The Right Policy Structure Will Help Housing Bottom Out in 2008

NAHB’s baseline (most probable) forecast shows stabilization of home sales by mid-2008 and stabilization of housing starts and residential fixed investment by the end of the year.

In view of recent weakening of the U.S. economy and intensification of credit market problems here and abroad, NAHB’s housing forecast places heavy reliance on aggressive monetary and fiscal policies to maintain growth of real GDP, payroll employment and personal income and to reduce prime mortgage rates to historic lows.

The forecast also assumes expansion of the FHA mortgage insurance program along with GSE support to the prime jumbo market before long.

Temporary home-buyer tax credits, if enacted, would be a major offset to downside risks to NAHB’s current baseline forecasts for home sales and housing production in 2008. [return to top]

Webcast of Fall Construction Forecast Conference Available Till Feb. 5

The webcast of the NAHB Fall Construction Forecast Conference held in Washington, D.C. on Oct. 24. is available for purchase through Feb. 5.

Those interested can purchase the conference webcast, which includes panels of nationally recognized experts discussing economic trends, government policies, developments in the housing industry and the results from NAHB's recent surveys.

Purchasers will receive unlimited access to the webcast archive though Feb. 5, as well as electronic copies of the conference handouts and presentation material. Purchasers can watch at their own pace, rewind, fast forward and review important sections.

To Purchase the Webcast

To purchase the webcast, visit www.nahb.org/cfcwebcast. [return to top]

Want to Know the Housing Forecast for the Top 100 Metros?

Find out in HousingEconomic.com’s 2008 to 2009 Metro Forecast (free preview).

Get the metro forecast with in-depth analysis, overviews and downloadable Excel tables.

To learn more, visit www.HousingEconomics.com. [return to top]

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