by Calculated Risk on 3/02/2005 07:05:00 PM

Here is a new paper that does an historical review of previous CAD adjustments , "Financial Market Developments and Economic Activity during Current Account Adjustments in Industrial Economies" by Croke, Kamin and Leduc.

The consequences of an adjustment in the current account deficit is being widely discussed. Some observers believe that an orderly adjustment is probable. Others, like Roubini and Setser, argue that a disorderly adjustment is very possible and "could result in a sharp economic slowdown in the US." This new paper looks at historical occurrences of Current Account Adjustments and Croke, Kamin and Leduc conclude:

"a significant subset of the adjustment episodes we studied were associated with substantial declines in GDP growth ... Thus, the fear that current account adjustment might be associated with recession is not entirely without basis."

BUT ...

"[O]ur second main finding is that the shortfall in growth experienced in the contraction episodes appears to reflect the playing out of standard cyclical developments rather than a response to current account adjustment."

My interpretation of their conclusion is that a CAD adjustment doesn't necessarily cause a recession, but a recession cures a CAD problem. Is that good news or bad?

NOTE: DeLong reviews another recent paper "The U.S. Current Account and the Dollar" by Oliver Blanchard, Francesco Giavazzi, Filipa Sa". I also recommend Macroblog and New Economist.

UPDATE: Both Macroblog and New Economist have posts reviewing this new paper.

by Calculated Risk on 3/02/2005 03:06:00 PM

Here is the current Year over Year deficit number (March 1, 2004 to March 1, 2005). As of March 1, 2005 our National Debt is:

$7,701,629,503,518.55 (that is over $7.7 Trillion)

As of March 1, 2004, our National Debt was:

$7,065,724,603,168.71

So the General Fund has run a deficit of $635.9 Billion and change over the last 12 months. SOURCE: US Treasury

Source: U.S. Treasury 

For comparison:
For Fiscal 2004 (End Sept 30, 2004): $596 Billion
For Jan 1, 2004 to Jan 1, 2005: $609.8 Billion
For Feb 1, 2004 to Feb 1, 2005: $618.6 Billion

It just keeps getting worse.

NOTE: I use the increase in National Debt as a substitute for the General Fund deficit. For technical reasons this is not exact, but it is close. Besides I think this is a solid measure of our indebtedness; it is how much we owe!

by Calculated Risk on 3/02/2005 02:53:00 AM

In my earlier post, I suggested that the volume of New Home Sales might be a leading indicator for a consumer led economic slowdown. One of the questions I was asked was how many times did housing decline and the economy not slide into recession (a false positive)? Another reasonable question would be how many recessions does the signal miss (a false negative)?

We only have 42 years of data from the Census Bureau that includes 6 recessions. This is a very small sample. A housing slowdown did not immediately precede either the 1969 or 2001 recessions (the 2001 recession was mostly business related). The following graph shows the annual volume of New Home Sales since 1963 (the earliest data from the Census Bureau).

NOTE: The annual data loses resolution and does not show all of the information contained in the previous post's graphs.

The shaded lines on the graph are approximate and represent U.S. economic recessions.

Source: Census Bureau 

Click on the graph for a larger image.

Here is a graph from the earlier post showing housing and the early '80s recession. Compare that to the double dip recession in the previous graph. In this graph we can see the monthly detail and that the declining volume of New Home Sales were a reasonable leading indicator for both economic recessions.

Source: Census Bureau 

K Harris pointed out some potential anomalies in the Census Bureau data. It is very possible that the January numbers were impacted by weather or other factors. I was NOT suggesting that the January drop in housing was indicative of a slowdown, only that if housing volumes continue to decrease that that might be a strong leading indicator. For this indicator to suggest an economic slowdown, the volume of New Home Sales would have to continue to decline over the next few months.

Predicting recessions is very difficult. The only reliable indicator is a flattening (or inverted) yield curve - and the running joke is that the yield curve has predicted 11 of the last 7 recessions! Also there is a strong incentive for most economists to always be bullish on the economy. Nobody will blame you if you miss a turning point, but to cry wolf is a disaster for your reputation. Here are a couple of examples from the Fed Chairman Alan Greenspan:

"It is very rare that you can be unqualifiedly bullish as you can be now."
Alan Greenspan, Jan 1973 (about 6 months before the economy went into recession).

"But such imbalances and dislocations as we see in the economy today probably do not suggest anything more than a temporary hesitation in the continuing expansion of the economy."
Alan Greenspan, Jan 1990 (about 6 months before the recession)

I'm not picking on Mr. Greenspan, just using him as an example. Here is another example: The WSJ conducted a survey of 40 economists in July 1990, and only one predicted a recession. The Journal went so far as to ridicule the one economist predicting a recession, suggesting that he "now has predicted four of the past zero recessions." With hindsight we now know that in July 1990 the economy was ALREADY in recession!

For an excellent analysis of recession prediction, I suggest the following paper by the IMF's Prakash Loungani "The Arcane Art of Predicting Recessions".

by Calculated Risk on 3/01/2005 01:26:00 PM

The National Association of Realtors released a new report today. Here are a few key findings:

"... 23 percent of all homes purchased in 2004 were for investment, while another 13 percent were vacation homes. In addition, there was a record of 2.82 million second home sales in 2004, up 16.3 percent from 2.42 million 2003. The investment-home component rose 14.4 percent to 1.80 million sales in 2004 from 1.57 million in 2003, while vacation-home sales rose 19.8 percent to 1.02 million in 2004 from 850,000 in 2003."

And in the NYTimes today, "Speculators Seeing Gold in a Boom in the Prices for Homes", the story starts with this anecdote:

'Within six months last year, Carlos and Betti Lidsky bought and sold two condominiums. Then they bought and sold two houses. They say they will clear a half-million dollars in profit, and none of the homes have even been built.

Now Mr. Lidsky, a lawyer, and his wife, a charity fund-raiser, have put down a deposit on a fifth property, a $1.3 million condo in a high-rise under construction, and are planning to sell before the deal closes, without even taking out a mortgage.

"It is much better than the stock market," Mr. Lidsky said. "This is an extraordinary, phenomenally good result." '

And this on speculation:

'According to LoanPerformance Inc., a San Francisco mortgage data firm, about 8.5 percent of mortgages nationwide in the first 11 months of last year were taken out by people who did not plan to live in the houses themselves, up from 5.8 percent in 2000. In some markets, that proportion is much higher: in Phoenix, more than 12 percent of mortgages were taken out by investors; in Miami, the figure is 11 percent.

The National Association of Realtors, a trade organization that represents real estate brokers, said in a study being released on Tuesday that the percentage of homes bought for investment might be as high as one-quarter of the 7.7 million sold last year.

"Americans are treating real estate as a viable alternative to stocks and bonds," said David Lereah, chief economist at the Realtors association. And some are buying at least two properties at a time.'

Excessive speculation, poor credit quality, excessive leverage, oversupply of housing units ... all indicators of a bubble.

"Homeownership has become a vehicle for borrowing and leveraging as much as a source of financial security."
Former Fed Chairman Paul Volcker, Feb 11, 2005 (See Volcker's speech)

by Calculated Risk on 2/28/2005 07:52:00 PM

The Census Bureau announced today that New Home Sales "in January 2005 were at a seasonally adjusted annual rate of 1,106,000" and that "is 9.2 percent below the revised December rate of 1,218,000 and is 4.2 percent below the January 2004 estimate of 1,155,000". Although this decrease could just be normal monthly fluctuations, the volume of New Home Sales is very important to watch over a several month period. Below are several graphs showing the value of watching New Home Sales as a leading indicator for the economy.

There are three main numbers released each month: New Home Sales (Census Bureau), Construction Permits (Census Bureau) and Existing Home Sales (National Association of Realtors). The most important one to watch is New Home Sales. These are reported in the month that the buyer signs the contract, whereas existing home sales are reported at the close of escrow, usually 30 to 60 after the purchase agreement is signed. Permits are inexpensive and are therefore not predictive since they are not indicative of a builder's commitment to a project.

Here is a graph of the last two years of seasonally adjusted New Home Sales volume (Source: Census Bureau)

Source: Census Bureau 

NOTE: Click on Graph for larger image.

It appears that a peak may have occurred last October, but it could also be another head fake (like last March). A few more months of declining sales would be concerning.

The following are the last three consumer recessions (four counting the '80s double dip). The gray area signifies that the economy was in recession based on the National Bureau of Economic Research's cycle dates. In each of these recessions New Home Sales were falling for 8 to 12 months prior to the onset of the recession. This holds true for the double dip recession of the early '80s; both dips were preceded by significant declines in sales volume.

Source: Census Bureau 


Souce: Census Bureau 


Source: Census Bureau 

As an aside: Some observers might assume that mortgage interest rates were increasing while housing volumes were declining. This was not true for the '91 recession - mortgage rates were declining from a high of 11% in '89 to under 9% in '91. (See FreddieMac's Mortgage Summary)

If the peak for this housing cycle was in October, then we might see a housing related economic slowdown (even possibly a recession) starting in the 2nd half of 2005. However it also depends on the steepness of the decline. To be concerning volumes would need to drop 20% to 25% or more over a 6 to 8 month period.

We need to see several more months of sales declines, and seasonal volume under one million units, before we start to worry.

by Calculated Risk on 2/27/2005 03:21:00 PM

Here is an overview of the National Debt and the Federal Budget deficit. For the purposes of this analysis:

Income to the Federal Government includes all Income taxes, Payroll Taxes, Corporate Taxes, etc, but does NOT include the surplus payments that are credited to the various Trust Funds (like Social Security and military retirement).

Outlays from the Federal Government includes all expenses (including certain off-budget items) but does NOT include payments to the same Trust Funds (as above).

The General Fund Deficit (or Surplus) then equals:
Deficit/Surplus = Income - Outlays.

This is not quite technically correct, but it is very close. Using this approach, the annual increase in the National Debt = General Fund Deficit (Surprise!). For you accountants: Balance!

NOTE: We could account for the Trust Funds the other way: add the surpluses to income and add the credit to the Trust Fund as an outlay. Of course, the Government adds the surpluses to income but doesn't add the Trust Fund credit to outlays. They call this the "unified budget". Under the Unified Budget, the annual deficit does not equal the increase in National Debt. Don't try that in a Public Company or plan on spending time in jail!

Main data sources: U.S. Treasury Historical Monthly Statements, CBO Historical Budget Data, SS Administration: Social Security Trust Funds

Here is a graph of Federal Income vs. Outlay as % of GDP since 1971:

Source: U.S. Treasury 

NOTE: Click on graphs for larger image.

In the '80s you can see the impact of the Reagan tax cuts as Federal Government tax receipts dropped significantly. Although Reagan slowed the rate of increase of Government spending, outlays as a % of GDP still were high and the annual deficits grew significantly. In the '90s, under President Clinton, with a combination of higher taxes, lower spending (as a % of GDP) and a healthy economy, the deficit was reduced to close to zero in 2000. It took almost 10 years of fiscal discipline to bring the budget into balance.

After 2000, spending increased and taxes were reduced substantially. Once again this has caused ever larger annual budget deficits. This second graph shows the main two reasons for the lower tax receipts:

Source: U.S. Treasury 

The lower Individual Income taxes are the primary reason for the lower tax receipts. Corporate Income taxes, and a few other sources (mostly other corporate tax breaks), account for most of the remaining fall in Federal income. Record low tax receipts (as a % of GDP) and increased spending has led to budget deficits approaching 6% of GDP.

But what is wrong with including the Trust Fund surplus as part of the Federal Government Income (without a corresponding debit)? First, take a look at just the SS portion of the Trust Fund. The following graph shows the SS payroll tax (income to the SS program) and the SS payments (Outlay).

Source: U.S. Treasury 

In the '70s and early '80s the SS outlays were increasing faster than SS income for demographic reasons. In fact the SS program ran a deficit for several years (the Purple line higher than the Green line). In 1983, Reagan appointed current Fed Chairman Alan Greenspan to head a commission on SS reform ("The Greenspan Commission"). To satisfy the needs of retirees from 1983 until now, the Greenspan Commission only had to make minor changes. As the graph shows, over the last 20 years outlays have decreased slightly as a % of GDP. However in the next few years outlays will start increasing again. Since the Greenspan Commission was concerned about the retirement of the Baby Boomer generation, they proposed having the Boomers pre-pay a portion of their retirement insurance. That is the increase in the "income" line. The difference between the "income" and "outlays" is the Social Security surplus that is credited to the SS Trust Fund.

If we include the SS overpayment as part of the income for the Federal Government (without including a corresponding debit), then we are using a regressive tax to replace the progressive individual income tax. That substitution doesn't make any economic sense.

The final graph shows the growth of the SS Trust Fund since 1983. As the program is today, the SS Trust Fund will peak around 2026 and then start declining. It is important to note that SS only accounts for a little over half of the Federal Government Trust Funds. The other portion includes Medicare, Civil Service retirement funds, Military Retirement Funds, Unemployment Insurance, and about 150 other programs.

Source: U.S. Treasury 

Hopefully this overview was informative.

Best Regards to All.

by Calculated Risk on 2/25/2005 02:34:00 PM

After a few posts of Gloom and Doom, here are a few positives on the housing market:

From "California January Home Sales" we learn that "Last month was the strongest January in DataQuick's records, which go back to 1988." Also:

"Market stress indicators are still very low: Down payments are stable, speculation buying is moderate, there are no significant shifts in market mix and default rates are low. A recent rise in ARM usage has leveled off. Earlier increases in non owner-occupied purchase activity and flipping activity have leveled off."

And this AP article: "Existing Home Sales Slip in January" was actually positive despite the headline.

"Realtors chief economist David Lereah said even with the small overall decline in sales, demand for homes remained strong. In fact, the supply of homes fell to a record low of 3.7 months, the amount of time it would take to sell all of the homes on the market at the January sales pace."

And finally I'd like to point out the Fed paper by Jonathan McCarthy and Richard W. Peach last year that asked: "Are Home Prices the Next 'Bubble'?" The authors concluded:

"Our analysis of the U.S. housing market in recent years finds
little evidence to support the existence of a national home price bubble. Rather, it appears that home prices have risen in line with increases in personal income and declines in nominal interest rates. Moreover, expectations of rapid price appreciation do not appear to be a major factor behind the strong housing market.

Our observations also suggest that home prices are not likely to plunge in response to deteriorating fundamentals to the extent envisioned by some analysts."

I agree that we are not likely to see a "plunge" in prices; Real Estate prices are sticky and they tend to slowly decline during a bust. Besides I'm more concerned about a slowdown in volume that would impact employment than a "bust". And I disgree about pricing; I think we are seeing a housing bubble.

by Calculated Risk on 2/24/2005 06:11:00 PM

Here are three interesting stories about credit quality, refinancing and over-supply in the housing market.

From chief economist David Berson, "Data Pointing to Home Sales Slowdown":

"Recent trends in production versus sales are a bit disturbing, and may suggest the excess inventories of unsold homes may have increased in early 2005 from already relatively high levels ... The obvious implication, if these data are indicative of actual trends, is that housing production may be exceeding demand."

And this article about Downpayment Aassistance Programs (DAPs): "Plan To Boost Homeownership May Spur Problems, Critics Say" FHA loans are about 10% of all mortgages. They offer a 3% down payment loan - and that is still to0 much. So non-profit organization step in and pay the downpayment ... OK, actually the seller donates the downpayment to the non-profit and the non-profit gives it to the buyer. Amazing. DAPs were essentially non-existent 4 years ago and now make up 25% of FHA loans! See this chart:

Source: IBD 

And finally this article related to my previous post "Americans using home equity pile up billions in extra debt". This chart shows Americans using their homes as ATMs:

Source: SacBee 

by Calculated Risk on 2/24/2005 04:56:00 PM

Is the current recovery built on a "marshland of debt"?

Over the last 4 years, GDP has increased 19%. Meanwhile, mortgage debt (by households) has increased 54% and the National Debt 30%. In dollars, mortgage debt increased $2.6 Trillion and the National Debt $1.7 Trillion. Over that same period, the GDP grew by $1.88 Trillion. So it is easy to imagine that America just "bought" GDP growth by adding debt.

Primarily I've focused on the increases in the National Debt and the astounding increase in mortgage debt over the last 4 years. The following graph shows the increases in the National Debt and Mortgage debt since 1971.

Source: Federal Reserve 

If we normalize the data (by comparing to the GDP), we can really understand what is happening. The following graph shows the enormous increase in National Debt in the '80s and early '90s, followed by a period of declining debt (as a % of GDP). However, starting in 2001, the National Debt started to climb once again. Since the structural General Fund deficit is forecast at almost $650 Billion for fiscal 2005 (ends Sept 30th), so the chart will continue to climb for the foreseeable future.

Source: U.S. Treasury 

The following chart shows household mortgage debt as a % of GDP. Although mortgage debt has been increasing for years, the last four years have seen a tremendous increase in debt. Last year alone mortgage debt increased close to $800 Billion - almost 7% of GDP.

Source: Federal Reserve 

Some obervers have remarked that mortgage debt is still below 50% of household RE assets - and that is an accurate statement. In fact, if you plot mortgage debt vs. household RE assets everything looks reasonable.

Source: Federal Reserve 

But lets plot household RE assets as a % of GDP.

Source: Federal Reserve 

This final graph shows the potential problem. Household assets have really soared in the last few years. Many homeowners have refinanced their homes (or moved and taken cash out), in essense using their homes as an ATM.

It wouldn't take a RE bust to impact the general economy. Just a slowdown in both volume (to impact employment) and in prices (to slow down borrowing) might push the general economy into recession. An actual bust, especially with all of the extensive sub-prime lending, might cause a serious problem.

by Calculated Risk on 2/23/2005 09:48:00 AM

The BLS reports that real weekly earnings declined 0.2% from Dec '04 to Jan '05. For the full year, real weekly earnings decreased by 0.7%.

Average weekly hours declined 0.3% from Dec '04 to Jan '05. This decrease in weekly hours is unusual for a "recovering" economy.

The annual decline in real wages and the decline in hours worked are concerning. One of my points in yesterday's post, A Recovery Built on a Marshland of Debt?, was that "an astounding increase in debt ... has occurred while the median real wage has hardly changed." That trend is continuing.

NOTE: The BLS offers a service that provides News Releases via email. I recommend it.