The Job Market of 2045
12 minutes ago
U.S. retailers may struggle to boost sales this month as consumers grappling with lower home values and higher food and energy costs shun full-priced goods.
Target Corp., the second-largest U.S. discount chain, said yesterday that it needs sales to ``meaningfully improve'' in December to achieve fourth-quarter profit growth. J.C. Penney Co., the third-biggest department-store chain, expects sales at stores open at least 12 months to fall for the five weeks through Jan. 5.
Retailers may cut prices further during what the National Retail Federation in Washington forecasts will be the slowest holiday shopping season in five years. Consumers contending with defaults on mortgages and higher costs for milk and gasoline may wait until closer to Christmas to spend, hoping for discounts of 50 percent or more on sweaters and electronics.
``I don't think there's going to be anything that's going to take the focus away from price,'' said Christian Andreach, who helps manage more than $15 billion at Manning & Napier Advisors Inc. in Fairport, New York. ``Everyone's pretty much aware of the negatives.''
U.S. homeowners’ real estate equity dropped a record $128.5 billion, or 1.2%, in the third quarter to $10.6 trillion as home prices fell and mortgage debt rose. That’s the second quarterly decline after surging 38% from 2002 through the end of last year. In the second quarter of this year, homeowners’ equity dropped by $31.4 billion from the peak, $10.7 trillion, reached in the first quarter.
At the same time, the fall in house prices may constrain consumer spending by changing the value of mortgage equity; less equity, for example, reduces the quantity of funds available for credit-constrained consumers to borrow through home equity loans or to withdraw through refinancing.
Nonfarm payroll employment continued to trend up in November (94,000), and the unemployment rate held at 4.7 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Job growth continued in professional and technical services, health care, and food services. Employment continued to decline in manufacturing and also fell in several housing-related industries, including construction, credit intermediation, and real estate. Average hourly earnings rose by 8 cents over the month.
The plan seeks to combat a rising tide of foreclosures by making it easier for lenders to freeze the "starter" interest rate for certain borrowers for five years. The initiative includes an agreement, brokered by Bush administration officials, between the loan servicers who would administer a rate freeze and the investors to whom the mortgage debt has been sold. The agreement sets conditions under which rates on certain loans could be temporarily frozen. It isn't binding, but because it has the support of major investors, it is expected to give loan servicers much more flexibility to quickly rework some loans and direct other borrowers toward refinancings.
Among those sure to be disappointed are borrowers whose introductory rates expire before Jan. 1. About $57 billion in subprime loans were scheduled to be reset at higher rates in the final three months of this year, according to estimates by First American LoanPerformance.
Mortgage companies could also exclude borrowers who they conclude are making enough money to afford higher monthly payments. Barclays Capital — extrapolating from a similar program recently unveiled in California — estimates that only about 12 percent of all subprime borrowers, or 240,000 homeowners, would get relief.
The 1.2 million borrowers relatively current in their mortgages will be considered for the government-endorsed program. They will pass through the next set of screening to determine whether they can refinance at more-favorable mortgage rates. Some 600,000 borrowers are expected to qualify. These borrowers are expected to be offered counseling and a fast track to secure refinanced mortgages.
The remaining 600,000 won't qualify to refinance their existing mortgage, the alliance estimates. Such borrowers' loan servicers or counselors would determine whether they can afford to pay the higher interest rates once their introductory rates expire. The servicers will assume that those with better credit scores and more equity can afford to pay when their existing loans adjust upward. They would receive no special assistance.
The assumption is that resetting rates causes delinquency and default. I am not sure this is correct. Research suggests that falling house prices and loans to folks without the income to pay are the leading issues. Delinquency research published in the September 2007 IMF Global Financial Stability Report (pdf) suggests trouble starts before interest rates reset upward. The chart (Figure 1.6) below makes this clear. The below data suggest that as we move forward in time, more folks are defaulting faster and faster. These defaults are not predominantly the result of resets. We know this because a rising portion of people are missing payments before rates change.
• The FOMC, who took rates down to historic lows, and left them there for a year;
• Ratings agencies, (not unlike the equity scandal of the 1990s) were in cahoots with underwriters, to the detriment of investors;
• The Federal Reserve, in their capacity of over-seers of the Banking industry, failed to supervise the rampant issuance of irresponsible debt;
Even some smart people overestimate the average borrower's sophistication in these matters—as evidenced by Alan Greenspan's 2004 speech in which he argued that more Americans would benefit from taking out adjustable-rate mortgages. It's a thesis that makes theoretical sense, but seems to assume the average homebuyer understands interest-rate risk as well as someone trading LIBOR (London Interbank Offered Rate) futures at Goldman Sachs.
The number of Americans who fell behind on their mortgage payments rose to a 20-year high in the third quarter as borrowers were unable to refinance or sell their homes.
The share of all home loans with payments more than 30 days late, including prime and fixed-rate loans, rose to a seasonally adjusted 5.59 percent, the highest since 1986, the Mortgage Bankers Association said in a report today. New foreclosures hit an all-time high for a second consecutive quarter.
The surge in foreclosures is expanding the inventory of unsold homes and contributing to the decline in housing demand. Sales of new and previously owned homes probably will drop to 5.09 million next year, 32 percent below the 2005 peak of 7.46 million, according to Frank Nothaft, chief economist of Freddie Mac, the second largest U.S. mortgage buyer. About 40 percent of lenders have increased standards for their most creditworthy borrowers, according to a Federal Reserve study in October.
``These are the first numbers we've seen that combine the meltdown of the credit markets with the drop in home prices,'' said Jay Brinkmann, vice president of research and economics for the Washington-based bankers trade group.
What's with all the gloom about the U.S. economy? The problem is that we have two problems. One is that the economy is slouching toward recession or, at best, slow growth. It's the consequence of falling house prices, higher energy prices, flagging consumers and shrinking profits.
Over the next few years, the pharmaceutical business will hit a wall.
Some of the top-selling drugs in industry history will become history as patent protections expire, allowing generics to rush in at much-lower prices. Generic competition is expected to wipe $67 billion from top companies' annual U.S. sales between 2007 and 2012 as more than three dozen drugs lose patent protection. That is roughly half of the companies' combined 2007 U.S. sales.
At the same time, the industry's science engine has stalled. The century-old approach of finding chemicals to treat diseases is producing fewer and fewer drugs. Especially lacking are new blockbusters to replace old ones like Lipitor, Plavix and Zyprexa.
American International Group Inc. shares gained more than 5% in early trading Wednesday after its chief executive indicated that the insurance giant's exposure to the ongoing meltdown in mortgage markets wasn't likely to spiral.
The firm's CEO Martin Sullivan said U.S. residential housing exposures at American International Group, Inc was "manageable" given the company's size and business diversification. The CEO said the five-year adjusted earnings-per-share growth target is between 10% and 12%, while return on equity is targeted at a range of 15% to 16% for the same period. Shares of AIG gained more than 4% Wednesday morning as the company held an investor meeting
With these developments in mind, let me review the economic situation. By the time of the October meeting, the data indicated that the economy had turned in a very strong performance in the second and third quarters. However, the fourth quarter is sizing up to show only very meager growth. The current weakness probably reflects some payback for the strength earlier this year—in other words, just some quarter-to-quarter volatility due to business inventories and exports. But it may also reflect some impact of the financial turmoil on economic activity. If so, a more prolonged period of sluggishness in demand seems more likely. The timing of the slowdown certainly matches well with the financial turmoil explanation. Of course, much of the data that drove the third quarter strength cover the earlier part of that quarter, just the very beginnings of the turmoil in July and August, and therefore probably do not reflect its effects very much. However, the data for the end of the quarter—that is, for September—did come in on the soft side, and the data for the beginning of the fourth quarter in October have shown even more of a slowdown.
I’d like to go into this “story” in more detail. First, the on-going strains in mortgage finance markets seem to have intensified an already steep downturn in housing. Indeed, forward-looking indicators of conditions in housing markets are pointing lower. Housing permits and sales are dropping, and inventories of unsold homes are at very high levels. Moreover, rising foreclosures will likely add to the supply of houses on the market. It’s well known that foreclosures on subprime adjustable rate mortgages have increased sharply over the past couple of years. More recently, we’ve begun to see increases in foreclosures on subprime fixed-rate mortgages and even on prime ARMs. The bottom line is that housing construction will likely be quite weak well into next year before beginning to turn around.
Turning to house prices, many measures at the national level have fallen moderately, and the declines appear to be intensifying. Indeed, the ratio of house prices to rents, which is a kind of price-dividend ratio for housing, remains quite high by historical standards, suggesting that further price declines may be needed to bring housing markets into balance. This perspective is reinforced by futures markets for house prices, which indicate further—and even larger—declines in a number of metropolitan areas this year.
This weakness in house construction and prices is one of the factors that has led me to include a “rough patch” in my forecast for some time. More recently, however, the prospects for housing have actually worsened somewhat, as financial strains have intensified and housing demand appears to have fallen further.
Moreover, we face a risk that the problems in the housing market could spill over to personal consumption expenditures in a bigger way than has thus far been evident in the data. This is a significant risk since personal consumption accounts for about 70 percent of real GDP. These spillovers could occur through several channels. For example, with house prices falling, homeowners’ total wealth declines, and that could lead to a pullback in spending. At the same time, the fall in house prices may constrain consumer spending by changing the value of mortgage equity; less equity, for example, reduces the quantity of funds available for credit-constrained consumers to borrow through home equity loans or to withdraw through refinancing. Furthermore, in the new environment of higher rates and tighter terms on mortgages, we may see other negative impacts on consumer spending. The reduced availability of high loan-to-value ratio and piggyback loans may drive some would-be homeowners to pull back on consumption in order to save for a sizable down payment. In addition, credit-constrained consumers with adjustable-rate mortgages seem likely to curtail spending, as interest rates reset at higher levels and they find themselves with less disposable income.
Consumption spending was moderately above trend in the third quarter, and though I had built in some slowing for it in my October forecast, there are signs suggesting even more moderation over the next year or so. For example, although consumers will continue to receive support from gains in employment and personal income, they will also confront constraints because of the declines in the stock market and house prices, the tightening of lending terms at depository institutions, and higher energy prices.
Moreover, there are significant downside risks to this projection. Recent data on personal consumption expenditures and retail sales are not that encouraging. They have begun to show a significant deceleration—more than was expected—and consumer confidence has plummeted. Reinforcing these concerns, I have begun to hear a pattern of negative comments and stories from my business contacts, including members of our Head Office and Branch Boards of Directors. It is far too early to tell if we are in for a sustained period of sluggish growth in consumption spending, but recent developments do raise this possibility as a serious risk to the forecast.
Central banks seek to promote financial stability while avoiding the creation of moral hazard. People should bear the consequences of their decisions about lending, borrowing, and managing their portfolios, both when those decisions turn out to be wise and when they turn out to be ill advised. At the same time, however, in my view, when the decisions do go poorly, innocent bystanders should not have to bear the cost.
In general, I think those dual objectives--promoting financial stability and avoiding the creation of moral hazard--are best reconciled by central banks' focusing on the macroeconomic objectives of price stability and maximum employment. Asset prices will eventually find levels consistent with the economy producing at its potential, consumer prices remaining stable, and interest rates reflecting productivity and thrift. Such a strategy would not forestall the correction of asset prices that are out of line with fundamentals or prevent investors from sustaining significant losses. Losses were evident early in this decade in the case of many high-tech stocks, and they are in store for houses purchased at unsustainable prices and for mortgages made on the assumption that house prices would rise indefinitely.
To be sure, lowering interest rates to keep the economy on an even keel when adverse financial market developments occur will reduce the penalty incurred by some people who exercised poor judgment. But these people are still bearing the costs of their decisions and we should not hold the economy hostage to teach a small segment of the population a lesson.
Related developments in housing and mortgage markets are a root cause of the financial market turbulence. Expectations of ever-rising house prices along with increasingly lax lending standards, especially on subprime mortgages, created an unsustainable dynamic, which is now reversing. In that reversal, loss and fear of loss on mortgage credit have impaired the availability of new mortgage loans, which in turn has reduced the demand for housing and put downward pressures on house prices, which have further damped desires to lend. We are following this trajectory closely, but key questions for central banks, including the Federal Reserve, are, What is happening to credit for other uses, and how much restraint are financial market developments likely to exert on demands outside the housing sector?
Some broader repricing of risk is not surprising or unwelcome in the wake of unusually thin rewards for risk taking in several types of credit over recent years. And such a repricing in the form of wider spreads and tighter credit standards at banks and other lenders would make some types of credit more expensive and discourage some spending, developments that would require offsetting policy actions, other things being equal. Some restraint on demand from this process was a factor I took into account when I considered the economic outlook and the appropriate policy responses over the past few months.
An important issue now is whether concerns about losses on mortgages and some other instruments are inducing much greater restraint and thus constricting the flow of credit to a broad range of borrowers by more than seemed in train a month or two ago. In general, nonfinancial businesses have been in very good financial condition; outside of variable-rate mortgages, households are meeting their obligations with, to date, only a little increase in delinquency rates, which generally remain at low levels. Consequently, we might expect a moderate adjustment in the availability of credit to these key spending sectors. However, the increased turbulence of recent weeks partly reversed some of the improvement in market functioning over the late part of September and in October. Should the elevated turbulence persist, it would increase the possibility of further tightening in financial conditions for households and businesses. Heightened concerns about larger losses at financial institutions now reflected in various markets have depressed equity prices and could induce more intermediaries to adopt a more defensive posture in granting credit, not only for house purchases, but for other uses a well.
Central banks have been confronting several issues in the provision of liquidity and bank funding. When the turbulence deepened in early August, demands for liquidity and reserves pushed overnight rates in interbank markets above monetary policy targets. The aggressive provision of reserves by a number of central banks met those demands, and rates returned to targeted levels. In the United States, strong bids by foreign banks in the dollar-funding markets early in the day have complicated our management of this rate. And demands for reserves have been more variable and less flexible in an environment of heightened uncertainty, thereby adding to volatility. In addition, the Federal Reserve is limited in its ability to restrict the actual federal funds rate within a narrow band because we cannot, by law, pay interest on reserves for another four years.
At the same time, the term interbank funding markets have remained unsettled. This is evident in the much wider spread between term funding rates--like libor--and the expected path of the federal funds rate. This is not solely a dollar-funding phenomenon--it is being experienced in euro and sterling markets to different degrees. Many loans are priced off of these term funding rates, and the wider spreads are one development we have factored into our easing actions. Moreover, the behavior of these rates is symptomatic of caution among key marketmakers about taking and funding positions, and this is probably impeding the reestablishment of broader market trading liquidity. Conditions in term markets have deteriorated some in recent weeks. The deterioration partly reflects portfolio adjustments for the publication of year-end balance sheets. Our announcement on Monday of term open market operations was designed to alleviate some of the concerns about year-end pressures.
The underlying causes of the persistence of relatively wide-term funding spreads are not yet clear. Several factors probably have been contributing. One may be potential counterparty risk while the ultimate size and location of credit losses on subprime mortgages and other lending are yet to be determined. Another probably is balance sheet risk or capital risk--that is, caution about retaining greater control over the size of balance sheets and capital ratios given uncertainty about the ultimate demands for bank credit to meet liquidity backstop and other obligations. Favoring overnight or very short-term loans to other depositories and limiting term loans give banks the flexibility to reduce one type of asset if others grow or to reduce the entire size of the balance sheet to maintain capital leverage ratios if losses unexpectedly subtract from capital. Finally, banks may be worried about access to liquidity in turbulent markets. Such a concern would lead to increased demands and reduced supplies of term funding, which would put upward pressure on rates.
With respect to household spending, the data received over the past month have been on the soft side. The Committee will have considerable additional information on consumer purchases and sentiment to digest before its next meeting. I expect household income and spending to continue to grow, but the combination of higher gas prices, the weak housing market, tighter credit conditions, and declines in stock prices seem likely to create some headwinds for the consumer in the months ahead.
Core inflation--that is, inflation excluding the relatively more volatile prices of food and energy--has remained moderate. However, the price of crude oil has continued its rise over the past month, a rise that will be reflected in gasoline and heating oil prices and, of course, in the overall inflation rate in the near term. Moreover, increases in food prices and in the prices of some imported goods have the potential to put additional pressures on inflation and inflation expectations. The effectiveness of monetary policy depends critically on maintaining the public’s confidence that inflation will be well controlled. We are accordingly monitoring inflation developments closely.
The incoming data on economic activity and prices will help to shape the Committee’s outlook for the economy; however, the outlook has also been importantly affected over the past month by renewed turbulence in financial markets, which has partially reversed the improvement that occurred in September and October. Investors have focused on continued credit losses and write-downs across a number of financial institutions, prompted in many cases by credit-rating agencies’ downgrades of securities backed by residential mortgages. The fresh wave of investor concern has contributed in recent weeks to a decline in equity values, a widening of risk spreads for many credit products (not only those related to housing), and increased short-term funding pressures. These developments have resulted in a further tightening in financial conditions, which has the potential to impose additional restraint on activity in housing markets and in other credit-sensitive sectors. Needless to say, the Federal Reserve is following the evolution of financial conditions carefully, with particular attention to the question of how strains in financial markets might affect the broader economy.
Spinning Tops are Japanese Candlesticks that have small bodies with upper and lower shadows/wicks that are longer than the body. Spinning tops reflect uncertainty in the market.
Lennar's (LEN - Cramer's Take - Stockpickr) sale of a chunk of its land portfolio at a steep discount boosts liquidity for the homebuilder, but it also points to troubling signs about the stock's valuation.
The company sold its land to Morgan Stanley (MS - Cramer's Take - Stockpickr) at a 60% discount to book value. That raises the question: What if all of Lennar's land is worth 60% less than what is stated in the company's financials?
If that's the case, Lennar's stock is wildly overpriced.
The Morgan Stanley deal highlights how much land values are plummeting across the country. The discount falls within the range at which builders are shopping deals to real estate vulture funds, sources say.
Investors bid up the value of housing stocks Monday as the U.S. Treasury secretary said a plan to aid strapped homeowners is close to being finished.
Henry Paulson said he is confident there will soon be an agreement to help thousands of homeowners avoid mortgage defaults by temporarily freezing interest rates. Some 2 million subprime mortgages, loans issued to people with spotty credit histories, are scheduled to reset to higher interest rates in 2008.