May Housing and Mortgage Market Trends

Last month in the April post on Housing and Mortgage Market Trends, we looked at the implications from the expiration of the homebuyer tax credit program. The final day to participate in the program was April 30, 2010 – when applicants were required to have entered into a binding purchasing contract that closed by June 30, 2010. Congress is currently considering an extension of the June 30th deadline for applicants already under contract. As expected both May new and existing home sales numbers were down after the tax credit date expired. Additionally, many buyers are having difficulty with tougher appraisals. Unlike new homes sales, existing home sales are recorded at the closing date, so the June data may be boosted by a logjam of buyers trying to push their contracts through to meet the June 30th cut-off date.

Below are the highlights from the May numbers:

• After rising for two months, new home sales plunged 33% over the month to a seasonally adjusted annualized pace of 300,000 units. May’s sales pace set a new cyclical low and was 18% below the sales pace in May of last year. Based on the most recent indications of mortgage applications, it is likely that the June sales number will also prove to be quite weak.
• Existing homes sales fell back 2.2% in May to an annualized rate of 5.66 million units. As sales declined, the inventory rose to 9.5 months supply of homes. The supply of housing inventory will have to decline before prices can be certain to have bottomed out.
• In May, housing starts plunged 10% to an annualized pace of 593,000 units. This brings the rate down to its lowest level since December. Following the expiration of the credit, demand has fallen off. Single family starts fell by an even larger 17% in May. In contrast, the far more volatile multi-family component jumped 33%.
• The OCC/OTS Mortgage Metrics Report found that the delinquency rates fell in all mortgage categories—prime, Alt-A, and subprime during the first quarter. Additionally, the delinquency rates fell for all pre-foreclosure stages. However, the rate of foreclosures rose during the quarter as servicers exhausted options to assist seriously delinquent mortgage holders and these mortgages graduate through the foreclosure stages.
• The number of home retention actions increased 6% in the first quarter after a decline in the quarter before – the growth was due to a rapid jump in HAMP modifications. The OCC/OTS report found that so far 2009 vintage modifications (52%) have responded with a higher level of loans remaining “current” than 2008 vintage modifications (27%). Additionally, HAMP modifications after 60 days have a lower level of delinquency (7.7%) relative to other types of modifications after the same number of days (11.3%).

The Housing and Mortgage Market Trend Sheet, located in the "OCE Documents of Interest" column at the right, is now updated with May figures. The trend sheet includes sales, pricing, construction, underwriting and delinquency data.

ADP Employment Report: Private Payrolls Up Only 13,000

In June, according to the ADP Employment Report, private sector payrolls rose by 13,000. This followed an upwardly revised increase of 57,000 over the month of May (previously an increase of 55,000). June was the fifth consecutive month of private payroll expansion; however, this was a significant deceleration from the prior months. June’s number was the weakest since February. This only modest increase in private payrolls coupled with the likelihood that government sector jobs fell in June due to the expiration of the census hiring, suggests that Friday’s Bureau of Labor Statistics job growth number will be negative.

The increase over the month was driven by growth of service sector jobs, which increased by 30,000, but this was a deceleration from over 70,000 per month for the prior two months and the weakest number since January. Manufacturing added 16,000 jobs; however, goods producing jobs as a whole still fell by 17,000, driven down by construction and resource extraction industries.



10.06.30 (Source: Automatic Data Processing)

States Face Large Budget Shortfall, Problems to Persist

A recent Federal Reserve Bank of San Francisco Economic Letter looked at the fiscal crisis confronting state governments.

According to the Center on Budget and Policy Priorities, state governments faced a combined budget shortfall of $110 billion for fiscal year 2009 and the budget gap increased to $200 billion for fiscal year 2010.

The article points out that fiscal stress at state governments is expected to persist for a long time. Historically, the recovery of state finances lags the national economic recovery. The Center on Budget and Policy Priorities estimates that significant state budget gaps will persist through at least 2012, while the Rockefeller Institute notes that the problem could continue well beyond 2012. Additionally, the depletion of rainy-day funds and the end of federal stimulus funds, which helped the states to narrow their budget gaps, will likely worsen state budget problems.

To address their budgetary gaps, states will cut programs and increase taxes. This will act as a fiscal drag on the U.S. economy, but the impact will likely be modest. “Projected 2010 state budget gaps account for only about 1 percent of national GDP. The combined state budget gaps from 2009 through 2012, as calculated by the Center on Budget and Policy Priorities, total less than the estimated cost of the 2009 federal stimulus package.”

Case-Shiller Index: Existing Home Prices Rise 0.8%, Up 3.8% from Year Ago

According to the twenty-city Case-Shiller Index, existing home prices rose in April by 0.8% on a non-seasonally adjusted basis. The ten-metro area index rose by 0.7%. Prices were likely bolstered in April by increased home sales related to the home buyer tax credit. From a year prior, the ten-city index was up 4.6% and the twenty-city index was up 3.8%. This is a new cyclical high and is the third consecutive month for both indices where the year-over-year change was positive.

Conference Board Consumer Confidence Drops by 9.8 Points

After rising briskly for two months, the Conference Board Index of Consumer Confidence fell in June by 9.8 points. This places the index at a level similar to where it was in March. The month’s decline was primarily driven by the future expectations component of the index, which fell 13.4 points. It has been this component that has caused most of the volatility in the index in recent months. The current conditions component also fell, but by a lesser 4.3 points. This decline is at odds with the consumer confidence findings of the last University of Michigan survey, which showed improvement in June. Regardless of what the true movement was during the month, confidence levels remain quite depressed by historical standards.

Treasuries Continue to Surge – 10-Year Bond Yield Falls Below 3 Percent

Investors continue to show a seemingly endless appetite for US Treasuries. The yield on the ten-year bond fell below 3 percent on Tuesday for the first time since April 2009, when markets were still recovering from financial shock. Since the Greek debt crisis this spring and the corresponding policy moves by the EU and ECB, investors looking for a safe haven have been moving away from Euro based assets and into Treasuries.

An additional surge in buying is likely happening this week for a couple of reasons. A year-long ECB liquidly program is coming to an end this Thursday where European banks will have to begin to repay €442 billion. There is some market apprehension that this may help trigger another credit crunch. Also on Thursday, some index-linked funds will begin to automatically dump Greek bonds from their portfolio, following June downgrades by Standard & Poor's.

Under normal circumstances, ten-year bond yields this low would be a strong sign that the market is pricing in deflation or a significant slowdown in economic activity. Assuming that the current modest recovery continues to build steam, it is quite likely that the Treasury market will be in for a significant reversal. Yields will need to rise in order to reflect long term inflationary expectations.

Assistance to Banks to Reap Billions in Profit: Part II, Federal Reserve

As discussed in a post last week, the assistance to banks through the TARP program has generated a large return for taxpayers. However, the government’s stability programs and taxpayer returns were not only limited to TARP. Assistance through numerous Federal Reserve programs helped stabilize and jumpstart financial markets while providing billions in profit to taxpayers as well.

In 2009, the Federal Reserve recorded a profit of $52.1 billion, the biggest profit on record dating back to 1913 when the Fed was created. After retaining a portion of its profit to cover future operating expenses, the Fed transferred $46.1 billion of the remaining profit to the Treasury, a direct benefit to taxpayers. Of the net income to Treasury, the Fed noted “$2.9 billion in earnings on loans extended to depository institutions, primary dealers, and others” with additional profits coming from its LLC investment that facilitated JPMorgan Chase’s acquisition of Bear Stearns.[1] The remaining profits were from open-market operations which includes the purchase of GSE debt.

Over the past year, the Fed purchased riskier assets than its traditional Treasury security holdings. The increased risk translates into a greater return for the Fed and ultimately taxpayers, which the Congressional Budget Office estimated to be over $70 billion in profit for 2010.

Footnote:

1. http://www.federalreserve.gov/newsevents/press/other/20100112a.htm

GDP Growth Revised Downward to 2.7% – Final Sales Growth Down to 0.8%

First quarter real GDP growth was revised downward to 2.7% annualized from the previously reported 3.0% growth rate. Most of the downward revision was due to consumption expenditures being revised downward. Consumption added 2.1% to GDP, rather than 2.4% earlier reported. Net exports and non-residential fixed investment were also revised down slightly, but this was offset by an upward revision to business inventory investment.

Inventory accumulation has been the primary driver of growth the past three quarters. With the downward revision to overall growth, this factor has only increased in importance. Real final sales, which strips out the effects of inventory changes in order to measure current demand was revised downward to 0.8% from 1.3%. This was the slowest pace of growth since Q2 of 2009.

Though inventories add to growth as any other component does, the effect is likely only temporary as firms have had to readjust their inventories during the early stages of recovery. With evidence showing that the bulk of the inventory adjustment period is behind us, it is likely that going forward, future GDP growth numbers will be much more in line with the corresponding final sales number.



10.06.25 (Source: Bureau of Economic Analysis)

How Underwater Must One Be Before Walking Away?

Three Federal Reserve Board of Governors’ economists recently published a working paper looking at what point do underwater homeowners walk away from their homes even if they can afford to pay. The study found that the median borrower does not walk away until he or she owes 62 percent more than their house’s value.

The study examines borrowers from the states of Arizona, California, Florida, and Nevada who purchased homes in 2006 using non-prime mortgages with 100 percent financing. Default is defined as being 90+ days delinquent for two consecutive months. Of the 133,281 loans in their sample, 78 percent of the loans ended in default by September 2009.

There are two hypotheses in the economics literature that explain mortgage defaults: 1) strategic or ruthless defaults and 2) double trigger default. A strategic default occurs when the borrower believes that the equity in the property has fallen sufficiently below some threshold and decides that the cost of paying the mortgage outweigh the benefits of making the mortgage payment. The double-trigger default hypothesis argues that it is the combination of negative equity coupled with a negative income shock that causes a mortgage default.

While rising interest rates may induce mortgage defaults, the study found that most defaults were not driven by this factor. Fewer than 10 percent of borrowers actually experienced an interest rate increase during the period investigated.

The study also found that borrowers living in Florida and Nevada, which are recourse states, have higher estimated costs of default than those living in Arizona and California. “The median borrower in the recourse states defaults when he is 20 to 30 percentage points more underwater than the median borrower in the
non-recourse states.” This outcome would suggest that borrowers take into consideration potential legal liabilities resulting from a foreclosure when determining when to walk away from a mortgage.

The authors found that “the odds of default increase monotonically as borrowers fall deeper underwater. For example, equity between -1 and -9 percent does not substantially elevate the odds of default relative to zero equity, whereas equity below -60 percent more than doubles the odds of default.”

In conclusion, while strategic defaults are common, borrowers do not exercise this option at low levels of negative equity.

New Home Sales Fall 32.7% as Tax Credit Expires; Prices Up 5.2%

After rising greatly for two months, new home sales plunged in May, falling 32.7% over the month to a seasonally adjusted annualized pace of 300,000 units. The main driver of this volatility over the past few months was the homebuyer tax credit. Sales grew at a brisk pace in March and April, but after the credit expired at the end of April, sales fell back greatly. May’s sales pace set a new cyclical low and was 18.3% below the sales pace in May of last year. Based on the most recent indications of mortgage applications, it is likely that the June sales number will also prove to be quite weak.

After falling 16.0% in April, the median sales price rose by 5.2%. It is likely that homebuilders discounted their prices in April in order to move inventories while the credit still existed. The rise in price in May reflects the winding down of that effort. Still, prices are lower than they were prior to the credit. The median sales price was $203,100, down 9.7% from a year earlier.

With the large drop in sales, the months supply of inventory of homes for sale jumped to 8.5 from 5.8. The historical norm is about 4.5 to 5 months. Before it can be certain the prices have stabilized, this ratio will likely have to find its way back to this area.



10.06.23 (Source: Census Bureau)

More on TAG: Conference agrees on two-year extension

Late yesterday, the House and Senate conferees on the regulatory reform bill agreed to a provision that would extend the TAG Program for two years beyond its current Dec. 31, 2010 expiration date. The provision also grants coverage of non-interest bearing deposit accounts to credit unions, something NCUA has been requesting since October, 2008.

We’re still reviewing the language to understand the details of the extension.

FDIC Extends TAG For 6 Months, Possibly Longer

Today the FDIC's Board approved a 6-month extension to the Transaction Account Guarantee Program (TAG), which provides full insurance coverage for deposits in qualifying transaction accounts. The TAG, which was set to expire on July 1, 2010, was extended through December 31, 2010.

If warranted by adverse economic conditions, the Board has the authority to further extend the program through December 31, 2011 without additional rulemaking. However, any further extension is limited to December 31, 2011. The Board must announce any extension beyond December 31, 2010 by October 29, 2010.

Assessment rates for participating institutions do not change, and rates continue to be charged on average daily account balances.

The maximum interest rates paid on qualifying negotiable order of withdrawal (NOW) accounts was reduced from 50 basis points to 25 basis points. However, the FDIC will continue to monitor interest rates for TAG-qualifying NOW accounts to see if a future adjustment in the interest rate is warranted.

Current participants had a one-time opt out opportunity through April 30, 2010, with the opt-out becoming effective on July 1, 2010. 441 banks opted out by the April 30th deadline. Current participants that did not opt out by this deadline will remain in the program through December 31, 2010 and through any additional extension through December 31, 2011.

Existing Home Sales Fall 2.2%; Median Sales Price Up 4.2%

After increasing steadily for two months leading up to the end of the homebuyer tax credit, existing homes sales fell back 2.2% in May to an annualized rate of 5.66 million. Existing home sales are recorded at the date of closing, so the credit may continue to bolster sales through June. However, at some point in the next few months, it is likely that sales will fall off as the effects of the credit have now worn off.

Despite the decrease in sales over the month, the months supply of inventory fell to 8.4 from 8.3 as less homes were listed. The supply of inventory will have to continue to decline before prices can be certain to have bottomed out. Over the month the median sales price rose 4.2% to $179,600, continuing a three month trend of price appreciation. From a year earlier, prices were up 2.7%.

Source: National Association of Realtors

PPI: Headline Down 0.3%; Core Prices Up 0.2%

In May, the Producer Price Index for finished goods fell 0.3%. This was the third decline in four months. The index has been quite volatile over the past few months largely due to changes in energy prices. May’s decline was driven down by a 1.5% drop in energy prices. The core index, which excludes prices of food and energy products, rose 0.2% for the second consecutive month. From a year prior, the topline index was 5.1% higher, down slightly from a 6.1% year-over-year increase in March. The core index was up by a much smaller 1.3% from a year earlier. However, this is an acceleration from a 0.8% increase as recently as March.



10.06.16 (Source: Bureau of Labor Statistics)

Housing Starts Fall 10.0%, Single Family Starts Down 17.2%

In May, housing starts plunged 10.0% to an annualized pace of 693,000 units. This brings the rate down to its lowest level since December. As seen in other housing market indicators, a ramp up in housing starts occurred going into April as the homebuyer tax credit caused an increase in sales. Following the expiration of the credit, demand has fallen off. Single family starts fell by an even larger 17.2%. In contrast, the far more volatile multi-family component jumped 33.0%. From a year prior, single family starts were up 13.9%. Total starts were up 7.8%.

New building permits, which tend to lead future starts, continued to decline, falling by 5.9%. Single family permits fell 9.9%.



10.06.16 (Source: Census Bureau)

Industrial Production Up 1.2%, Manufacturing Up 0.9%

In May, industrial production rose 1.2%. Manufacturing output continued to expand, increasing by 0.9%. This was the third consecutive month of manufacturing growth near 1.0%. The manufacturing sector remains in a phase of strong recovery.

Mining output fell 0.2%, ending four months of strong growth. Utilities output rose 4.8% after declining in March.

The capacity utilization rate rose for the ninth consecutive month, increasing by 1.0 point to 74.7%. There still remains heavy productive slack; however, an increasing utilization rate is an encouraging step in the right direction as it will have to continue to increase in order to drive significant capital expenditures and payroll expansion.



10.06.16 (Source: Federal Reserve)

Economists See Moderate But Sustained Recovery

The ABA Economic Advisory Committee released its semiannual economic forecast. The committee sees that the economy is on a moderate but solid recovery path and that sustainable private sector job growth has begun.

"The economy is moving ahead in a lengthy rehab process and will eventually return to full health and strength. This involves transitioning from monetary and fiscal stimulus to a self sustaining recovery in the private sector," said Stuart G. Hoffman, committee chairman and chief economist of PNC Financial Services Group Inc.

The committee unanimously noted that a double-dip recession in the U.S. is very unlikely. More than 500,000 private industry jobs were created in the first five months of this year, and the committee foresees a total of 2.2 million new jobs in 2010 and another 2.5 million new jobs in 2011.

Still, despite this job growth the unemployment rate is seen to still by around 9.5 percent by the end of the year.

The full press release can be found here, while audio clips from the press conference can be listened to here.

The full forecast sheet can be downloaded here.

10.06.16 (Source: American Bankers Association)

Household Wealth Up on Improving Financial Assets and Declining Liabilities

The Federal Reserve announced last week that household net worth increased by slightly more than $1 trillion during the first quarter of 2010. This is the fourth consecutive quarterly increase in household net worth. Household net worth at the end of the first quarter totaled $54.57 trillion.

Household net worth is up almost 13 percent from its low at the end of the first quarter of 2009, but is 17 percent below its high at the end of the second quarter of 2007.

According to the Federal Reserve’s Flow of Fund data, two factors contributed to the increase in household net worth during the quarter – an increase in the value of financial assets and a decline in household liabilities. However, tangible assets fell again during the quarter, which negatively impacted household net worth.

Financial assets held by the household sector increased by slightly more than $1 trillion to $45.542 trillion. Equities, mutual fund shares, pension fund reserves, and credit market instruments all posted improvements during the quarter.

However, tangible assets, such as real estate, continued to shed value falling by $67 billion to slightly less than $23 trillion.

The household sector continued to deleverage, as household liabilities fell by almost $100 billion. Mortgage debt fell by $94.1 billion during the quarter, while consumer credit declined by $57.1 billion.

Assistance to Banks to Reap Billions in Profit: Part I, TARP

“…assistance to banks, once thought to cost the taxpayers untold billions, is on track to actually reap billions in profit for the taxpaying public.”
President Obama, December 8, 2009

There is a great deal of misunderstanding about the cost of government programs that relate to banks. The fact is that every program involving banks will result in a profit to the taxpayers. The upcoming series of posts will review three government programs related to banks that will turn a profit: the Troubled Asset Relief Program, the Temporary Liquidity Guarantee Program, and Federal Reserve lending programs.

TARP – Expected Profit From Banks to Exceed $20 Billion
Taxpayers have already earned a significant return – estimated at 8.5%[1] – on the bank TARP investments that have been repaid to Treasury. Treasury also earned $1.2 billion in fees – with no losses – on its Money Market Fund Guarantee Program.[2] The loss on the TARP program, which was originally expected to total over $340 billion, is now expected to cost $105.4 billion, all of which is the result of non-bank TARP programs. Breaking down the Treasury’s latest estimate, the bank programs are expected to return a profit of $17 billion, while the non-bank TARP programs are expected to close at a loss of $122 billion.

On Friday, the Treasury announced that, for the first time, the amount of TARP investments repaid to the Treasury exceeded the amount of outstanding investments. The Treasury reported $23 billion in proceeds from dividends, interest, and warrants through May 2010, $21 billion of which was realized through the banking programs.

Had TARP been limited to the banking industry, there would be no losses on that program.

Perhaps Treasury Secretary Geithner summed it up best:

"(W)e've had roughly $200 billion come back from these banks, all the major banks, with over $20 billion in both dividends and proceeds from the sale of warrants. The taxpayer got a very good deal on these investments because we were so effective in stabilizing the system."[3]

Footnotes:

1. SNL Financial, “Treasury reaps 8.5% return from companies exiting TARP,” April 1, 2010.

2. Treasury Secretary Geithner testimony. December 10, 2009.

3. Treasury Secretary Geithner testimony (transcript of Q&A) before the Committee on Finance, U.S. Senate, May 4, 2010 .

Reg Reform Impact: 4.87 Million Fewer US Jobs, Higher Borrowing Costs

According to an Institute of International Finance report, the cumulative impact of proposed banking regulations would lower US real GDP growth by 2.7% through 2020, and result in 4.87 million fewer jobs than the economy would have otherwise created. As discussed in prior posts, the regulatory burden for many banks is at a breaking point and some provisions of the proposed reform will have a direct impact on the economic recovery. The report found that the implementation of all proposed international regulatory reforms would strip an average 0.6 percentage points from real GDP growth annually for the G3 – United States, Euro Area, and Japan – through 2015. The G3 would have 10.12 million fewer jobs through 2020 than would otherwise be the case.

Passage of the regulatory reform would also cause consumers to pay more for loans. Real lending rates in the US would be 169 basis points higher from 2011 through 2015 as banks reconcile the additional reporting and compliance expenses.

University of Michigan Consumer Sentiment Index Up 1.9 Points

In June, the University of Michigan Consumer Sentiment Index rose 1.9 points to 75.5. This move edges the confidence level slightly above where it has been trending since February. Despite the improvement, this level is still quite depressed based on historical standard, though off its cyclical low of the last years. The improvement in May was evenly due to both of the major components of the index. Both the future expectations component rose and the current conditions component rose 1.9 points.

Inflationary expectations fell back to their recent trend after jumping up temporarily in May. The one-year outlook fell to 2.7% from 3.1% in May. The five-year outlook fell to 2.8% from 2.9%.

Source: University of Michigan

Retail Sales Fall 1.2 Percent – Led By Large Drop Off at Building Supplies Stores

In May, retail sales dropped 1.2% following a rise of 0.6% in April. This large drop came after seven months of increases, including a very strong gain in March. Though the sales report is certainly weak, details are more positive. The index was driven down in part due to a large fall off of 9.3% at building supply stores. This decline followed two strong months of sales growth of over 8% each. This volatility was likely due to the homebuyer tax credit expiring in April. This caused a surge in sales along with the increase in home sales and then a corresponding fall back.

In contrast, about half of major retail subsectors showed sales growth over the quarter. Core sales, which do not include the volatile autos and gasoline components, fell by 0.8%.

From a year prior, sales were up 6.9%, down from 9.0% in April. Core sales, were up 4.4% from a year earlier, down from 5.3% in April.

Source: Census Bureau

Trade Deficit Widens By 0.7%; Total Trade Volume Declines

In April, the trade deficit widened by 0.7% to a monthly pace of $40.3 billion. Though the pace has been choppy in recent months, the trade deficit has been trending upwards for most of the past year.

The bigger story with this month’s report is that total trade volume fell, the reverse of a long standing trend over the past year. Exports fell 0.7% over the month while imports fell 0.4%. Though one month is not enough to draw lasting conclusions, if trade volume continues to decline, it could be indicative of a stalling global economic recovery.

Source: Census Bureau

Homebuyer Tax Credit Payback – Home Sales Now Appear to Be Declining

The most recent release of the Mortgage Bankers Association’s Mortgage Application Index continues to suggest that, with the expiration of the homebuyer tax credit, home sales have begun to decline.

In order to qualify for the tax credit, a contract had to be entered into by the end of April. Through April, the most recent data available, home sales were rising as buyers rushed to take advantage of the credit. Therefore, the likely effect is that many sales that would have occurred in later months were pulled forward into the months of March and April. This shift of demand helped to bolster sales numbers over these months, but likely did so at the expense of future sales. This pattern is similar to what occurred last fall when the original credit was first set to expire. The “cash for clunkers” program also produced this effect, where auto sales spiked and then fell back in the wake of the demand that was pulled forward.

The purchase component of the MBA Mortgage Application Index and new home sales are correlated, which is why forthcoming new sales numbers for May and June will likely show a decline.

The same dynamic is present with existing home sales. However, in this relationship, there is a time lag due to the way existing home sales are measured. These sales are recorded at the point of closing. So there is a one to two month time lag between the mortgage application number and the sales number. Therefore, it is likely that existing home sales rose in May and may even do so in June, but the July number will probably start to show a large decline.

Automatic Stabilizers' Contribution to the Federal Budget Deficit

The Congressional Budget Office estimated that automatic stabilizers added $282 billion or the equivalent of 1.9 percent of potential Gross Domestic Product to the federal deficit in 2009 and the budget deficit from automatic stabilizers is going to grow through the end of 2011.

Automatic stabilizers are automatic changes in revenues and outlays that are attributable to cyclical movements in real (inflation-adjusted) output and unemployment. So during recessions, the economy contracts and tax revenues automatically fall. At the same time, some federal spending programs, such as unemployment insurance and food stamps, automatically increase. As the economy expands, these trends reverse as tax revenues grow and automatic spending programs contract.

Given the expectations that the economy will grow well below potential, the CBO estimates that the contribution of automatic stabilizers to the budget deficit will be roughly 2.3 percent of potential GDP in 2010 and 2.5 percent of potential GDP in 2011. But beginning in 2012, automatic stabilizers as a share of potential GDP will begin to fall.

CBO estimates that reduced tax revenues will account for the bulk of the deficits arising from automatic stabilizers, which is estimated to average 1.8 percent of potential GDP over the period of 2009 thru 2012.

See the full CBO report here.

I Repeat, Small Businesses Say Their Credit Needs Are Met

It is not always in the best interests of a business to take out more debt, so it is not surprising that a June NFIB report shows that 92% percent of the small business participants reported all their credit needs met, or they did not want to borrow.

This is information that I have been trying to spread in answer to the many “banks aren’t lending” articles that are out there. Most recently, I reviewed lending data in my Lending Metrics series of blog posts, but we have also repeated this information in congressional testimony over the last two years.

In its June report, the NFIB noted that only 3% of owners cited finance as their top concern. To put this in perspective, before 1983, 37% of owners cited finance or interest rates as their top concern.

And why is this? The NFIB answers that question quite clearly:

Even if credit were free, these business owners would not spend the money to hire or make capital outlays since such expenditures have no prospect of earning their keep. … What businesses need are customers, giving them a reason to hire and make capital expenditures and borrow to support those activities.

Consumer Credit Up Slightly in April on Nonrevolving Credit Growth

The Federal Reserve reported that consumer credit increased at an annual rate of 1/2 percent in April 2010. This negligible increase in consumer credit indicates that household balance sheets are still suffering from the worst financial and economic strain since the Great Depression.

Revolving credit decreased at an annual rate of 12% in April. This is the 19th straight monthly decline. From a year ago, revolving credit was down 9.6% and down 14.1% from its peak in September 2008. Seeking greater financial stability, households have reduced revolving credit borrowings.

However, on a positive note, nonrevolving credit increased at an annual rate of 7% in April and has increased in four of the last five months.

April Housing and Mortgage Market Trend Sheet Now Available

April’s explosive housing market activity was driven by the expiration of the Home Buyer Tax Credit program and the low mortgage rate environment. Below are this month’s highlighted trends:

• Existing home sales in April rose 7.6% to an annualized 5.77 million units, their fastest pace since November, when the original first-time home buyer tax credit expired.
• New home sales also surged to an annualized 504,000 units, which was an increase of 14.8% from the month before and a year-over-year expansion of 47.8%.
• Housing starts rose 5.8% at an annualized pace of 672,000 units. The increase was driven by a large surge in starts of single-family units, which jumped 10.2%.
• In April, the NAR Housing Affordability Index (HAI) continued to trend downward signifying that a median income family would need to put up more of their income to qualify for a mortgage loan on a median-priced home. The fall in the HAI is tied to sale prices rising with the increase in home demand at the end of the tax credit program.
• The Fed’s Senior Loan Officer Opinion Survey reported that underwriting standards remained tight in the first quarter, although less so relative to the quarter before. Meanwhile, mortgage demand continued to fall.
• In the first quarter, the percentage of seriously delinquent loans fell after growing for more than three years. The news is positive, but the small decline could be attributed to seasonality.

The Housing and Mortgage Market Trend Sheet, located in the "OCE Documents of Interest" column at the right, is now updated with April figures. The trend sheet includes sales, pricing, construction, and delinquency data.

Bank Tax May Be a Crowd-Pleaser, but It Isn't Fair

A recent posting What the banks owe America on the Washington Post “Post Partisan” blog caught my attention. Charles Lane makes the point that a Congressional proposal to tax banks to recoup losses from the TARP program “looks like an exercise in punitive populism.” Lane uses Treasury’s own numbers to show that the losses on TARP are not coming from banks, but from the auto companies, government mortgage relief programs, and AIG (which is an insurance company).

In fact, had TARP been limited to the banking industry, there would be no losses on that program. Treasury Secretary Geithner, in Testimony before the Senate Finance Committee on May 4, 2010 confirmed that taxpayers are benefiting from the investments made in banks: “...independent analysts’ look at the total return for the taxpayer in those [bank-TARP] programs would show that it is a very very high return.”

The story doesn’t end here, though. At that same hearing, I testified to the broader impacts that such a tax would have. The tax – proposed to be $90 to $117 billion over 10 years – directly reduces funding that would have otherwise been available for loans. Even worse, since $1 of bank capital can support up to $10 in lending, the simple translation is that it could mean up to $1 trillion in loans not made over the 10-year period of the tax.

Certainly, it is hard to know precisely what level of lending is ultimately not made, but the connection is direct and the impact is real. Even if it is only half of this amount, the potential impact is very large and has consequences for jobs in this economy. For example, the Congressional Budget Office estimated that the $787 billion stimulus in the American Recovery and Reinvestment Act “increased the number of full-time-equivalent jobs by 1.8 million to 4.1 million compared with what those amounts would have been otherwise.” Using that same relationship, the loss of $500 billion in loans would translate into between 1.1 million and 2.6 million in lost jobs over the 10-year period.

It’s important to consider all the impacts of these proposals to tax banks. Lane summed it up: “While it may be a crowd-pleaser, this particular proposal has never struck me as entirely fair.”

Payroll Employment Up 431,000 - Almost Entirely Due to Census Hiring

In May, payroll employment jumped by 431,000. However, virtually the entire gain was due to the temporary hiring of census workers, which added 411,000 workers to payrolls. Private sector payrolls only grew by 41,000. Though positive, this was the weakest growth rate since January. Private sector employment had been accelerating and gaining momentum in recent months, reaching 218,000 new jobs in April. May’s slowdown halted this trend. Going forward, due to the temporary nature of census workers, this factor will be a drag on payroll growth in the near future months as their employment comes to an end.

The increase in payrolls in May drove down the unemployment rate to 9.7% from 9.9% in April. However, the labor force participation rate, which had been steadily recovering since last December, fell 0.2%. The workforce declined by over 320,000 during the month, suggesting that many individuals are again becoming discouraged workers.

10.06.04 (Source: Bureau of Labor Statistics)

Hoenig on Steps to Normalizing Monetary Policy

In a speech to Bartlesville (OK) Federal Reserve Forum on June 3, Federal Reserve Bank of Kansas City President Thomas Hoenig outlined the steps that the Federal Open Market Committee (FOMC) should take to normalizing monetary policy. First, the Federal Reserve should finish unwinding its extraordinary policy actions it implemented during the financial crisis in the fall of 2008. Hoening states that

As part of this first step, the FOMC would also eliminate its commitment to maintaining “exceptionally low levels of the federal funds rate for an extended period.”(emphasis added)

Second, the FOMC should be prepared to raise the target federal funds rate to 1% by the end of this summer. While this move will maintain a highly accommodative policy stance, it would move the nominal federal funds rate away from zero and make the real federal funds rate less negative.

We would then pause, maintaining the funds rate at 1% while we assess the economic outlook and emerging financial conditions. This would provide time to judge whether and to what degree further policy adjustments are warranted to assure long-run financial equilibrium and stability.

By taking these two actions, Hoenig contends that this “would serve to reduce the likelihood of a buildup of new financial imbalances.”

After taking these two steps, the next move would be to move the federal funds rate target to neutral. This would involve moving the target rate from 1% to 3% reasonably quickly. The final step would be to take the target federal funds rate to between 3.5% and 4.5% as economic growth reaches its long-run potential.

However, if the past is a prologue to the future, the Federal Reserve will take a more gradual approach to raising its target fed funds rate. After the 1991 and 2001 recessions, the Federal Reserve waited 19 and 14 months after the unemployment rate peaked to begin tightening, respectively. Unemployment for this cycle appears to have peaked at 10.1% in October 2009. If the Fed were to follow its previous tightening pattern, the first rate increase would come between December 2010 and late spring 2011. In the previous tightening periods, the Fed has taken about one year to raise the federal funds rate by 200 basis points, or 2%. Having rates at one percent by the end of the summer would be a much more aggressive policy move for the Fed, yet symmetrical to its quick rate reductions and financial market support at the onset of the crisis.

Labor Productivity Up 2.8%; Unit Labor Costs Fall 1.3%

Labor productivity grew 2.8% in the first quarter at a seasonally adjusted annualized rate. This follows three consecutive quarters of growth in excess of 6%. It is typical that in the early stages of economic recovery that productivity rates grow very quickly as firms find ways to utilize their existing labor force before hiring new workers. This is why there is generally a lag between GDP growth and employment growth. The slowdown in productivity growth may now be signaling the need for firms to begin to start hiring at a brisker pace in order to keep up with stronger demand.

Therefore this is a good sign for future payroll growth; however, it brings back into the equation that inflationary pressures from the labor market could come back moving forward. For the time being though, this is not occurring. Output per hour of labor rose by 2.8% annualized over the quarter. This is compared to compensation per hour, which rose by a lesser 1.5%. Therefore, the cost per unit of output fell 1.3%. There is still deflationary pressure in the labor market, though at a lesser rate than the previous two quarters where cost of output per unit fell by over 7% annualized.



10.06.03 (Source: Bureau of Labor Statistics)

ADP Employment Report: Private Payrolls Up 55,000

In May, according to the ADP Employment Report, private sector payrolls rose by 55,000. This followed an upwardly revised increase of 65,000 over the month of April (previously an increase of 32,000). May’s rise was the fourth consecutive improvement; however, payroll gains continue to only be modest. In order to drive down the unemployment rate, total payrolls will need to grow at a pace much faster than what is currently occurring.

The increase over the month was driven by growth of service sector jobs, which increased by 78,000. Manufacturing added 15,000 jobs; however, goods producing jobs as a whole still fell by 23,000, driven down by construction and resource extraction industries.



10.06.03 (Source: Automatic Data Processing)

ISM Non-Manufacturing Index Steady at 55.4

In May, the ISM Non-manufacturing Index was unchanged, remaining at 55.4. This was the third consecutive month where the index has been at this level and the fifth consecutive month where it has been over the expansionary threshold of 50. Service sector activity has therefore been growing at a steady pace in recent months.

The business output component moved upwards slightly by 0.8 point to 61.1. However, the new orders component fell back 1.1 points to 57.1. Of note is that the employment component rose above the expansionary threshold for the first time this cycle, hitting 50.4. This indicates that service sector firms are adding slightly to their payrolls on net.



10.06.03 (Source: Institute for Supply Management)

Construction Spending Up 2.7% Led by Residential

In April, new construction spending surged upward by 2.7%. The increase was primarily driven by a 4.4% increase in residential construction spending. The residential component has been very volatile in recent months; however, it is up 4.2% from a year prior.

Though residential spending led the increase, private non-residential spending also rose 1.7%. This was the first monthly increase since March 2009. Despite the rise, from a year prior non-residential spending was down 24.6%.

Public sector spending rose for the second straight month, increasing by 2.4%. However, from a year prior, it was down 4.4%.

ISM Manufacturing Index Shows Expansion for 10th Consecutive Month

In May, the Institute for Supply Management's Manufacturing Index fell back slightly, falling 0.7 point to 59.7. Despite the decline, the index remains well above the expansionary threshold of 50. Therefore, the change over the month represents a slower rate of manufacturing sector activity growth, not an output decline. This was the tenth consecutive month where the index was in expansionary territory. The recovery of manufacturing continues to be robust.

It was the inventories component which drove most of the top line decline, which fell back 3.8 points to 45.6. This was the second consecutive month where the inventory component has been below the expansionary threshold. This is perhaps indicative that the inventory readjustment period of the past couple quarters is coming to an end.

The production component fell 0.3 point to 66.6, while the new orders component remained the same at 65.7. Employment continued to improve, increasing 1.3 points to 59.8.

Source: Institute of Supply Management