Michelle Girard: Uncertainty Undercuts Already Struggling Housing Market

by: Harlan Levy

Michelle Girard is managing director and senior economist at the Royal Bank of Scotland.

H.L.: What kind of shape is the U.S. economy in, considering the latest data on the housing market, industrial production, and jobs?

M.G.: The U.S. economy is growing. It’s just not growing rapidly enough to bring the unemployment rate down. Concerns over an economic double dip have faded, and, on balance, the economic data do confirm a sustained expansion. However, the pace is sub-par at just between 2 and 2 ½ percent, and the economy is just moving sideways. This is why we expect the Federal Reserve will engage in further quantitative easing, buying Treasury securities to pour more money into the banking system.

H.L.: How effective can that be?

M.G.: Even the Fed admits that the impact of additional Treasury purchases on the economy is likely to be limited. They’re hoping that by purchasing a significant amount of Treasury securities they will be successful in lowering longer-term interest rates, which should help spur economic activity.

Even if rates decline by 20 or 30 basis points – 20 or 30 hundredths of a percent – they believe that this benefit more than offsets any potential costs associated with the action.

H.L.: What do you see as the effect of the foreclosure problem on housing and the banks involved?

M.G.: The foreclosure situation is unfolding and will likely take years to resolve the various issues. From an economic standpoint, the impact on the housing sector is probably limited. However, it’s the uncertainty now associated with the foreclosure process and mortgage securities more generally presents another headwind that the struggling housing sector doesn’t need.

I think the impact is mixed. There are those who feel that home prices will not decline because it will delay the supply of these foreclosed homes onto the market until a time when the underlying level of demand may be higher. In that sense, it may certainly bode well for home prices in the near term. On the other hand, if there’s a reluctance for investors to buy a foreclosed property because of the uncertainty, then that’s one source of demand that may exit the market. It’s just not clear what the impact is, but increased uncertainty is not a good thing.

H.L.: Is the stock market’s relentlessly upward trajectory mainly based on fundamentals or just hedge funds playing games?

M.G.: Generally I think the market is improving as a reflection of the expectation of increased liquidity provided by the Fed. The money has to go somewhere, and the market is the beneficiary. You can loan the money to Treasurys for two years and make 30 basis points, or you can buy stocks and earn more than a half a percentage return over two years. The consequence of the Fed’s quantitative easing is that money is moving out the risk curve. You’re willing to buy riskier assets.

H.L.: What do you think is the way to go to fix the economy?

M.G.: We need to control spending and get the deficit down and above all reduce uncertainty about future fiscal policy. We need to have a better idea of what future tax rates, spending, and regulatory requirements will be. The uncertainty regarding all of these things has created major drags on the economy.

But there’s no easy fix. There’s no magic bullet. There are adjustments that have to take place, and it won’t happen quickly. Companies are clearly well positioned to invest and hire and express an unwillingness to do so in part because of uncertainty over the economy and the costs of hiring additional workers, in terms of healthcare reform and other factors. We need to develop some long-term plans to adjust the deficit. Those will go a long way to providing support for the economy, eliminating a significant drag.

Disclosure: No positions