Why Wouldn't The Economy Go Into Recession?

It is not a pleasant topic, but the time has come to talk about recession. Although the probability of recession has obviously risen by a significant amount in recent months, most economists, including those at the Federal Reserve, are still betting the U.S. will be able to avoid one. Yet almost all economists, even those at the Fed, have lowered their projections for growth.

Minutes from the Fed’s Oct. 30-31 meeting reveal the new thinking. Most notably, the Fed is now projecting that economic growth will range from 1.6% to 2.6% for 2008, down from the 2.5% to 3% projection made just four months earlier. It is important to realize that the Fed is predicting anemic growth, but not recession. This, however, does not provide much comfort.

Not long ago, the so-called real estate experts claimed that housing prices never fall on a national basis. Those who said things were different this time were ridiculed. That argument is now settled. Not only have prices fallen; they are still plunging. The quarterly S&P/Case-Shiller U.S. National Home Price Index fell 1.7% sequentially in the third quarter, the biggest drop in its 21-year history. This index is down 4.5% year-over-year, and the rate of decrease has accelerated. This means that more than $11,000 of value has been erased from a home that was worth $250,000 a year ago. Of course, in some parts of the country, the story is much worse. In Tampa, you can now fetch just $222,250 for a house that was worth $250,000 a year ago.

Given losses of this magnitude, it is no surprise that foreclosures are up. Particularly hard hit have been homes financed with subprime adjustable-rate mortgages. The Fed estimates that monthly payments on more than two million such mortgages will be reset by the end of 2008. We will see many more foreclosures between now and then.

The real estate market is in a downward spiral. Falling property values contribute to foreclosures, and rising foreclosures contribute to falling property values. When a house is foreclosed, all the houses in that neighborhood lose value. In fact, Global Insight, an economic consultancy, recently estimated that property values will fall by $1.2 trillion in 2008. Foreclosures are being blamed for about half that amount.

In recent years, local governments have reaped a windfall in revenues by taxing all those inflated properties. That game will come to an end as homeowners demand that assessments be brought down to more realistic levels. Financial institutions are just starting to write down the values of their securitized subprime mortgage portfolios. Citigroup provides just one example of how devastating this can be for stockholders. The stock started the year at $55 per share. It is currently the biggest loser in the Dow Jones Industrial Average year-to-date.

Given the extent of the housing debacle, and a stock market that could potentially go much lower, why wouldn’t the economy go into recession? The Fed’s lowered growth projections are still too rosy. Perhaps the Fed is betting that the shrinking dollar will cause a huge boost in exports. We are certainly seeing some of that already. While it is true that a weak dollar can help prop up the economy in the short run, over the long run the U.S. is better off having a currency that everyone wants to hold. It's time for Treasury officials to do more than just give lip service to a strong dollar policy.

Comments

[David Roskoph:]

Vahan,
Don't you get it? Close your eyes and the problem will go away. The interest rate pixie dust will restore credit, stop foreclosure, rebuild the dollar and most importantly dupe the public into thinking it's safe to load up the truck with more stuff. Don't you understand American Capitalism? It's not about economic reality, it's about secuction.

2007 Dec 10 01:28 PM

[Kunst:]

If you want to make money, you have to be willing to bet against the crowd. Of course, you also have to be right.

2007 Dec 10 03:04 PM

[VegasBob:]

I'm curious. How is it even possible to have a recession in an economy that produces nothing of value in the first place?

2007 Dec 12 02:27 AM

[techy:]

wait a second...i thought this article was going to answer the question, not end with a question.

2007 Dec 12 03:24 PM

[bcncv:]

So because "real estate experts" were wrong about the housing market means that optimistic economists are automatically wrong about a recession?
Way to go for original thought.

2007 Dec 12 09:23 PM

[Greg Pinelli:]

You're going to have to do better than that Mr. J....There are a number of reasons we might not have a recession..exceptional amounts of liquidity provided by the Fed...Infrastructure programs galore provided by the political apparatus...Of course Vegas whats his name ought to know about lack of substance..his namesake reeks of it..as well as his comment.
In any case, how about some analysis..Is someone eager to see your picture at the top of something?

2007 Dec 12 10:07 PM

[sasian:]

..now that the music has stopped, there are fewer chairs & fewer players.. and the rules say that for every game there can be only one winner.. the winner this time around will be the US DOLLAR..

2007 Dec 12 11:30 PM

[Smorales:]

I echo the comment made by techo - this article is typical of what the least sophisticated investors have to say & how they say it. If you want to discuss recession (a measurable quantity, albeit in the future) I recommend that you talk about the drivers of GDP which I hope I don't need to tell you are parameters like Consumer Spending etc. Maybe instead throwing around loose data that give a you a funny negative feeling about the future of the economy, discuss conumer spending drivers. How about look at the catalysts consumer spending llike wages and hours worked? How about company profit margins which determine employment trends, which ultimately lags consumer spending but it is informative. Where are those drivers headed and why? And what are the basis point impacts of those drivers on GDP in the future? How much is housing and autos subtracting from GDP? What percentage of the economy do they represent? What about C&I bank lending? Hows that going? That's the hardcore credit cruch and recession indicator? Are we still far from recessionary levels just like the other indicators that I'm pointing out above. Fed governors are telling you these facts all the time as they try to put the situation in perspective. If you need help, the sources are all publicly available on the internet for free. Otherwise, judging from your article it doesnt appear that you're qualified to be talking about the economy to anyone but the least sophisticated. On the other had if you research what I've laid out for you above, you may come to some new fresh conclusions. Good luck. Smorales

2007 Dec 14 09:58 AM