Housing Weakness Spilling Over To Manufacturing

More confirmation that the slowdown in housing has spilled over to manufacturing.

The Federal Reserve Board announced this week that its index of industrial production fell 0.5% between January and February, putting it about back to the level we saw last June.

Source: FRED

The separate Business Outlook Survey from the Federal Reserve Bank of Philadelphia continued to be strongly negative, meaning that more firms in the northeast reported that March was worse than February compared with the number reporting improvements. I don't take much comfort in the fact that fewer firms reported a drop from February to March than had reported a drop from January to February.

Source: Calculated Risk. The shaded recession for most recent observations represents the assessment of CR, and not a declaration from NBER.

The discussion is increasingly shifting from "are we in a recession" to "how long will the recession last?" The latter question is one that I'm very hesitant to answer. Historically, the average postwar U.S. recession has lasted 10 months, with the longest being 16 months. However, current developments do not look to me like a typical recession, but instead seem to be something without clear precedent in the last 50 years.

Credit markets at the moment are profoundly insecure. The mortgage securitization model looks broken, and it is not clear what is going to replace it. No one is sure how to evaluate the creditworthiness of a huge volume of assets and the institutions that hold them, or what would be the fallout of further big drops in real estate prices and increases in default rates.

There are those who argue that first we need to avert the immediate crisis, namely preventing widespread financial defaults, before we can turn our eyes to needed regulatory reforms. But it may be that until we can establish adequate equity cushions and more transparent accounting standards for financial institutions, the economy will continue to languish.

Comments

[Bo Peng:]

The way out of this mess is to address the root cause -- liar's loans.

The lax (possibly criminal) mortgage loan standards in the past few years have poisoned market's confidence and ultimately (and quickly) spread the fear and panic throughout most asset classes. People can't tell the good assets from the bad. This is the most fundamental reason for the mess we're in today (others like over-leveraging serve as channels and amplifiers for the contagion).

So how do we address the root cause? Re-examine all subprime and alt-A mortgages originated, including refinancing, since 05.

-> Loans without documented income or with lies -- bad, lender's negligence or borrower's fraud, no bailout whatsoever, bankruptcy/prosecution...
-> Loans up to standard, even if the relaxed standard of "normal" subprime -- good, go on trading them, gov/bank help possible.
-> Loans with documented income but with overly lax terms (teaser rate etc) -- Lender's decision to take excessive risk for short-term revenue, should take the loss, may also be forced by gov to modify the loan with borrower.

Yes, it'd take a lot of work. But what's the alternative? We've pumped a huge amount of liquidity into the market, broke many rules and precedences, risking huge moral hazard and very real damage down the road. And it's been seven long and painful months, with no end in sight. All we've done is to ease the symptom.

The real problem is not lack of liquidity, but fear to lend/invest and the distrust from not knowing what's on others' books. Hell, even one's own books. Once such re-examination is done, investors can use the database to quickly sort out their books, including derivatives. Then we can talk about sensible repackaging, restructuring, rebalancing, and refinancing. We can have valuation with more confidence, and writedowns only on those that should be written down.

I'm amazed nobody has talked about such a true solution to date.

2008 Mar 23 08:41 PM

[TM:]

Given the weakness in a number of the manufacturing indicators, I am expecting Wed. durable goods report to probably throw more coal on the fire...

-TM
fiateconomics.blogspot.../

2008 Mar 23 10:25 PM

[James Seaberg:]

The final solution is to abolish the Fed. It is a failed institution and has cost hundreds of millions of people their lifes by financing wars and destruction.

2008 Mar 23 10:56 PM

[User 49284:]

Sounds like the author is spouting the politically correct line here.

2008 Mar 24 09:06 AM