Delos Smith: Housing, No Double Dip; Job Growth, Better Soon; Recovery, Sticky

Includes: DIA, QQQ, SPY
by: Harlan Levy

Delos Smith is senior economist for The Security Executive Council, a Fordham University economics professor, and president and chief economist for Delos Smith & Associates. Previously, he was the senior business analyst with The Conference Board, which issues a monthly consumer confidence survey.

H.L.: Let’s start with the first-quarter Gross Domestic Product report before we get to the financial reforms. Is the U.S. economy mired in really slow growth?

D.S.: It’s just slow growth. But GDP up 2.7 percent is decent, and you’ll probably have 3 percent growth in the second quarter. Actually, you need something much higher, like 4.7 or 5.7 percent growth to offset the various negatives – jobs and housing problems, the horror story of the Gulf oil spill, and the war in Afghanistan.

But there are a lot of good signs: Manufacturing inventory is now in balance, which is very very key for the manufacturing sector, and business confidence is up and very positive. The auto sector is improving. You’re only getting one scoop of ice cream rather than two or three to have a satisfying desert, but one scoop isn’t bad.

H.L.: Are you surprised?

D.S.: No, not when you’re coming out of the type of recession that we’ve been in. Usually there’s an inventory imbalance, and this was not. This was a frightening global financial breakdown, and that stalled the economy, which was different, so the recovery will be very different too.

You see it in jobs, with a very slow increase, and you see it in consumer confidence measures. The jobless rate is too high for where we should be. And it’s disappointing how high the unemployment claims are. They’ve stalled. The best measure to look at is the four-week average, and it’s higher than where it was in February, so we have not made any gains and in fact have taken steps backward, not a good outlook

Consumer confidence is extremely low, amazingly low. Until consumers start to have more confidence you really will not get the plusses you hope for. However, the economy is recovering. It could be much worse, but it is not recovering in a way to get us back to full employment. It’s a very sticky recovery.

H.L.: What do you think of the new financial reforms -- a ban on most proprietary trading by banks, oversight of the derivatives market, and measures to close big firms whose collapse could crush markets, to oversee hedge funds, and to ease investors’ ability to sue credit rating agencies?

D.S.: The bill is positive and should be helpful, but it does not and cannot contain two key things we need to have. You have to have the regulators, the rating agencies, and the financial institutions really understand what the derivatives are all about. Also the financial institutions – the Chases, the Goldman Sachses -- and the rating agencies have to have the internal controls that are not there, and they have to create them themselves. Before the crisis you did not have the senior management of those companies understanding what the derivatives were all about and the possible abuses.

I’ve been in this business of manipulating large amounts of numbers for over 50 years and the abuses by the major institutions, including Merrill Lynch and Citicorps, the whole bunch of them, was simply unbelievable and absolutely profound. It was incredible ignorance of what was really happening, and so many of the regulators and rating agencies were really just praying that everything would work out without knowing what was going on. AIG was actually healthy except for one division which went bonkers and wrecked the whole company. You have to control your numbers, and that comes down to risk assessment.

H.L.: Do the reforms require financial institutions to maintain enough money to cover potential trading losses, a major problem in the foundering of the swaps market?

D.S.: The bill, which is still being put together, does increase the capital requirements, but we have to see how it works out in actual practice. But it’s a good start, although a lot more has to be done.

H.L.: The most recent data show extremely weak new and existing home sales, even before the federal tax credit expired. Is housing heading for a double dip?

D.S.: I don’t think so. The existing and new home numbers were only one-month numbers, and I would not want to put that much into them. Earlier you had a distortion in there from buyers using the tax credit, with numbers way too high. Now you’re going the other way with very low numbers in the last month, and that’s also unrealistic.

But I don’t think the housing market is collapsing in any way from just abysmal numbers for one month, but we have to wait and see where we are in a few more months. Also, the inventory numbers are all over the place, and we don’t have the true meaning of that. For instance, the inventory of new homes was for six months a couple of months ago, which is normal and where you want it to be, but in the last month it went up to 8 ½ months, which is too high and too distorted for what the true trend is. So you have a lot of noise in the series, distorting what the two trends – inventories and sales -- are. We’re in between now.

H.L.: What about the banks. Are they too stingy in lending.

D.S.: Credit is a little looser but not loose enough. You also have the new reform bill, which knocks out a lot of income for banks, and they’ve got to find income elsewhere, like different kinds of fees. It’s probable that free checking accounts will disappear, or you’ll have to have more in them to keep them free.

H.L.: The stock market has been gyrating all over the place making investors bilious. What’s ahead?

D.S.: The equity markets are trying to find where they want to be. They’re down from their highs but not even close to their lows. They’re going to be in a tight range until the markets start to see job growth and consumers and businesses starting to heal. But the big thing is employment, and I think certainly by the fall we’ll start to see much better numbers.

H.L.: But right now the debt crisis in the eurozone has reemerged as a major concern, with the Federal Reserve seeing a possible effect on the U.S. economy and major jitters unnsettling the stock market. Is this reaction exaggerated, and are eurozone countries doing what they have to?

D.S.: It’s very hard to tell if they’re dealing with their problems, although they are trying. We do have a global economic financial system, and what happens there does affect us, because our companies are all over the world.

But there are a lot of political challenges: Can the European Union actually work, with northern and southern countries together? The differences are huge. German and France have very strong economies. Portugal, Greece, Spain, and Italy don’t. Can they change? Can the European Union nations work together? Will Greece actually put in the reforms that are needed, and will the Greek people accept them? And will Germany -- and France to a lesser extent because it’s not as powerful -- bail the other eurozone countries out, and how much are they willing to do, and what kind of growth can they maintain?

But I’m optimistic the problems will be worked out in time. The eurozone countries are not being obstinate. They’re trying to work things out and trying to adjust to a global system, and that’s very positive.

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