Interview With Fred Carstensen: Commercial Real Estate Crash Imminent

Includes: IYR, XHB
by: Harlan Levy

Economist Fred Carstensen is a professor of finance and economics at the University of Connecticut and executive director of UConn's Center for Economic Analysis.

Harlan Levy: Is the U.S. economy headed for worse than just slow growth this year in the wake of the dismal June job numbers and retail sales?

Fred Carstensen: No. We're continuing the same pattern we've had for some time. In the first quarter we had robust job growth. In the second quarter we still had positive private-sector job growth, but it's anemic, and we're having the continuing pattern of public sector contraction. The International Monetary Fund, the Organization for Economic cooperation and Development, and the Federal Reserve have been lowering their forecasts for economic growth. The general consensus, with which I agree, is that Europe is already in or will go into recession, while the U.S. will continue to have very modest growth. I think 1.5 percent to 2 percent growth is reasonable, and that simply would be entirely covered by productivity growth, so we won't see job creation in the 200,000 to 250,000 range per month, which is what we have to achieve to impact substantially the unemployment rate.

H.L.: The U.S. economy can't fully recover without housing. Can housing get off the bottom this year?

F.C: Housing is showing some very, very modest improvement, but it seems unlikely that it's something that's going to make significant improvement. Housing is driven by the employment situation, so as long as job creation remains weak, it's hard to see the housing market really improving substantially. I think it will take a couple more years until we see it move off the low levels it's currently at.

In part, that's because there's another real estate crash that we're not really dealing with right now - in the commercial area. We're facing a large number of delinquencies in commercial real estate. Commercial loans are typically short-term - five to seven years - so there are a tremendous number of loans taken out in 2007 which now must be refinanced, and a large share of those properties are under water, currently worth less than the outstanding mortgage on the property. So we're going to have a lot of turmoil flowing out of commercial real estate.

H.L.: Can corporate earnings and profit growth be robust with slow global economic conditions?

F.C.: No. I just don't see where corporations are going to have pricing power that would continue to provide them with robust earnings. And I do not expect the stock market to generate any significant gains in the next couple of years. In fact, I think it will flat-line for the next few years.

H.L.: What do you predict will happen to the euro zone and the global economy?

F.C.: I think it's still teetering on the edge of a major collapse. They keep opting for short-term Band-Aids rather than making the kind of systemic changes that they have to make. Now, there has been some very, very halting movement toward a comprehensive solution that they must adopt to sustain the euro in the long run. It's better than 50 percent now that they will end up doing that. I think their commitment to taking those steps is very, very weak. The political leadership in Europe has been very unwilling to put their arms around this problem and do what economists and observers feel must be done.

The upside is that China, the euro zone, the Bank of England, and the Danish Central Bank all took steps to stimulate their economies, and the Federal Reserve has already extended quantitative easing. These are all positive steps to shore up the global economy. American mortgage rates hit a historic low last week, and I expect the low interest-rate environment will continue for at least two years. That will certainly encourage investments, home purchases. It is only tool that monetary authorities have available to help the global economy, and it's particularly important, given the almost universal refusal of governments to provide fiscal stimulus.

The one notable exception, of course, is China, where they are both cutting interest rates and providing stimulus. Here in the U.S. we not only have refused to use fiscal stimulus, which clearly would be appropriate, but we're also facing this really frightening fiscal cliff in January when we will both dramatically cut federal expenditures and see the expiration of the Bush tax cuts. We have to go through raising the federal debt ceiling and the same time, and, given the track record in Washington, it's a real concern that we will mismanage how we will handle this challenge, and if that scenario plays out it would clearly plunge the U.S. back into recession.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours.

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