The nation's economic hangover: Two years down, and two years to go, says local Fed economist
This article first appeared in the St. Louis Beacon, Aug. 15, 2010 - Just as there is no magic pill to cure a hangover, it will take time -- at least two more years -- for the United States to recover from the economic binging of the last decade, says a local economist who was sounding the alarm about over-leveraging and cash-out home refinancing, even while the housing market was still bubbling along in 2005 and 2006.
"I would say things look worse now than they did in 2008," said Bill Emmons of the St. Louis Federal Reserve, who knows that is the last thing Americans want to hear two years after the bottom fell out of the U.S. economy, leaving some of the nation's biggest financial institutions teetering on the brink.
"A lot of the interventions by the Fed and others did put a floor under the panic, and some of the policies created a bit of an impression of a turnaround late last year, but I'm afraid that was a false dawn," Emmons said. "The underlying problems haven't gone away.''
Pushed over the edge initially by the failure of risky sub-prime mortgages, the housing market remains on a downhill slide with declining house values continuing to erase equity and turning more and more mortgages upside down, he said.
In July, 325,229 properties -- or one in every 397 U.S. housing units -- received some type of foreclosure filing, according to RealtyTrac, an online marketer of foreclosure properties, which is forecasting that 1 million American homes will be lost to foreclosure this year. Though national foreclosure filings were down 10 percent from July 2009, they were up 4 percent from June 2010. In the St. Louis region, foreclosures have increased in the past few months, with more than 2,100 homes either repossessed are put on the auction block in July.
"We had a giant party, and this is the hangover," said Emmons, a longtime critic of U.S. household spending that was too high and savings that were too low because, well, we could always just sell our houses to pay the bills.
While Wall Street continues to have its ups and downs, economists say that stabilizing the housing market is a key to turning things around. But for now, foreclosures -- and a near-10 percent national unemployment rate -- are driving the economy, and some economists, including James Bullard, president and CEO of the St. Louis Fed, are voicing worries over the possibility of deflation setting in.
"Ben Bernanke (chairman of the U.S. Federal Reserve) quite some time ago said that the economy will not be stable and have a foundation to recover until the housing market stabilizes,'' Emmons said. "And he hasn't repeated that a lot, but I think it's just being proved true. The fact that the housing market looks like it's on the verge of another step down is extremely troubling."
Here are more excerpts from a recent interview with Emmons, who shared his own economic views and was not speaking for the Federal Reserve.
Two years ago, economists were predicting that it would take several years for the foreclosure crisis to ebb and the housing market to stabilize. Where are we now, in terms of housing?
Emmons: In the earlier part of 2008, housing prices had fallen and unemployment was moving up and the forecast we would have made at that point was that it will take a couple of years before we stabilize. But then the bottom fell out in late 2008, and that has really complicated things for housing, and so here we are in 2010 and it would be optimistic to say that it will be a couple of years before we get back to any sort of a robust feeling. And it could be a couple of years before we even stabilize.
There's an undercurrent brewing among the economics community and the business economists and the FOMC (Federal Open Market Committee) that there was a bit of a recovery last year, but it looks like it potentially wasn't sustainable and it was built on the extraordinary measures taken by the Fed and Treasury and FDIC. So I think -- and I'm not alone in saying this -- housing is probably going to get worse before it gets better. So foreclosures are probably going to continue rising or at least continue at a very high level.
Housing will get worse before it gets better? That's an unsettling thought that won't boost consumer confidence. And isn't psychology part of the economic battle?
Emmons: The biggest problem in the housing market right now is depleted homeowner equity. Some estimates are that one out of four (U.S.) households with mortgages are under water.
Both the futures markets and a survey that Robert Shiller, an economist from Yale has been running for some time, indicate that house prices are likely to fall again this year. That is what's driving the problem with equity, and it's going to be exacerbated.
It is discouraging, but my point here is this is not just about psychology. You can't just will yourself to have more equity in your house. It's just the hard facts. It's the hangover from the tremendous amount of debt taken on by households over a number of years. It was a bet both by the borrowers and the lenders that house prices wouldn't go down, and we lost the bet big time. And now any further decline in house prices is even more serious because of the effect of the leverage. There's so little equity left in so many households that it doesn't take much of a decline to have pretty serious effects.
I really believe this is what (St. Louis Fed) president Jim Bullard is talking about. The Japan scenario -- the deflation risk. This is why if you watch mortgage rates or bond yields, it's frightening what's happening. The 10-year treasury yield is back down in the same level as it was in late 2008 when people thought the world was ending.
Explain why the possibility of deflation -- the so-called Japan scenario -- is so worrisome.
Emmons: With deflation, there are two senses of that word that people talk about.
One is just falling price levels -- the CPI (Consumer Price Index) falling from month to month -- and we already have that kind of deflation. Yet what most economists talk about regarding deflation is a chronic condition of not just declines in some price index or a number of price indexes but this whole mindset or psychology that everybody starts to expect it.
If that were to set in to the United States, and I don't think that has happened -- there is no evidence of it, that people are expecting a consistent fall in prices. If that happens -- and this is what Jim Bullard has been saying -- it's not at all clear how you get out of it. Japan has been trying for 20 years, and many people say, well, Japan didn't try the right thing or they didn't try it long enough. It was a mistake of policy. But Jim says when you actually look at what they've done, they have tried a lot of different things. And they did try it on a very large scale. And that's why I think he felt it was necessary to bring it up now. Because once you get into deflation, it is not easy or obvious how to get out.
One of the ways that economists talk about this is in expectations. The key is to avoid a lot of people starting to expect prices to fall. Another aspect, though, is with individual households. Yes, you want to have positive attitudes, but there is just the reality of what your financial situation is.
The fact that consumers are saving more and spending less -- isn't that what the financial analysts advised us to do?
Emmons: If you have a sudden outbreak of thrift, even though it might be what an individual household needs to do to pull itself up out of this problem, it can have a very jarring effect on the overall economy. It's what (economist) John Maynard Keynes called the paradox of thrift. If a lot of people start saving at the same time, it's going to have this contractionary effect on the economy.
That's kind of independent of what people's expectations are of this abstract term of inflation. Even though you don't see people telling you in surveys that they expect deflation, there are these financial problems with the potential to create conditions or people's behavior to change in a way that pushes us in that direction.
It's too early to know, but the CPI has been falling, and this is just very anecdotal evidence, but it seems a lot of price cutting is going on, in the retail business, or if you've traveled much you can get some really good deals. Actions are pushing in that direction because of the pressures on individual businesses to drum up some sales. Another example is restaurants. There has been an unusual amount of deals. That's price-cutting -- that's deflation. And that's not a bad thing for individual businesses trying to drum up business. But the cumulative effect is that businesses have less income, and they're putting pressure on wages or people are losing jobs.
Any good news in any of this?
Emmons: Like a hangover, it takes time to recover -- and maybe we will learn from this. Maybe this is a teachable moment. Maybe there will be changed attitudes.
This article originally appeared in the St. Louis Beacon.