Tuesday, July 25, 2006
FDIC Summer Outlook
Since ancient times, credit markets have undergone periodic booms and busts. In 594 BC, for example, the Greek state of Attica found itself under severe economic stress because of the massive debt incurred by many of its citizens. The ensuing civil disorder resulted in a handover of power to Solon, one of the “seven wise men” of Greece. Solon took radical steps to restore balance to the economy, such as canceling debts, freeing those enslaved for failing to repay their loans, and devaluing the currency by 25 percent.I mean, "canceling debts" and "devaluing currency" are not the words a banker likes to encounter when settling down for a spot of afternoon reading. But apparently the FDIC thinks we're stupid, because they go on to 'splain things:
Simply put, credit cycles are fluctuations in loan quality and quantity. They are often correlated with, but not always identical to, business cycles, which are based on fluctuations in the overall output of goods and services.The article seems to be suggesting a somewhat less than rosy future:
So, is the credit cycle merely a reflection of the general business cycle, or is it a phenomenon unto itself? Clearly, looking at quantity and ex-post quality measures, such as charge-offs, the credit cycle in recent decades has tracked the economic cycle fairly closely. However, many observers of the credit cycle throughout history believed that credit extension and contraction drive business activity, rather than the other way around.
The economics profession has recently begun to reconsider the role of psychology and expectations in investment decisions. Recent research has found that underwriting standards, as measured by the Federal Reserve Board Senior Loan Officer Opinion Survey on Bank Lending Practices, are a better determinant of future business lending than either GDP or the federal funds rate.23 Similarly, analysis of a Federal Deposit Insurance Corporation survey of underwriting standards finds that underwriting standards are an important determinant of future loan losses.24 A modern theoretical response to this finding might be that credit markets are efficient and that loan officers, having just as good access to GDP and interest rate numbers as anyone else, should make decisions that incorporate all available information in a rational, profit-maximizing way. Another interpretation from a 19th-century perspective might describe the easing and tightening of standards as the reflection of alternate swings between “greed and fear.”25I think they are suggesting that the next recession is in the bag, and that creditors did it to themselves. Of course, we know George Bush is going to get the blame for it, but the Fed is independent of the President and Bush certainly wasn't out on the street telling people to get option-ARM mortgages. Greenspan, now.... did.
The implication of the article is that the 19th-century theories make more sense than later theories when applied to current economic conditions. Writing bad loans has produced a loan quality problem; this will force a tightening of underwriting standards which will amount to a credit contraction, which will constrain the market for goods and services, which will further reduce credit quality.... biff, boom, bang. Recession.
As for the market in goods and services, see this thread up at Professor Piggington's:
Was reading a link from someone elses post about some secondary markets to profit from in the housing bust. It got me thinking about some of my own experience with different suppliers to the housing market and the numbers do strongly support the end of the housing ATM.The fall in retail employment over the last couple of months and the weak sales figures for WalMart and Target amount to a red flag. There is major weakness in the auto industry, and I think the US government has already had almost all the stimulative impact it will have on the defense industry. Consumer spending is a very large factor in GDP, although there are different schools of thought on its net effect. Without a significant rise in real wages, it's hard to see what would increase consumer spending in the next few years.
I work with an Advertising Agency as a search engine marketer for several major national home improvement franchises (among several other companies). They span from driveway paving, to window coverings, to kitchen remodling, to floor coverings. Basically everything people have been sucking cash out of their homes to buy over the past 5 years with reckless abandon.
I've had the ability to track exactly how much demand there is for these types of products and how often this traffic converts into actual business for the client. Without much exageration, I can report that the level of both interest and sales are crashing quickly. While the level of interest is a slower decline, sales conversions have declined quite quickly in the last 5-6 months.
From speaking directly with some of the clients, they have admitted that other online efforts have been declining just as quickly. It would seem that the pain of the slow reduction in "easy" credit along with flattening/dropping equity levels is already hitting these secondary home improvement companies.
Shilling hasn't been that shy about what he thinks will happen:
SHILLING: The economy is slowing, and I suspect that by the end of the year it could very well be in recession. The basic reason is that housing activity is weakening, and that has been the mainstay of consumer spending, which in turn has been propelling the economy. During the past 17 quarters of expansion, spending growth has exceeded income growth by 2.5 percentage points on average, on an annualized basis. And housing is what has been supporting that, with people pulling money out of housing by home equity loans or refinancing.We need a new area of production or new markets, which is why I think opening up the domestic energy sector is so important. Companies aren't going to take risks unless they see strong rewards for those risks. They're not going to spend money just because they have it. We have a lot of mature markets that aren't going to reward
Once consumers see that housing price appreciation is no longer the order of the day, then they are going to curb their spending, as they basically have no alternative. Construction and mortgage brokerage and all of what is related to it has accounted for about a third of the job creation so far in this expansion.
One is that business investment [in software and hardware] has already been quite strong. If you look at the last couple of years, it has been growing at about a 10.5-percent annual rate. That's not markedly different than the 12.5-percent growth rate back in the late 1990s, during what was clearly an overblown capital-spending boom. So the first point is that in investment spending, the growth hasn't been all that weak.
The second point is, what do you do for an encore? You still have a lot of excess capacity left over from the late 1990s boom. My favorite example is fiber optic capacity. At the bottom, 3 percent of the existing capacity that was put in place in the late 1990s was being used, and now the figure is only about 5 percent of capacity. This is admittedly an extreme case, but there's a lot of capacity left over. So how much can you expect investment to grow from here to really spur the economy? Moreover, to make up for the consumer spending component I cited earlier, investment would have to grow at a 30-percent annual rate, and that is just not in the cards. So this idea of capital spending rescuing the consumer is not realistic.
When you look at capital spending, you have got to see the motivation for it. Profit growth is one motivator, no question about it.
large investments with large returns. Generally that happens more in investment in industrial capacity, but with the US making so little of what we consume, business investment is not that strong a fundamental stimulator for our domestic economy. We do consume energy. We can produce energy at cheaper prices than at which we are currently importing it. If we just removed the regulatory barriers to producing energy or even establishing old-fashioned production plants, we'd have a more balanced economy, with better jobs and less speculation. Right now we push industrial investment overseas, which is one reason why our job market is hurting so.
This latest round of speculation was exceedingly broad-based. There were $10-an-hour workers banding together to flip houses in some of these markets. One of the reasons why they are doing it is because they cannot profit in the old-fashioned but less risky ways. Part of that is due to illegal immigration, which has driven down real wages. The sum of US economic policy has been deeply irrational, and it has produced irrational markets. We really cannot continue lurching from bubble to bubble, so it is time to get our house in order.
(just swattin' at mosquitoes here...)
ed in texas
You really are on top of the economics/finace game- and I appreciate that.
The credit issues hav ebeen debated for a long time- it seems less science, more art- and like anything else, it depends who is wielding the brush.
That said, there is no question that mood and psychology of the business- and consumer- communities.
Ho, Ho, Ho! is the best example of that. Reality means a bit less that time of year.
SC&A, it will be interesting to see what the HO-HO-HO factor adds up to this year, won't it?
There's another truth too. Even in recessions, some areas and industries gain jobs and boom. The economy is NEVER a one-note deal, and neither is real estate.
It would be nice if we could start to dig out now to lighten this whole load.
I don't know whether you encountered Hillary's plan to "stimulate" homeownership. To me it looked like a plan to bail out Pelosi's husband. Now they want to pay people to buy overpriced condos. UR TAX DOLLARS @ WORK!
I am afraid Bilgeman is a prophet.
It's the much-ballyhooed Service-Based Economy (TM). Basically, everybody makes money serving hamburgers and fries to each other, suing each other for money, and trading hot tips on condos to flip. What Could Possibly Go Wrong?
The Headless Unicorn Guy
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