The psychology of the consumer is the biggest impact. When you think your piggy bank will get larger every year, you are much more likely to spend (often like a drunk sailor). However, when you think your piggy bank will get smaller every year and you don't have your MEW and their is inflation and ARM payments, you go into panic mode. Thus, the psychological effects will tighted PCE much greater than the model likely shows.
Real Unemployment is already somewhere between 9% and 13% -- so saying unemployment won't reach 8% is already superseded. Maybe the BLS liars and idiots will be talking
We had a discussion about MEW on Monday (and I used CRs great charts.) The post discusses the phenomenon and shows a the activity of a specific homeowner with regards to the MEW phenomenon.
The marginal propensity to consume may be asymmetric: maybe it's 9 cents per $1 when asset prices are increasing but more than 9 cents per $1 when they are going down. Results from behavioral finance suggest that people feel losses much more acutely than gains.
This is where economists are forced to accept miscalculated presumptions to come up with even more miscalculated presumptions.
Firstly, I believe that ALL MEW is consumed. If you paid down consumer debt, then you were able to rack it up again. If you invested in your home then you bought stuff and hired people. If only half gets spent, then where praytell does the other half go? Anyway:
MEW over the last several years took on a different form and was spent much more freely than before. People weren't "borrowing" money, they were withdrawing their own money from their house.
If you make 100 grand a year then you probably live off of, after you paid your mortgage, taxes etc, about 40-50 thousand dollars to spend on life's necessities. So an increase in income of 50 grand (a 50% increase in income) would actually increase your spending power by 100%!
So when people took out MEW of say 100 grand tax free, that spread out over say three years was essentially increasing the spending power of a 70-80 grand earner by 100% each year.
Over the last 5 years there are people who had the spending power of essentially having a 200% raise.
This all went directly into the economy.
That is all gone now.
There is no good way to crunch the numbers to account for this.
It simply takes common sense and personal experience to say..."things are going to get worse."
Moe Gamble, yes, this is the impact from house prices only. There are other impacts - such as from less employment, from people pulling back during a recession, etc. But I wanted to put this into perspective.
Charlie Poole, I think the implied impact is in the same ballpark. Some people argue to just ignore MEW, and look at the wealth effect from house prices. Others argue MEW is more tangible, so we need to follow that too (I find myself in that group).
Let's see, property taxes, sales taxes, key component of job growth over past seven years, commercial RE development, HD and LOW and other big box expansion accross America, billions in profits for financial institutions, manufacturing, transporting all those goods, even more jobs
Not HUGE? Not sure if there has ever been anything HUGIER!!!!
ok fine, PCE decline is a small fraction of GDP.
What about Roubini estimate of up to 2.7 trillion in losses for financial industry? That is 20% of GDP. Would that be a DRAG on growth?
I keep very detailed track of my families spending.
My wife and I made 180 grand gross last year.
After everything (taxes, mortgage, investments in 457, roth's etc) We spend $6000 month on everything from clothes to food to vacations.
6000 x 12 = $72000 spending power.
So with an increase of only $72000 I would live and spend like I made twice the money.
MEW came in the form of tax free money and generally the added debt service was minimal if any as it was spread over 30 years and often at lower rates or offset with other debt buydowns.
So inject tax free money into families and you have a huge increase in spending power over a very short period of time that is much greater than many economists have factored in.
The wealth effect (Carroll's 2% -> 9%) and the consumption of MEW are two separate and additive items.
Also, both the wealth effect and the consumption portion of MEW represent increased debt or decreased savings. Sooner or later they both must be repaid by GDP. The cumulative effects enjoyed by GDP in the past must now be repaid. Is there a way to quantify this overhang (hangover)?
I concur with CR that the effects will be prolonged, because unlike inventory, or even capital investment corrections, these effects can be worked out over a long time.
"It simply takes common sense and personal experience to say..."things are going to get worse."" -- Average Joe
This brings me to a future conversation somewhere in CA...
"Daddy can we take out the boat for a ride."
"Honey, money doesn't grow on trees anymore. How do you expect me to pay for the gas?"
"The same way you use to pay for it. With your credit card that taps into your mortgage equity."
"Sorry, but that credit card along with the 7 others is tapped out. Also, our house is now worth $500,000 less than our debts on it."
"Well, Daddy, it sounds like you really messed up. But, it is not my fault. I want to go ride the boat, now!"
"OK, just hand me that five foot hose over there. You gotta stand look out while I syphon the gas out of the neighbor's car."
--
"This is one of the reasons I think the recession will not be severe (unemployment will not rise to 8%), although I do expect the slowdown to linger, and the recovery to be sluggish..."
As usual your thinking is shallow, i.e., lacks depth.
The fact that households now know that they wouldn't be able get money out of their homes will significantly curtail the current consumption, or be forced to curtail consumption, say by 5%. Then, factor in the failure of many small businesses that depend on discretionary spending and you are looking, at the minimum, at a severe and prolonged recession.
All of CRs forecasts will be proven to be too optimistic.
Of course, all that MEW from past years must be paid back or written off. So it's not just the decrease MEW that will result in decreased consumption, but the cumulative debt incurred in those years...
CFO's seem to think a recession is here. That wont have an impact on business spending will it.... Expired
Can someone please just get these guys some Wright Model B's?
The consumer isnt the only thing that is going to slow down. Prepare for the second leg down in the 2nd half of 2008.
Long live the consuming boomer! Consboomers die hard... so us future generations can expect nice tax hikes to keep the consboomer comfortable at the end of their life...
I think MEW traces out a good part (but perhaps not all) of the wealth effect and is therefore useful. The wealth effect often is measured in an equation estimated for total PCE. Such equations are preposterous: PCE is 2/3 of the US economy. To think that one equation can describe that large a share of the economy is delusional. The exogeneity assumptions in PCE equations, for example, are ridiculous. Yet people continue to use them1
Based on the MEW and wealth effects, I agree with your conclusions -- this recession is likely to be longish but not overly severe.
I think you also need to consider the effects on GDP from:
(a) a contraction in overall credit, and
(b) likely increases in (retirement) savings (by consumers) to compensate for the loss of value of their homes.
In other words, the wealth effect during a period in which housing values decline may well be more pronounced than estimates of wealth effects based on historical periods in which housing prices were rising and the average age was less (than it is now).
Missed Information, I think Roubini's estimates are too pessimistic. It's possible - if there is a systemic meltdown - but IMO very unlikely.
When I first proposed losses could reach $1 trillion (which Roubini very nicely credited me!), I argued that would take several very negative events. I'm still of the view that $1 trillion is the upper bound on the actual losses, and something on the order of $500 billion makes sense to me.
Jas, you have it backwards - I've been close - you've been consistently overly pessimitic.
If you make 100 grand a year then you probably live off of, after you paid your mortgage, taxes etc, about 40-50 thousand dollars to spend on life's necessities.
$50K?
100K
less 15K 401K
less 25K taxes
less 5K Roth IRA
less 25K net housing costs
try ~20K for living expenses. . .
MEW was an IMMENSE boost to the consumer economy 2003-2007. It was the invisible engine pulling the train, but it's certainly losing steam now.
MEW is huge, falling rapidly, and going to fall in an even bigger way soon. Here in So Cal I know of hundreds hanging on only by playing debt-bingo. My friend in the LA County Social Services is seeing huge increases in homeless, people needing food stamps, applications for section 8 housing vouchers, large increases in people looking for jobs and 2nd jobs because their primary low-wage jobs won't pay the bills. At a recent party we attended he went person-to-person asking if anyone / anyone's company was hiring / had open positions that he could add to the listings the county provides. The large numbers of fairly well off and middle class families that we are hearing are in dire straits is just amazing and growing. In North Los Angeles County friends I know live in recently developed neighborhoods where there is already 30%-40% vacant / abandoned houses from foreclosures and jingle mail. Nearby one friend nearly the entire new developement is empty and there is literally no buyer traffic of any kind. Local Real Estate businesses and Mortgage Business everywhere have "For Lease" signs on them and I see more every week. Every week I am hearing of more layoffs from friends and acquaintances. Lots and lots of people I know who rode the bubble up into self-employment of various sorts are telling me that their business are tanking and they are starting to think about looking for employment -- but there is little to be found. Fear is in the air everywhere -- and I am talking about the well off neighborhoods. Somebody has to go out into the real world and do some real world reporting because 90% of what is being reported in the news media is just garbage.
We are into the first .001% of this economic catastrophe -- long, long, ways down to go.
I don't see how you can possibly forecast the depth of the recession without considering the effect of $110 oil on the employment picture. The consumer is unlikely to spend if he is not employed.
Be honest, how many of you have friends/family who, were it not for MEW, would have the financial wall years ago....I have been waiting for it on several and it seems that it will never end..someone is always willing to lend them more.
I know people that, were it not for MEW they would be destitute.
With median household incomes having fallen since 1999, it seems also reasonable to conclude the consumer is entering the recession much weaker than it was just before the 2001 recession. The specter of declining consumption seems only the realistic result of MEWs declining now leaving sort of a vacuum. I imagine it will be pretty moderate/severe recession on the scale of 1974, but its effects will be even more pronounced as the economy struggles to recover. GDP per capita should decline under a contracting GDP through 2008 and then stay flat as GDP hovers around 1% throughout 2009. It's hard to imagine what sector will catch the economy as it falls toward the earth and help it recover. That's mainly why I don't really cling to these forecasts claiming GDP will rise 3% in 2009. What will be the sectors contributing the 3%? Exports? We'll see..
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If only CR can learn to think simply and clearly like Elvis here. But that is very hard for an economist to do.
I bet that CR would have hard time even thinking about the probability of a depression within the next two years. But for the reckless mortgage-lending boom, the economy would have already been in a depression few years earlier. Now that gone the depression would walk in easily. The Housing Bubble was lot more to the economy than CR thinks and the bust would be far worse than CR can think.
MEW was 5% of the $13T economy tnat is projected to grow at 2-3%. So how doesn't just the drop in MEW predict a recession? What sectors are growing at a pace to replace that missing MEW?
Add to that all of the GDP factors from construction, real estate transactions and financial transactions and where does the economy go?
Then use the money recycle rate (multiplier effect) and where then does the economy go?
I think nowhere but down significantly.
I would be interested in finding out why this thinking is flawed.
I, too, used to think that Roubini was overly pessimistic. Then again, if you'd have told me that the housing bust (which I foresaw) would spread toxic fallout all the way to a small town in Norway via fraudulent securities, I'd have said you were crazy.
These things apparently have a way of snowballing.
Let's just consider $110 oil for a moment (simply). If oil is $55 a barrel, depending on your car, let's say you spend $120 a month filling your tank ($1440 per year). Now, since oil prices are double, you spent $2880 per year on gas for your car. Also, other items cost a little more due to oil cost, so you spend $1500 more on pass-on costs. That is roughly $3000 more per year. Sizeble, yes. However, when your $300,000 house decreases 10% in a year, that is $30,000 or 10 times more than the oil effect. Which one is going to have a bigger effect?
"MEW is huge, falling rapidly, and going to fall in an even bigger way soon. Here in So Cal I know of hundreds hanging on only by playing debt-bingo."
Hmph. On the Central Coast, the only growth industry I can find is food banks. I have friends who run one. There's been a steady upturn in demand over the years, with a real spike in the last two.
What happens at the bottom, eventually ripples to the top.
The Carroll et al piece you cite apparently regresses back to 1960.
Is this a complete enough data set? We don't know, because, like in most econometric analyses, the authors seem to just assume that it is.
Another thing: the reality is that the advent of HELOC's likely had a significant impact on housing wealth effects, for obvious reasons. As such, we would expect a rather discontinuity in the "fit" of the regression line beginning in 1990 and another, larger kink in 2001. Is this true? We don't know, because, again, the authors of the piece did not see fit to discuss the impact of HELOC's on the "marginal propensity to consume" housing wealth.
Lastly, what of the demographics of the homeowner base? Surely a move down in median homeowner income would, all else equal, result in a higher propensity to consume. Presumably subprime caused just such a move. And yet, again, the authors don't see fit to discuss this presumably important development.
What is the value of Carroll's conclusions on the MPC? Not much. I'm afraid we can do better using common sense than he can using a computer.
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"Jas, you have it backwards - I've been close - you've been consistently overly pessimitic."
I have always been early, but never wrong or too pessimistic. My predictions in 1999 on Silly.con Valley economy and prices of CSCO and JNPR (CSCO didn't hit my projection of $5 but it did lose 90%+ to $8.12 and JNPR did go below $5 after being above $250) were better than anyone else. Loss of employment for Santa Clara Co. by 19.7% (during 2001-2003) does qualify for depression, no?
Anyway, we shall find out in 2009 who is right about the severity, or lack thereof, of the current recession.
CR, I'm really confused about your reliance on the BLS unemployment number without adjusting for or discussing the participation rate.
Anecdotally, I personally know several educated boomers who would like to work but can't. They've been searching for years. It is truly a significant problem for many families. I'm sure I'm not the only one on this board who knows several under-employed or unemployed friends who are no longer counted in the employment roles.
A lack of a significant increase in the unemployment does not mean that there isn't significant joblessness and systemically reduced incomes. With prices rising this is a significant problem for many households.
Perhaps you have addressed this issue already in a prior post, but I think that it is worth covering since you use that statistic so much to argue against a severe recession.
I agree with Elvis' assessment re psychology. The ratchet backwards is going to be a lot more than that, esp as they are having to handle increased costs of fuel, food and jacking up their savings rates. I expect that that study was predicated upon then-current (and probably still) savings rates.
So expect that folks are going to scrimp and cut back to re-establish a cash cushion while they take care of the debts.
Elvis-
It's a little bit different when you think about $110 oil from the perspective of the PPI, shrinking margins, and what that means to the employment picture.
Mild recession? I don't think so. My wife and I are looking into Chapter 7. My wife let it slip while she was at work. Come to find out, three other people where she works are in the process of filing Chapter 7. We have to file because I was injured and almost paralyzed. Her co-workers just got in over their heads I guess.
CR, I'm really confused about your reliance on the BLS unemployment number
I think it's because CR wants to look like a serious researcher to serious people.
Serious people would not take you seriously if you don't agree to stay within the official framework.
The same reason Roubini does not openly challenge inflation methodology, etc...
You are way underestimating the impact of all this.
1) Consumer's budgets will be capped as they have not been before.
2) Gas / Food will take up more of that capped budget.
3) Very little of the number is truly discretionary (a lot of it is implied rents, health insurance etc etc)
4) This will have stunning impact on discretionary spending - vacations, going out to eat, fancy clothes, tvs etc.
5) There is no engine at this point to pick consumption back off ground. Expansion in last 3-4 years was mirage. The good news, no huge loss in jobs as there aren't that many manufacturing jobs to lose - the bad news is that there are no jobs to regain to give us that nice big recovery thing.
You need to separate out the one time impact (drop in housing wealth) - temporary, manageable - from the long term ongoing change in run rate.
To go back to 8% savings rate that we will need to be at, it is $700 bn / year change - ongoing. $700bn means limited MEW plus some additional savings.
I'm seeing a significantly higher number of used cars for sale on the street/driveway than I've noticed before. Whether I'm more sensitized to that is a question; regardless, many of them are SUV.
Well I have said it before Ill say it again...I am sorry I missed the free money train...I pulled zero MEW out of my home since I bought it in 1993..did many upgrades, on cash...but then again I must not count I work 15 hour days sometimes 7 days a week...and i am debt free.....would this make me Un American?..so much for hard work and land of opportunity.. The last decade its been free money and greed...like I said sorry I missed it.
I want to be clear: I do not think the BLS is fraudulently reporting the unemployment rate. I just think the unemployment rate is only one piece of the jobs puzzle.
funny stuff:
I have many friends who do not work in finance, and most of them still look at me like I'm a nutter when I say that this financial crisis can change their very lifestyles.
But today one of them told me that he thinks there is no crisis at all, that stocks have just dropped a little and Bush-haters are blowing this out of proportion to hurt his presidency!
It's probably a mistake to think the folks who were spending everything that wasn't nailed down will change habits and begin saving....people do pretty much what they've always done. The folks who were saving will continue to save (maybe even moreso), but I suspect that'll be at the margin. I don't think it'll impart momentum to the downside. The dollar trajectory alone has savers wondering what they should go buy, just to protect their wealth.
We'll have trouble, but increased savings rate won't be part of it.
The mean has been misleading throughout the housing crash. The "average" homeowner may not be much affected, but I think we really need to look at where MEW cashouts are concentrated, and how these local economy effects then relate to the larger economy.
Most of the "growth" since 2000 has been one the coasts and a few other places. In fact, growth was a huge increase in debt accumulation, not real increases in productivity. In places like California and the East Coast, people experienced substantial increases in housing capital, which they then converted into big cashouts to pay for higher lifestyles. The "inlandia" of Krugman's imagination has neither the boom nor the bust, yet.
OK, so how does this matter. The point is that the average consumer will not be much affected by the declines in MEW. It is a few consumers, those who happen to have been the main thrust of the consumer-led expansion, who will suffer. Look to see Walmart and Costco doing OK for the next year or so, while tonier stores start to fade.
Now, because the MEW dropoff and huge housing price declines are occurring simultaneously in these same regions, they are starting to have real effects on employment, spending, etc. These, I think, will spread, but the effects are going to be slow, as have been the problems in housing spreading to MBS, etc. The titanic did not sink all of a sudden. Enjoy the band music, but don't get lulled into false confidence. We are going down.
Jas-- If you would post links to the numerous articles describing how small businesses depent on MEW, that would help everyone here understand that there is more to it than simply personal spending.
What really drives consumption is income and that has been flat for sometime and will probably decline over the coming years with the impact of high energy prices. The household wealth factor reflected in the flow of funds report is paper wealth that has little or no connection to real life as various banks and lenders pull the HomeEquity line plug.
I will agree MEW here on the East Coast was un-real..but also I have to say the Jobs Market here is holding up quite well...as there are plenty of jobs around...its the qualifying (person) skill level that is lacking.
Gosh! I thought I was poor because my income is around 95K. I guess I can afford the airplane because my housing cost, including insurance, is $8K. Never realized what it's like to have a mortgage these days. OTOH, can't fly as much as I did last year - price of gas has doubled.
If you live here in California, $100k income is about 57k after state, state disability insurance, fed taxes, social security and medicare.
minus rental housing, $24k ($2000 a year is pretty typical) and you're down to $33k. That's $33k including retirement savings like 401k and IRA. Assuming you max out the 401k and IRA like you stated, you are left with $13k. That's just over $1k a month for all the other expenses. including utilities and gas! And people don't think gas is a big part of the equation.
You see, I don't think many people can max out their 401k and IRA with this income. And guess what? the average income is $70k in the bay area.
So. yeah. As much as I'm Democrat, I think tax cut might be the best way to get out of this. But the budget problem makes it impossible.
So how can people afford a mortgage for the average $700k house in the bay area?
Not sure, but it seems reasonable that net MEW could go negative whenever either the net amount paying off HELOCs exceeds the amount being borrowed or if HELOCs are being written off as a loss.
Great work CR. But don't all roads end at the consumer? Aren't the components of GDP are consumer, military/govt and industrial/corporate? Industry serves both of the prior, so as they go, goes industry. Military/govt is trying to cut back, not increase spending, which leaves consumer, which is something like 70% of GDP.
I don't understand how a marginal cutback of this large a component won't result in a much larger result.
Predicting how deep the recession will be is just a guessing game at this point. Crisis has moved everything into an unstable state and the ball can roll down in many directions from here, moved by seemingly small perturbations.
There are huge uncertainties at play. For example, Brad Setser argued since 2004 that foreign support of US deficit is overstraining asians and could stop at any moment. But it continued 3 years beyond what Brad thought possible. I think its a huge risk factor that has slowly gone out of fashion and people like to pretend that just because it has continued beyond imaginable, it can continue forever.
It's hard to perceive that this will be a soft landing, with a mild hit to employment.
Just listing the litany of negative data and the multipliers on a global scale vs. the paucity of positive potential data seems to overwhelm that option.
Hmmm, it would be interesting to actually write those lists out, perhaps in excel...
If only there was a way to spend our way out of debt!
CR writes: "..but the impact probably isn't large enough to reduce nominal PCE."
PCE (GDP component 'C', currently roughly 70% of GDP) has not declined in nominal terms since 1933 even on a QoQ basis.
If you want to be looking for recessionary effects, look for investments 'I'. That has declined many times in nominal terms as well. In a recession what you typically get is a real decline in PCE and real (or even nominal) decline in investments. Decline in investments often substracts equal amount from the growth, or even more than PCE, although it's much smaller component.
If PCE begins to decline in nominal terms, go ahead and take a deep breath. Then there is likely to be some real trouble ahead, something you haven't seen in about 80 years.
I agree with CR - he is making a limited point with regard to the impact of MEW and MEW alone which is perfectly reasonable. He is looking at the Macro economic numbers, not whether he knows a guy who knows a guy who maxed out his HELOC and doubled his income in the past 3 years.
I think there will also be a consumer confidence hit due to the negative wealth effect, but that is not the same as MEW reductions.
And yes, if you presuppose some sort of systemic financial melt down, then the impact of decreased MEW is going to look tiny.... if the worst happens.
I think people are somewhat overinterpreting CR's comments here. His post is limited to the direct impacts of reduced home prices on consumption. This is a large but not overwhelming impact.
I think the question is obviously how large the indirect impacts are when the economy has been so dependent on the housing bubble for employment, wealth, and industry. This is the vicious cycle concept CR had early on, and quantifying the impact is not going to be possible. For now, let's be respectful of his predictions, since he certainly has garnered more credibility than anyone else on this issue.
So inject tax free money into families and you have a huge increase in spending power over a very short period of time that is much greater than many economists have factored in.
Average Joe
I guess that's the plan right now. You only have to file for your tax return.
O-Joe
"Speaking at the CFO Rising conference in Orlando, former IBM and Chrysler Corp. finance chief Jerry York predicted a lengthy and deep recession for the American economy.
Addressing the topic of what boards are demanding from CFOs, York said if he had only five minutes to give his speech, he would tell finance chiefs that: "CEOs and boards are just going to expect you to get these companies through the mess," emphasizing that, "I think this is going to be a very ugly recession, I think it is going to be lengthy, I think it is going to be deep."..."
"NEW YORK (Reuters) - A recession has already started and the downturn is likely to last longer than in the recent past, with the economy recovering only late next year, according to a quarterly survey of corporate finance chiefs released on Wednesday"
also:
it seems that people are arguing 3 different things
1) what is the effect of MEW ONLY on PCE and hence recession. (which was my interpretation of CR's post... trying to pull out ONE variable)
2) should we consider the effect of having to pay back previous MEW, and the effect of declining home values on MEW?
3) does that impact the rest of the ecoomy (jobs, etc)
CR's original point IMO is valid. The loss of MEW IN AND OF ITSELF is a small matter.
However, I feel like we have lots of pain as the MEW "hid" other structural problems in the US economy. now
-the MEW must be paid back, WITH INTEREST
-many jobs were created due to MEW, that now cannot be supported
-this could cause feedback death spiral
"Yesterday's rally in the equity market restored close to $700 billion of lost wealth (the equity market is valued at close to $18 trillion, and prices gained about 4%). That's enough to boost aggregate spending by about $32 billion over the next 18 months, using the widely accepted rule that each dollar change in equities imparts a 4-cent change in spending. While encouraging, the problem obviously is that wealth losses remain substantial from the peak, amounting to nearly $4 trillion, enough to pull aggregate spending lower by about $160 billion."
"Of course, what must be added to this is the impact of the recent decline in home prices, which at about 10% amounts to about $2 trillion in lost wealth. The wealth effects for housing are greater than the wealth effects for corporate equities, say between 7 cents and 10 cents, mainly because households extract equity from the homes in ways they do not in equities -- for example, through the sale of a home, refinancing, and home equity borrowing. This means that the wealth effects from the recent decline in home prices amounts to close to $150 billion. "
"Combined, the wealth effects from declines in equities prices and home values amounts to roughly $300 billion -- certainly a large headwind for consumers, who are facing plenty of other headwinds, particularly the weaker job market and accelerated inflation."
"Although the impact on PCE from declining house prices will probably be significant, the size of the impact is not huge when compared to the overall U.S. economy."
Thank you. I've been screaming this for months. The elephant in the room for the permabears is the strength in corporate balance sheets that will sustain employment indefinitely IMO
An economy that is at full employment is pretty powerful and has considerable forward momentum. If we even need an "engine of recovery" at all.
S.
Sebastian | 03.12.08 - 2:37 pm | #
Seb, the unemployment rate is only one aspect of the employment picture. Check out the percent of the population employed or the labor force participation rates. not all of that is Bush's fault, some of it is demographics, but relying on the unemployment rate alone is very misleading. Also check out the year over year growth in employment. Spend virtually all of the 1990's well over 2%, and usally above 3% (except right after the papa bush recession). Was also up over 3% for most of RR term (except early part) and for Carter's term. Just managed to kiss the 2% level for a month or two back in 06 this time. Now Yr/Yr growth rate is plunding again. Data is available here St. Louis Fed: Economic Data - FRED®
I'm not sure that the MEW effect and the wealth effects are additive. Rather think of MEW as being part of the transmission mechinism for the wealth effect.
MEW or lack thereof has a huge negative impact on consumption (my guess by about 25% on aggregate consumer spending.But it won't be as big as the negative impact downstream of curtailed investment. Unemployment is set to rise sharply from the CRE collapse, capital expenditure slashing , retail decline and manufacturing. Personal consumption will fall dramatically. Whatever spending power may be left will be swallowed up by higher energy bils and rising local taxes.
$500 billion in losses just from subprime which does not include losses from HELOCs ($200+ billion) as a result of price declines followed by CRE ($200+ billion) and CLOs ($200+ billion).
...because housing will not be an engine of recovery this time.
What about a couple new wars as "engines of recovery?" I mean we could invade Iran, and then N. Korea and take out a few more central Asian nations to make sure they don't fall under Chinese or Russian influence. War rescued the German economy in the 1930s. It could do the same for us in the 2010s.
Dirk van Dijk said: "...Also check out the year over year growth in employment..."
Employment growth falls as unemployment falls. Unemployment fell to extremely low levels during the 1990's, down to sub-4%.
Or look at it another way. You've just gotten a new job, with a salary range of $80,000-$100,000. The HR person that's hiring you is a little eccentric, and offers you two choices in how you can be paid.
You can either start out at $80,000/year and receive $4,000 raises for 5 years until you top-out on the range. Or you can start out at $100,000/year and receive no raises for 5 years.
Which choice makes you more money?
An economy at full employment with no job growth is doing better than an economy with high unemployment and strongly rising job growth.
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"$1 trillion looks low when you add everything up."
Someone in investment community has already said that it will be more than a trillion and upto $2Tr. I saw him on CNBC-World, but I don't recall his name.
Let us see how we avoid depression with no signs of housing prices stabilizing.
Radar Logic's PPSF for all metros have fallen 10.9% in the past 9 months and the pace has accelerated in recent months. With prices falling at rate more than 2% a month we will have a mess in 3-5 months. We have a deadly combination of Scam Market and the housing prices falling at the same time and at a rapid pace. More than $5Tr. of "wealth" has already been destroyed in the past 9 months.
-x-x-x-x-x-
"This recession will be by far the worst since the great depression."
JT, it WILL BE worse than the Great Depression. We have had far bigger CROOKS in control of the economy since 1995 than in 1920s and 1930s.
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Don't you have any shame, Sebastian, in making ridiculous arguments defying all history of employment and recessions?
OK, how about REAL Retail Sales Excluding Autos being 1%, YoY.
In data dating back to January 1968, we have never seen such a weak twelve-month trend in real non-auto retail sales except when the economy was already in a recession, or just climbing out of one. Bottom line: these data look like a recession. -- Suzanne Rizzo
Probably the impact of real estate prices on personal consumption is just one facet of the economic siutation. That will be linked to loss of construction jobs (one estimate I may have seen here predicted 1 million jobs lost.) That will cut into consumption, adding to the impact on the retail sector as well as the public sector, leading to more job losses there.
Banks' losses will mean less to lend, less business activity going forward.
The big unknown Xs in the equation are how far home prices will fall, and how much the banks (and the investors downstream) will lose. I think that big uncertainty factor is what's spooking the markets, with everyone wondering about the worst-case scenario. People say it's banks not trusting each other, but I think it's more about the uncertainty, and the impossibility of figuring out what is really going to happen--until it DOES happen, slowly, over the rest of the year.
-MEW-history seems rather short to get a good feel for what part is consumed (Greenspan's 50%). Even if true, where did the other 50% percent go: value of home improvement is deceminated by declining prices; MEW is just not there anymore. The impact of MEW and GDP is not limited to Consumption but also impacts Investment (GDP = G+C+I+NX).
-couldn't the propensity to ("dis-") consume your wealth be higher when you're leveraged to the hill?
-unemployment: overcapacity in construction, financial services, of which many are "below-radar-don't- show-up-in-the-statistics" self-employed people. Also note that the labor population decreases in the BLS-statistics.
The psychology of the consumer is the biggest impact. When you think your piggy bank will get larger every year, you are much more likely to spend (often like a drunk sailor). However, when you think your piggy bank will get smaller every year and you don't have your MEW and their is inflation and ARM payments, you go into panic mode. Thus, the psychological effects will tighted PCE much greater than the model likely shows.
Real Unemployment is already somewhere between 9% and 13% -- so saying unemployment won't reach 8% is already superseded. Maybe the BLS liars and idiots will be talking
We had a discussion about MEW on Monday (and I used CRs great charts.) The post discusses the phenomenon and shows a the activity of a specific homeowner with regards to the MEW phenomenon.
Irvine Housing Blog - Irvine Real Estate and Resale Homes - Mortgage Equity Withdrawal
IMO, MEW is going to decline significantly. Who would make these loans in a declining market?
You are forgetting the impact on PCE from higher oil prices.
CR: in your opinion, are the implied PCE effects from MEW (based on the assumptions you used) and Carroll et al about the same?
The marginal propensity to consume may be asymmetric: maybe it's 9 cents per $1 when asset prices are increasing but more than 9 cents per $1 when they are going down. Results from behavioral finance suggest that people feel losses much more acutely than gains.
This is where economists are forced to accept miscalculated presumptions to come up with even more miscalculated presumptions.
Firstly, I believe that ALL MEW is consumed. If you paid down consumer debt, then you were able to rack it up again. If you invested in your home then you bought stuff and hired people. If only half gets spent, then where praytell does the other half go? Anyway:
MEW over the last several years took on a different form and was spent much more freely than before. People weren't "borrowing" money, they were withdrawing their own money from their house.
If you make 100 grand a year then you probably live off of, after you paid your mortgage, taxes etc, about 40-50 thousand dollars to spend on life's necessities. So an increase in income of 50 grand (a 50% increase in income) would actually increase your spending power by 100%!
So when people took out MEW of say 100 grand tax free, that spread out over say three years was essentially increasing the spending power of a 70-80 grand earner by 100% each year.
Over the last 5 years there are people who had the spending power of essentially having a 200% raise.
This all went directly into the economy.
That is all gone now.
There is no good way to crunch the numbers to account for this.
It simply takes common sense and personal experience to say..."things are going to get worse."
Moe Gamble, yes, this is the impact from house prices only. There are other impacts - such as from less employment, from people pulling back during a recession, etc. But I wanted to put this into perspective.
Best Wishes.
Charlie Poole, I think the implied impact is in the same ballpark. Some people argue to just ignore MEW, and look at the wealth effect from house prices. Others argue MEW is more tangible, so we need to follow that too (I find myself in that group).
Best Wishes.
Size of the impact NOT HUGE?
CR, I love your optimism.
Let's see, property taxes, sales taxes, key component of job growth over past seven years, commercial RE development, HD and LOW and other big box expansion accross America, billions in profits for financial institutions, manufacturing, transporting all those goods, even more jobs
Not HUGE? Not sure if there has ever been anything HUGIER!!!!
ok fine, PCE decline is a small fraction of GDP.
What about Roubini estimate of up to 2.7 trillion in losses for financial industry? That is 20% of GDP. Would that be a DRAG on growth?
Personal example:
I keep very detailed track of my families spending.
My wife and I made 180 grand gross last year.
After everything (taxes, mortgage, investments in 457, roth's etc) We spend $6000 month on everything from clothes to food to vacations.
6000 x 12 = $72000 spending power.
So with an increase of only $72000 I would live and spend like I made twice the money.
MEW came in the form of tax free money and generally the added debt service was minimal if any as it was spread over 30 years and often at lower rates or offset with other debt buydowns.
So inject tax free money into families and you have a huge increase in spending power over a very short period of time that is much greater than many economists have factored in.
CR, good summary. Thank you.
The wealth effect (Carroll's 2% -> 9%) and the consumption of MEW are two separate and additive items.
Also, both the wealth effect and the consumption portion of MEW represent increased debt or decreased savings. Sooner or later they both must be repaid by GDP. The cumulative effects enjoyed by GDP in the past must now be repaid. Is there a way to quantify this overhang (hangover)?
I concur with CR that the effects will be prolonged, because unlike inventory, or even capital investment corrections, these effects can be worked out over a long time.
"It simply takes common sense and personal experience to say..."things are going to get worse."" -- Average Joe
This brings me to a future conversation somewhere in CA...
"Daddy can we take out the boat for a ride."
"Honey, money doesn't grow on trees anymore. How do you expect me to pay for the gas?"
"The same way you use to pay for it. With your credit card that taps into your mortgage equity."
"Sorry, but that credit card along with the 7 others is tapped out. Also, our house is now worth $500,000 less than our debts on it."
"Well, Daddy, it sounds like you really messed up. But, it is not my fault. I want to go ride the boat, now!"
"OK, just hand me that five foot hose over there. You gotta stand look out while I syphon the gas out of the neighbor's car."
--
"This is one of the reasons I think the recession will not be severe (unemployment will not rise to 8%), although I do expect the slowdown to linger, and the recovery to be sluggish..."
As usual your thinking is shallow, i.e., lacks depth.
The fact that households now know that they wouldn't be able get money out of their homes will significantly curtail the current consumption, or be forced to curtail consumption, say by 5%. Then, factor in the failure of many small businesses that depend on discretionary spending and you are looking, at the minimum, at a severe and prolonged recession.
All of CRs forecasts will be proven to be too optimistic.
Sebastian is here to make CR look good!
Jas
Of course, all that MEW from past years must be paid back or written off. So it's not just the decrease MEW that will result in decreased consumption, but the cumulative debt incurred in those years...
CFO's seem to think a recession is here. That wont have an impact on business spending will it....
Expired
Can someone please just get these guys some Wright Model B's?
The consumer isnt the only thing that is going to slow down. Prepare for the second leg down in the 2nd half of 2008.
Long live the consuming boomer! Consboomers die hard... so us future generations can expect nice tax hikes to keep the consboomer comfortable at the end of their life...
I think MEW traces out a good part (but perhaps not all) of the wealth effect and is therefore useful. The wealth effect often is measured in an equation estimated for total PCE. Such equations are preposterous: PCE is 2/3 of the US economy. To think that one equation can describe that large a share of the economy is delusional. The exogeneity assumptions in PCE equations, for example, are ridiculous. Yet people continue to use them1
CR --
Based on the MEW and wealth effects, I agree with your conclusions -- this recession is likely to be longish but not overly severe.
I think you also need to consider the effects on GDP from:
(a) a contraction in overall credit, and
(b) likely increases in (retirement) savings (by consumers) to compensate for the loss of value of their homes.
In other words, the wealth effect during a period in which housing values decline may well be more pronounced than estimates of wealth effects based on historical periods in which housing prices were rising and the average age was less (than it is now).
Great stuff. Thanks.
Missed Information, I think Roubini's estimates are too pessimistic. It's possible - if there is a systemic meltdown - but IMO very unlikely.
When I first proposed losses could reach $1 trillion (which Roubini very nicely credited me!), I argued that would take several very negative events. I'm still of the view that $1 trillion is the upper bound on the actual losses, and something on the order of $500 billion makes sense to me.
Jas, you have it backwards - I've been close - you've been consistently overly pessimitic.
Best Wishes.
If you make 100 grand a year then you probably live off of, after you paid your mortgage, taxes etc, about 40-50 thousand dollars to spend on life's necessities.
$50K?
100K
less 15K 401K
less 25K taxes
less 5K Roth IRA
less 25K net housing costs
try ~20K for living expenses. . .
MEW was an IMMENSE boost to the consumer economy 2003-2007. It was the invisible engine pulling the train, but it's certainly losing steam now.
MEW is huge, falling rapidly, and going to fall in an even bigger way soon. Here in So Cal I know of hundreds hanging on only by playing debt-bingo. My friend in the LA County Social Services is seeing huge increases in homeless, people needing food stamps, applications for section 8 housing vouchers, large increases in people looking for jobs and 2nd jobs because their primary low-wage jobs won't pay the bills. At a recent party we attended he went person-to-person asking if anyone / anyone's company was hiring / had open positions that he could add to the listings the county provides. The large numbers of fairly well off and middle class families that we are hearing are in dire straits is just amazing and growing. In North Los Angeles County friends I know live in recently developed neighborhoods where there is already 30%-40% vacant / abandoned houses from foreclosures and jingle mail. Nearby one friend nearly the entire new developement is empty and there is literally no buyer traffic of any kind. Local Real Estate businesses and Mortgage Business everywhere have "For Lease" signs on them and I see more every week. Every week I am hearing of more layoffs from friends and acquaintances. Lots and lots of people I know who rode the bubble up into self-employment of various sorts are telling me that their business are tanking and they are starting to think about looking for employment -- but there is little to be found. Fear is in the air everywhere -- and I am talking about the well off neighborhoods. Somebody has to go out into the real world and do some real world reporting because 90% of what is being reported in the news media is just garbage.
We are into the first .001% of this economic catastrophe -- long, long, ways down to go.
I don't see how you can possibly forecast the depth of the recession without considering the effect of $110 oil on the employment picture. The consumer is unlikely to spend if he is not employed.
Be honest, how many of you have friends/family who, were it not for MEW, would have the financial wall years ago....I have been waiting for it on several and it seems that it will never end..someone is always willing to lend them more.
I know people that, were it not for MEW they would be destitute.
With median household incomes having fallen since 1999, it seems also reasonable to conclude the consumer is entering the recession much weaker than it was just before the 2001 recession. The specter of declining consumption seems only the realistic result of MEWs declining now leaving sort of a vacuum. I imagine it will be pretty moderate/severe recession on the scale of 1974, but its effects will be even more pronounced as the economy struggles to recover. GDP per capita should decline under a contracting GDP through 2008 and then stay flat as GDP hovers around 1% throughout 2009. It's hard to imagine what sector will catch the economy as it falls toward the earth and help it recover. That's mainly why I don't really cling to these forecasts claiming GDP will rise 3% in 2009. What will be the sectors contributing the 3%? Exports? We'll see..
--
If only CR can learn to think simply and clearly like Elvis here. But that is very hard for an economist to do.
I bet that CR would have hard time even thinking about the probability of a depression within the next two years. But for the reckless mortgage-lending boom, the economy would have already been in a depression few years earlier. Now that gone the depression would walk in easily. The Housing Bubble was lot more to the economy than CR thinks and the bust would be far worse than CR can think.
Jas
MEW was 5% of the $13T economy tnat is projected to grow at 2-3%. So how doesn't just the drop in MEW predict a recession? What sectors are growing at a pace to replace that missing MEW?
Add to that all of the GDP factors from construction, real estate transactions and financial transactions and where does the economy go?
Then use the money recycle rate (multiplier effect) and where then does the economy go?
I think nowhere but down significantly.
I would be interested in finding out why this thinking is flawed.
CR -
I, too, used to think that Roubini was overly pessimistic. Then again, if you'd have told me that the housing bust (which I foresaw) would spread toxic fallout all the way to a small town in Norway via fraudulent securities, I'd have said you were crazy.
These things apparently have a way of snowballing.
Let's just consider $110 oil for a moment (simply). If oil is $55 a barrel, depending on your car, let's say you spend $120 a month filling your tank ($1440 per year). Now, since oil prices are double, you spent $2880 per year on gas for your car. Also, other items cost a little more due to oil cost, so you spend $1500 more on pass-on costs. That is roughly $3000 more per year. Sizeble, yes. However, when your $300,000 house decreases 10% in a year, that is $30,000 or 10 times more than the oil effect. Which one is going to have a bigger effect?
"MEW is huge, falling rapidly, and going to fall in an even bigger way soon. Here in So Cal I know of hundreds hanging on only by playing debt-bingo."
Hmph. On the Central Coast, the only growth industry I can find is food banks. I have friends who run one. There's been a steady upturn in demand over the years, with a real spike in the last two.
What happens at the bottom, eventually ripples to the top.
CR, you speak of a shallow but prolonged downturn. How long do you reckon?
Engine of recovery. Sovereign Funds?
CR,
The Carroll et al piece you cite apparently regresses back to 1960.
Is this a complete enough data set? We don't know, because, like in most econometric analyses, the authors seem to just assume that it is.
Another thing: the reality is that the advent of HELOC's likely had a significant impact on housing wealth effects, for obvious reasons. As such, we would expect a rather discontinuity in the "fit" of the regression line beginning in 1990 and another, larger kink in 2001. Is this true? We don't know, because, again, the authors of the piece did not see fit to discuss the impact of HELOC's on the "marginal propensity to consume" housing wealth.
Lastly, what of the demographics of the homeowner base? Surely a move down in median homeowner income would, all else equal, result in a higher propensity to consume. Presumably subprime caused just such a move. And yet, again, the authors don't see fit to discuss this presumably important development.
What is the value of Carroll's conclusions on the MPC? Not much. I'm afraid we can do better using common sense than he can using a computer.
--
"Jas, you have it backwards - I've been close - you've been consistently overly pessimitic."
I have always been early, but never wrong or too pessimistic. My predictions in 1999 on Silly.con Valley economy and prices of CSCO and JNPR (CSCO didn't hit my projection of $5 but it did lose 90%+ to $8.12 and JNPR did go below $5 after being above $250) were better than anyone else. Loss of employment for Santa Clara Co. by 19.7% (during 2001-2003) does qualify for depression, no?
Anyway, we shall find out in 2009 who is right about the severity, or lack thereof, of the current recession.
Jas
CR, I'm really confused about your reliance on the BLS unemployment number without adjusting for or discussing the participation rate.
Anecdotally, I personally know several educated boomers who would like to work but can't. They've been searching for years. It is truly a significant problem for many families. I'm sure I'm not the only one on this board who knows several under-employed or unemployed friends who are no longer counted in the employment roles.
A lack of a significant increase in the unemployment does not mean that there isn't significant joblessness and systemically reduced incomes. With prices rising this is a significant problem for many households.
Perhaps you have addressed this issue already in a prior post, but I think that it is worth covering since you use that statistic so much to argue against a severe recession.
I agree with Elvis' assessment re psychology. The ratchet backwards is going to be a lot more than that, esp as they are having to handle increased costs of fuel, food and jacking up their savings rates. I expect that that study was predicated upon then-current (and probably still) savings rates.
So expect that folks are going to scrimp and cut back to re-establish a cash cushion while they take care of the debts.
speaking of unemployment. here is the future.
Damn, I Need A Job
Elvis-
It's a little bit different when you think about $110 oil from the perspective of the PPI, shrinking margins, and what that means to the employment picture.
Mild recession? I don't think so. My wife and I are looking into Chapter 7. My wife let it slip while she was at work. Come to find out, three other people where she works are in the process of filing Chapter 7. We have to file because I was injured and almost paralyzed. Her co-workers just got in over their heads I guess.
CR, I'm really confused about your reliance on the BLS unemployment number
I think it's because CR wants to look like a serious researcher to serious people.
Serious people would not take you seriously if you don't agree to stay within the official framework.
The same reason Roubini does not openly challenge inflation methodology, etc...
You are way underestimating the impact of all this.
1) Consumer's budgets will be capped as they have not been before.
2) Gas / Food will take up more of that capped budget.
3) Very little of the number is truly discretionary (a lot of it is implied rents, health insurance etc etc)
4) This will have stunning impact on discretionary spending - vacations, going out to eat, fancy clothes, tvs etc.
5) There is no engine at this point to pick consumption back off ground. Expansion in last 3-4 years was mirage. The good news, no huge loss in jobs as there aren't that many manufacturing jobs to lose - the bad news is that there are no jobs to regain to give us that nice big recovery thing.
You need to separate out the one time impact (drop in housing wealth) - temporary, manageable - from the long term ongoing change in run rate.
To go back to 8% savings rate that we will need to be at, it is $700 bn / year change - ongoing. $700bn means limited MEW plus some additional savings.
Addition to Elvis post of 2:05 -
I'm seeing a significantly higher number of used cars for sale on the street/driveway than I've noticed before. Whether I'm more sensitized to that is a question; regardless, many of them are SUV.
Are they being replaced? Dunno.
because Roubini wants to be invited to Davos!
What will be the effects, both real and psychological, when net MEW goes negative?
Well I have said it before Ill say it again...I am sorry I missed the free money train...I pulled zero MEW out of my home since I bought it in 1993..did many upgrades, on cash...but then again I must not count I work 15 hour days sometimes 7 days a week...and i am debt free.....would this make me Un American?..so much for hard work and land of opportunity.. The last decade its been free money and greed...like I said sorry I missed it.
Does anyone know what percentage of homeowners used MEW over the last five years? 5%, 25%, 50%? Is it mainly a bubble area phenomenon?
Isn't there an additional impact from the folks who have their ARMs adjusted upwards and either pay it or walk away?
I want to be clear: I do not think the BLS is fraudulently reporting the unemployment rate. I just think the unemployment rate is only one piece of the jobs puzzle.
funny stuff:
I have many friends who do not work in finance, and most of them still look at me like I'm a nutter when I say that this financial crisis can change their very lifestyles.
But today one of them told me that he thinks there is no crisis at all, that stocks have just dropped a little and Bush-haters are blowing this out of proportion to hurt his presidency!
I guess all I can say is... we are not prepared!
It's probably a mistake to think the folks who were spending everything that wasn't nailed down will change habits and begin saving....people do pretty much what they've always done. The folks who were saving will continue to save (maybe even moreso), but I suspect that'll be at the margin. I don't think it'll impart momentum to the downside. The dollar trajectory alone has savers wondering what they should go buy, just to protect their wealth.
We'll have trouble, but increased savings rate won't be part of it.
The mean has been misleading throughout the housing crash. The "average" homeowner may not be much affected, but I think we really need to look at where MEW cashouts are concentrated, and how these local economy effects then relate to the larger economy.
Most of the "growth" since 2000 has been one the coasts and a few other places. In fact, growth was a huge increase in debt accumulation, not real increases in productivity. In places like California and the East Coast, people experienced substantial increases in housing capital, which they then converted into big cashouts to pay for higher lifestyles. The "inlandia" of Krugman's imagination has neither the boom nor the bust, yet.
OK, so how does this matter. The point is that the average consumer will not be much affected by the declines in MEW. It is a few consumers, those who happen to have been the main thrust of the consumer-led expansion, who will suffer. Look to see Walmart and Costco doing OK for the next year or so, while tonier stores start to fade.
Now, because the MEW dropoff and huge housing price declines are occurring simultaneously in these same regions, they are starting to have real effects on employment, spending, etc. These, I think, will spread, but the effects are going to be slow, as have been the problems in housing spreading to MBS, etc. The titanic did not sink all of a sudden. Enjoy the band music, but don't get lulled into false confidence. We are going down.
picosec writes:
What will be the effects, both real and psychological, when net MEW goes negative?
... MEW goes negative?
Are you implying that Mr. Homeowner will have the capacity to rebuild equity in the face of job losses and across-the-board inflation?
What am I missing?
"I know people that, were it not for MEW they would be destitute."
I think it's the other way around, people are destitute because they are paying a mortage and a home equity loan (speaking for myself anyway).
Jas-- If you would post links to the numerous articles describing how small businesses depent on MEW, that would help everyone here understand that there is more to it than simply personal spending.
What really drives consumption is income and that has been flat for sometime and will probably decline over the coming years with the impact of high energy prices. The household wealth factor reflected in the flow of funds report is paper wealth that has little or no connection to real life as various banks and lenders pull the HomeEquity line plug.
I will agree MEW here on the East Coast was un-real..but also I have to say the Jobs Market here is holding up quite well...as there are plenty of jobs around...its the qualifying (person) skill level that is lacking.
Gosh! I thought I was poor because my income is around 95K. I guess I can afford the airplane because my housing cost, including insurance, is $8K. Never realized what it's like to have a mortgage these days. OTOH, can't fly as much as I did last year - price of gas has doubled.
Barney Frank gave ratings companies one month to fix "ridiculous" standards that they apply to local govt debt, as his House committee opened a hearing today on how the firms evaluate muni bonds...
House's Frank Says Municipal Ratings Add Unfair Costs (Update2) - Bloomberg.com
Troy,
If you live here in California, $100k income is about 57k after state, state disability insurance, fed taxes, social security and medicare.
minus rental housing, $24k ($2000 a year is pretty typical) and you're down to $33k. That's $33k including retirement savings like 401k and IRA. Assuming you max out the 401k and IRA like you stated, you are left with $13k. That's just over $1k a month for all the other expenses. including utilities and gas! And people don't think gas is a big part of the equation.
You see, I don't think many people can max out their 401k and IRA with this income. And guess what? the average income is $70k in the bay area.
So. yeah. As much as I'm Democrat, I think tax cut might be the best way to get out of this. But the budget problem makes it impossible.
So how can people afford a mortgage for the average $700k house in the bay area?
jcaraway said: "Engine of recovery. Sovereign Funds?"
An economy that is at full employment is pretty powerful and has considerable forward momentum. If we even need an "engine of recovery" at all.
S.
People really contribute to their 401K plans? How responsible some people are.
OT:
The Fed's goal was to relieve some of the financial pressure on banks so they'll be encouraged to lend more freely.
Freddie's chief business officer, Patti Cook, said Wednesday the action was "a short-term help [but] it doesn't solve the long-term problem."
"I think the longer-term issue remains," Cook said, "Where do those mortgages ultimately end up?"
Not sure, but it seems reasonable that net MEW could go negative whenever either the net amount paying off HELOCs exceeds the amount being borrowed or if HELOCs are being written off as a loss.
Great work CR. But don't all roads end at the consumer? Aren't the components of GDP are consumer, military/govt and industrial/corporate? Industry serves both of the prior, so as they go, goes industry. Military/govt is trying to cut back, not increase spending, which leaves consumer, which is something like 70% of GDP.
I don't understand how a marginal cutback of this large a component won't result in a much larger result.
Predicting how deep the recession will be is just a guessing game at this point. Crisis has moved everything into an unstable state and the ball can roll down in many directions from here, moved by seemingly small perturbations.
There are huge uncertainties at play. For example, Brad Setser argued since 2004 that foreign support of US deficit is overstraining asians and could stop at any moment. But it continued 3 years beyond what Brad thought possible. I think its a huge risk factor that has slowly gone out of fashion and people like to pretend that just because it has continued beyond imaginable, it can continue forever.
Careful with predictions.
If we go to 100 billion MEW this year, then the difference between MEW this year and MEW in 2006 averaged 145 billion a quarter.
So essentially we had the equivilant of a Bush $145 billion Stimulus package for EACH QUARTER during the boom years.
(I would presume that MEW was spent at at least the same if not higher percentage toward consumption as the stimulus package will be).
It's hard to perceive that this will be a soft landing, with a mild hit to employment.
Just listing the litany of negative data and the multipliers on a global scale vs. the paucity of positive potential data seems to overwhelm that option.
Hmmm, it would be interesting to actually write those lists out, perhaps in excel...
If only there was a way to spend our way out of debt!
CR writes: "..but the impact probably isn't large enough to reduce nominal PCE."
PCE (GDP component 'C', currently roughly 70% of GDP) has not declined in nominal terms since 1933 even on a QoQ basis.
If you want to be looking for recessionary effects, look for investments 'I'. That has declined many times in nominal terms as well. In a recession what you typically get is a real decline in PCE and real (or even nominal) decline in investments. Decline in investments often substracts equal amount from the growth, or even more than PCE, although it's much smaller component.
If PCE begins to decline in nominal terms, go ahead and take a deep breath. Then there is likely to be some real trouble ahead, something you haven't seen in about 80 years.
OT -- Federal receipts in February are 12% below year ago levels. In January, Federal receipts were 2% below year ago levels.
Two months in a row of collections below year ago levels for the Feds. I bet the Treasury folks are getting nervous.
http://www.fms.treas.gov/mts/mts0208.pdf
I agree with CR - he is making a limited point with regard to the impact of MEW and MEW alone which is perfectly reasonable. He is looking at the Macro economic numbers, not whether he knows a guy who knows a guy who maxed out his HELOC and doubled his income in the past 3 years.
I think there will also be a consumer confidence hit due to the negative wealth effect, but that is not the same as MEW reductions.
And yes, if you presuppose some sort of systemic financial melt down, then the impact of decreased MEW is going to look tiny.... if the worst happens.
I think people are somewhat overinterpreting CR's comments here. His post is limited to the direct impacts of reduced home prices on consumption. This is a large but not overwhelming impact.
I think the question is obviously how large the indirect impacts are when the economy has been so dependent on the housing bubble for employment, wealth, and industry. This is the vicious cycle concept CR had early on, and quantifying the impact is not going to be possible. For now, let's be respectful of his predictions, since he certainly has garnered more credibility than anyone else on this issue.
So inject tax free money into families and you have a huge increase in spending power over a very short period of time that is much greater than many economists have factored in.
Average Joe
I guess that's the plan right now. You only have to file for your tax return.
O-Joe
All of CRs forecasts will be proven to be too optimistic.
Sebastian is here to make CR look good!
Jas
Jas Jain
So this year the G.D. is for real other than in the past? Or do we get another prolongation?
O-Joe
Why all the recession talk??
......well, here's some more fuel for the fire.
From CFO.com:
"Speaking at the CFO Rising conference in Orlando, former IBM and Chrysler Corp. finance chief Jerry York predicted a lengthy and deep recession for the American economy.
Addressing the topic of what boards are demanding from CFOs, York said if he had only five minutes to give his speech, he would tell finance chiefs that: "CEOs and boards are just going to expect you to get these companies through the mess," emphasizing that, "I think this is going to be a very ugly recession, I think it is going to be lengthy, I think it is going to be deep."..."
Full article here: York: A Long, Ugly, Deep Recession - - CFO.com
And here's is even more fuel:
"NEW YORK (Reuters) - A recession has already started and the downturn is likely to last longer than in the recent past, with the economy recovering only late next year, according to a quarterly survey of corporate finance chiefs released on Wednesday"
Full article here: Expired
Enjoy!
carol:
I think your math is a little off.
if you make 100k,
FIRST You take out the 401k
leaving you with 85k adjusted income.
after that, then you would do the IRA (maybe deductible, maybe not depending on Roth vs Trad).
then you run the tax brackets off of that basis.
the lower AGI will result in lower taxation across the board.
not only that, a lot of people are homeowners, and thus get large amounts back due to mortgage interest deduction.
not saying that $100k will make you rich, only that the average $100k earner that I know in Coastal California has more than $1k in disposible income.
your point is still valid, despite the fact that I argue your math.
also:
it seems that people are arguing 3 different things
1) what is the effect of MEW ONLY on PCE and hence recession. (which was my interpretation of CR's post... trying to pull out ONE variable)
2) should we consider the effect of having to pay back previous MEW, and the effect of declining home values on MEW?
3) does that impact the rest of the ecoomy (jobs, etc)
CR's original point IMO is valid. The loss of MEW IN AND OF ITSELF is a small matter.
However, I feel like we have lots of pain as the MEW "hid" other structural problems in the US economy. now
-the MEW must be paid back, WITH INTEREST
-many jobs were created due to MEW, that now cannot be supported
-this could cause feedback death spiral
Here's something on loss of wealth effects from MEW and equity losses that dovetails nicely with this blog post.
Tony Crescenzi Blog
Wealth Effects Are Still a Drag on the Economy
By Tony Crescenzi
RealMoney.com Contributor
3/12/2008 1:13 PM EDT
URL: Financial Investments and Stock Market Tips for Real Money - TheStreet.com
"Yesterday's rally in the equity market restored close to $700 billion of lost wealth (the equity market is valued at close to $18 trillion, and prices gained about 4%). That's enough to boost aggregate spending by about $32 billion over the next 18 months, using the widely accepted rule that each dollar change in equities imparts a 4-cent change in spending. While encouraging, the problem obviously is that wealth losses remain substantial from the peak, amounting to nearly $4 trillion, enough to pull aggregate spending lower by about $160 billion."
"Of course, what must be added to this is the impact of the recent decline in home prices, which at about 10% amounts to about $2 trillion in lost wealth. The wealth effects for housing are greater than the wealth effects for corporate equities, say between 7 cents and 10 cents, mainly because households extract equity from the homes in ways they do not in equities -- for example, through the sale of a home, refinancing, and home equity borrowing. This means that the wealth effects from the recent decline in home prices amounts to close to $150 billion. "
"Combined, the wealth effects from declines in equities prices and home values amounts to roughly $300 billion -- certainly a large headwind for consumers, who are facing plenty of other headwinds, particularly the weaker job market and accelerated inflation."
-the MEW must be paid back, WITH INTEREST
How do defaults affect that calculus?
"Although the impact on PCE from declining house prices will probably be significant, the size of the impact is not huge when compared to the overall U.S. economy."
Thank you. I've been screaming this for months. The elephant in the room for the permabears is the strength in corporate balance sheets that will sustain employment indefinitely IMO
An economy that is at full employment is pretty powerful and has considerable forward momentum. If we even need an "engine of recovery" at all.
S.
Sebastian | 03.12.08 - 2:37 pm | #
Seb, the unemployment rate is only one aspect of the employment picture. Check out the percent of the population employed or the labor force participation rates. not all of that is Bush's fault, some of it is demographics, but relying on the unemployment rate alone is very misleading. Also check out the year over year growth in employment. Spend virtually all of the 1990's well over 2%, and usally above 3% (except right after the papa bush recession). Was also up over 3% for most of RR term (except early part) and for Carter's term. Just managed to kiss the 2% level for a month or two back in 06 this time. Now Yr/Yr growth rate is plunding again. Data is available here St. Louis Fed: Economic Data - FRED®
I'm not sure that the MEW effect and the wealth effects are additive. Rather think of MEW as being part of the transmission mechinism for the wealth effect.
The Employment-Population Ratio is a better than the percentage of American collecting unemployment checks is...don't you think.
This recession will be by far the worst since the great depression. The entire housing industry will be a wasteland for the rest of my lifetime.
CNBC is not a good place to get your news.
More Mish and less faux financial news.
Cheers!
MEW or lack thereof has a huge negative impact on consumption (my guess by about 25% on aggregate consumer spending.But it won't be as big as the negative impact downstream of curtailed investment. Unemployment is set to rise sharply from the CRE collapse, capital expenditure slashing , retail decline and manufacturing. Personal consumption will fall dramatically. Whatever spending power may be left will be swallowed up by higher energy bils and rising local taxes.
Consumer spending is about to fall off a cliff.
$500 billion in losses just from subprime which does not include losses from HELOCs ($200+ billion) as a result of price declines followed by CRE ($200+ billion) and CLOs ($200+ billion).
$1 trillion looks low when you add everything up.
Cheers!
ReadingNLearning, Colleagues of mine coming back from Florida say you cannot miss the tent people, they are very visible.
CR and Tanta,
I can't thank you enough for providing such a great blog. I have learned so much and appreciate all that you post here.
...because housing will not be an engine of recovery this time.
What about a couple new wars as "engines of recovery?" I mean we could invade Iran, and then N. Korea and take out a few more central Asian nations to make sure they don't fall under Chinese or Russian influence. War rescued the German economy in the 1930s. It could do the same for us in the 2010s.
Dirk van Dijk said: "...Also check out the year over year growth in employment..."
Employment growth falls as unemployment falls. Unemployment fell to extremely low levels during the 1990's, down to sub-4%.
Or look at it another way. You've just gotten a new job, with a salary range of $80,000-$100,000. The HR person that's hiring you is a little eccentric, and offers you two choices in how you can be paid.
You can either start out at $80,000/year and receive $4,000 raises for 5 years until you top-out on the range. Or you can start out at $100,000/year and receive no raises for 5 years.
Which choice makes you more money?
An economy at full employment with no job growth is doing better than an economy with high unemployment and strongly rising job growth.
Sebastia
--
"$1 trillion looks low when you add everything up."
Someone in investment community has already said that it will be more than a trillion and upto $2Tr. I saw him on CNBC-World, but I don't recall his name.
Let us see how we avoid depression with no signs of housing prices stabilizing.
Radar Logic's PPSF for all metros have fallen 10.9% in the past 9 months and the pace has accelerated in recent months. With prices falling at rate more than 2% a month we will have a mess in 3-5 months. We have a deadly combination of Scam Market and the housing prices falling at the same time and at a rapid pace. More than $5Tr. of "wealth" has already been destroyed in the past 9 months.
-x-x-x-x-x-
"This recession will be by far the worst since the great depression."
JT, it WILL BE worse than the Great Depression. We have had far bigger CROOKS in control of the economy since 1995 than in 1920s and 1930s.
Jas
--
Don't you have any shame, Sebastian, in making ridiculous arguments defying all history of employment and recessions?
OK, how about REAL Retail Sales Excluding Autos being 1%, YoY.
In data dating back to January 1968, we have never seen such a weak twelve-month trend in real non-auto retail sales except when the economy was already in a recession, or just climbing out of one. Bottom line: these data look like a recession. -- Suzanne Rizzo
home page
I know that facts dont matter to Sebastian, but they do matter to CR and others.
Jas
Probably the impact of real estate prices on personal consumption is just one facet of the economic siutation. That will be linked to loss of construction jobs (one estimate I may have seen here predicted 1 million jobs lost.) That will cut into consumption, adding to the impact on the retail sector as well as the public sector, leading to more job losses there.
Banks' losses will mean less to lend, less business activity going forward.
The big unknown Xs in the equation are how far home prices will fall, and how much the banks (and the investors downstream) will lose. I think that big uncertainty factor is what's spooking the markets, with everyone wondering about the worst-case scenario. People say it's banks not trusting each other, but I think it's more about the uncertainty, and the impossibility of figuring out what is really going to happen--until it DOES happen, slowly, over the rest of the year.
Just adding some thoughts:
-MEW-history seems rather short to get a good feel for what part is consumed (Greenspan's 50%). Even if true, where did the other 50% percent go: value of home improvement is deceminated by declining prices; MEW is just not there anymore. The impact of MEW and GDP is not limited to Consumption but also impacts Investment (GDP = G+C+I+NX).
-couldn't the propensity to ("dis-") consume your wealth be higher when you're leveraged to the hill?
-unemployment: overcapacity in construction, financial services, of which many are "below-radar-don't- show-up-in-the-statistics" self-employed people. Also note that the labor population decreases in the BLS-statistics.