Mr. Sunshine Calls the Turn!

By Jeff Harding

Mr. Sunshine

I received a report from Brian Wesbury at First Trust in Chicago who declared that the recession is over. I also received reports from Nouriel Roubini of RGE, the famed “Dr. Doom,” but who now calls himself “Dr. Realist,” who says it isn’t over, and from the National Association of Homebuilders (NAHB) who see green shoots. Roubini and the NAHB cancel each other out.

Brian Wesbury is the chief economist at First Trust, a large investment company. I’ve called him “Mr. Sunshine” in my articles because he seems to think that the crash and the recession never happened. I recall him speaking at economic conferences a few years ago where he said there’s nothing really wrong with the housing market, long-term factors looked good, and everything will be fine. Maybe I’m exaggerating a bit, sorry Mr. Wesbury.

Here’s his argument:

1. The monthly average for claims normally peaks one or two months before the economy bottoms and it appears to have peaked in March at 658,000 versus 635,000 in April.
2. Consumer spending grew at a 2.2% annual rate in the first quarter and looks set to rise again in Q2.
3. A bottom has been reached for both housing sales and starts.
4. Inbound and outbound container traffic is up at both the Port of Los Angeles and Port of Long Beach.
5. In the first three months of 2009, prices are up at a 2.2% annual rate. Meanwhile, commodity prices bottomed in February, signaling that the economy has turned a corner.
6. The second largest month-to-month jump in the ISM Manufacturing Index in April in the past decade.

Mr. Wesbury just loves good news and that is characterizing his view of the economy. He sees a quick “V”-shaped recovery. I disagree. I’ve discussed 6 major points that tend to show that we are still in recession, that we have not bottomed out, as he suggests, and that the factors I discuss have a more significant impact on the economy. We’ve had the biggest credit cycle boom in history and he treats it as if it were just another mild recession. It takes time to cure the biggest credit boom and bust in history.

While I agree with him that we are starting to see a bottom in housing prices,  I don’t think we’ve seen The Bottom yet. When it happens, housing prices will not rebound to former levels. The national home ownership rate in the first quarter of 2009 was 67.3%, down from the peak of 69.1 percent in the first quarter of 2005 and the lowest since the second quarter of 2000, according to the U.S. Census Bureau. This decline will continue until we reach the historical average of about 65+% and when new home construction starts up again. Negative feedback from the housing crash will curtail a housing boom.

Consumer spending is not going to take off again because the driver of spending is gone: the housing credit card, a.k.a., home equity loans. Home equity has declined to 43%, the lowest since they started keeping this data (after WWII). Some commentators say that it is much lower (15%) because, since one-third of homes are debt-free, if you exclude them from the base, the numbers reduce drastically. Increased savings by consumers, job insecurity, increased taxation, and a subdued housing market will curtail a spending boom. What then will be the driver for increased consumer spending?

Is the “rebound” in spending Mr. Wesbury cites real? My guess is that these numbers are outliers and that spending will continue to decline. We’ll have to wait for the numbers.

If consumer spending doesn’t rebound, where will the jobs come from? Personal consumption expenditures were 70% of the economy during the boom. Since it doesn’t look as if we’ll go on a new spending binge, could it be that our recovery will result in a different kind of economy, where we actually provide goods and services that the world wants? If so, the new economy will take a lot of capital to do this and that won’t happen without savings.

It isn’t over yet. As I previously pointed out:

• Defaults on corporate bonds bought by U.S. life insurers may cost “substantially” more than losses on securities linked to subprime, Alt-A and commercial mortgages—further deflation.
• According to the most recent data from the U.S. Department of Education, default rates for federally guaranteed student loans are expected to reach 6.9% for fiscal year 2007, and are climbing dramatically.
• Credit cardholders had $962 billion in unpaid balances on general purpose and proprietary cards at the end of 2007, an 8.6 percent increase from the previous year. That figure is expected to climb to $1.2 trillion by the end of 2012, or $6,373 per cardholder.
• Two-thirds of the $154.5 billion of securitized commercial real estate mortgages coming due between now and 2012 won’t qualify for refinancing; Deutsche Bank, Goldman, and others estimate declines in commercial-property values of 35% to 45% from the peak in 2007. They believe the commercial real-estate slump will rival or even exceed the one in the early 1990s, when bad commercial-property debt played a big role in dragging the economy into a recession.

When the recovery comes, the most hopeful outcome would be a broad “U”-shaped recovery. The problem is the government. In economic theory they are a “Big Player.” That is, by their actions they can affect the course of the economy. The actions of the government are not easy to predict, which makes prognosis difficult. But I believe their current actions, monetary stimulus, fiscal stimulus, and propping up failed companies, are counter-productive and will delay recovery. The worst outcome would be one similar to the Japanese experience from 1990-2003: they suffered a 14-year “L”-shaped recession after their government did almost the identical things we are doing now.

I wish I could share Mr. Wesbury’s enthusiasm. But, I don’t. The good thing is that the economy tends to repair itself but this process is not finished. While the Obama Administration bemoans the negative impacts of the bust, the necessary asset liquidation and devaluation goes on despite their efforts to stop this process. This is vital part to the recovery.