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4/28/08
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Friends and Colleagues:
This week Michael Swanson of Wells Fargo Economics talks with us about how we got into this economic situation, and how we will get out of it.
How did this recession (or so it seems) begin, and how will it end?
• Swanson tells us that the current recession (whether labeled as such by the NABE or not) started differently than most.
• He contends that as a result, it will end differently than most.
• He proposes that businesses and investors should focus on housing and credit creation to lead us into the light.
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How does a recession typically start?
• Most recessions start when businesses build up unsustainable levels of inventory.
• Business activity then slows down to reduce inventories, resulting in job losses which cascade to the demand side and reinforce weak sales.
• This feedback loop continues until inventories fall low enough that companies need additional inventories.
• Then production and employment expand, starting a positive feedback between employment and consumer demand.
What's different about this recession?
• This recession started with the deflating of the residential housing bubble.
• Housing represented a type of inventory-to-sales cycle similar to the manufacturing cycles that typically start and end a recession.
• The cycle of this recession should therefore follow correction of the housing cycle.
How did it happen?
• Home builders and buyers made a mistake when they (we) acted as if there was no limit to the value of housing.
• In the long term, the value of housing can't grow out of proportion to the economy that supports it.
• An asset bubble exists when current assets sell for a large premium to their cost of replacement.
• Many housing markets clearly reached that point in this cycle.
So what happens next?
• Swanson tells us that there should be some good news on the horizon for the economy, since housing values should be self-correcting.
• He contends that the sharper they fall below their true economic value, the faster they'll recover.
• Real demand for housing comes from personal income growth and household formation.
• Currently, personal income growth has slowed, but household formation continues unabated.
• Eventually, he projects that the fundamental drivers of growth will overcome the downward momentum of the housing market.
The question of course is when will that happen? How long will it take?
• Swanson points out that it takes time to turn the tide in either direction.
• Many people pointed out that the housing market was overvalued in 2005 only to see it rise further.
• Similarly, seeing that housing values have overcorrected to the downside doesn't mean that the market will turn right away.
• Swanson projects that a downturn in the housing market could be a multi-year event similar to the housing market of the early 1990s.
And what about the credit markets?
• Another depressing element is the negativity surrounding the consumer side of credit.
• Currently, banks seem to be more skeptical of consumers than businesses, as the negative sentiment measure of Q1 2008 is the lowest since 1991.
• In contrast, credit skepticism for businesses is currently less than the 2001 recession and it appears to be bottoming out.
• Swanson projects that if businesses still find access to credit, then employment contraction should be limited, helping limit consumer credit losses as well.
Conclusion?
Swanson projects that this recession and slow recovery will be in place until both housing values and consumer credit have washed out the excesses and poor risk/reward premiums that resulted from the easy money environment of the past decade.
How long will this take? That's the key question....and only time will tell. We will do our best to keep you informed....so as always, stay tuned.....
THOUGHT FOR THE WEEK
Helping One Another....
This economy's challenges have become very real and very personal for many of our readers. Each week we hear of more friends and colleagues who have fallen victim to the economic slowdown, as their names are added to the growing list of lay-offs in the commercial mortgage industry.
These are talented people....seasoned professionals....and human beings with hopes and dreams and families to support. So as a community, what can we do?
We can help....we can listen....we can get together....we can make connections.... We can help!
In the days and weeks ahead, may each of us reach out to someone who is in need. May we offer our support, our resources, our contacts and our creativity to help those in need as they look for a job or as they re-invent themselves.
Together, we can help!!
Have a good week.
David Rosenthal, MAI
President & CEO
Curtis-Rosenthal, Inc.
drosenthal@curtisrosenthal.com
www.curtisrosenthal.com
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