All Eyes on Government Rescue Efforts

Written by: David Lereah   Tue, February 24, 2009 Commentary

There is a growing frustration among investors these days as incoming reports on economic activity remain dreary and conditions in the financial markets have soured. All eyes are on government rescue efforts to revive an economy headed in the wrong direction. Unfortunately, recent policy pronouncements have been unsuccessful in arousing investor confidence as evidenced by the underperformance of the equity and bond markets.

With regard to the economy, the industrial sector continues to contract, inventories are building and business confidence is down. Consumers have lost a great deal of net worth, job losses continue to mount, confidence has fallen and spending is in retreat. It appears that GDP contracted by over 5 percent in the fourth quarter of last year rather than the 3.8 percent contraction previously reported. We expect a similar decline in GDP in the first quarter of this year as well.

With regard to the financial markets, prior progress in market conditions appears to be unraveling. Recent stock price movements have been volatile and depressed and bank stocks are particularly under pressure. Credit has tightened a tad as the narrowing of credit spreads has ceased.

The $787 billion stimulus package will likely have some positive impact on economic activity, but it may not be enough to lift the economy out of the doldrums. We look towards the Federal Reserve and the Treasury to inject additional money into the financial system to unclog credit flows.

President Obama’s announcement of a housing stabilization plan is expected to provide needed assistance to households on the brink of default. The $75 billion program is designed to provide incentives for both mortgage holders and lenders to enter into a refinance arrangement or a loan modification program, depending on the homeowner’s situation. Specifically, the plan offers

homeowners who have less than 20 percent equity and who hold conforming loans owned or guaranteed by Fannie Mae and Freddie Mac an opportunity to refinance at current mortgage rates. The plan also offers a loan modification program to borrowers who are underwater on their mortgages to modify their loans to at least a 31 percent debt-to-income ratio. The program includes incentives to both homeowners and lenders to participate including fees for servicers for every modification, fees for lenders modifying a loan that is still current, and fees for borrowers who pay their loans on time.

The housing stabilization plan offers some hope for a housing recovery. At present, mounting foreclosures threaten to deepen and prolong the housing downturn as well as the recession. The supply of homes is presently excessive with a 9.3 months’ supply for existing homes and a 12.9 months’ supply for new homes. Over supply continues to exert downward pressure on home prices, which, in turn, is keeping households away from the home purchase market. The Obama plan is likely to bring inventories down by slowing the pace of foreclosure filings. Eventually, this is expected to ease downward pressure on home values, bringing buyers back to the market.

The housing sector could soon show signs that it is approaching a bottom if inventories begin to shrink in a meaningful way. We hope that the Obama plan has this positive influence on the housing sector. Lastly, it is equally important that the stimulus package has some positive impact on economic activity, particularly slowing the pace of job losses. If the stimulus package proves to be less than potent, job losses and falling consumer confidence could inhibit a housing recovery.

This past week’s economic releases had some mixed news about the economy. The consumer price index increased 0.3 percent in January, the first increase in six months. The core CPI increased by 0.2 percent in January. These numbers were better than expected but consumer prices are down 0.2 percent from a year earlier. Producer prices also rose for the first time in six months. The producer price index rose 0.8 percent in January, while the core index rose by 0.4 percent. Although there was a rise in producer prices, prices for intermediate goods fell 1.1 percent in January, reflecting weakness in the demand for goods and services.

Jobless claims for the week ending February 14 were flat at 627,000 compared to a week earlier. The level of claims is very high and continues to reflect a deteriorating labor situation. Industrial production fell 1.8 percent in January for the third consecutive month of declines. Suffice it to say, the manufacturing sector is continuing to contract.

On the housing side, the National Association of Home Builders’ housing market index for February increased to nine, as expected. Although the index rose slightly, there was a decline in the six month expectations component which suggests a dismal new home marketplace for the next two quarters. Housing starts (new residential construction) in January fell 16.8 percent to a cyclical low of 466,000. The drop in starts was larger than expected and paints a bleak picture for the residential housing construction industry.

1 Comments For This Post

  1. KonstantinMiller Says:

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