The recession may be over, but consumer and business debt — coupled with rising foreclosures and unemployment — will make for a slow recovery, economists with the UCLA Anderson Forecast said in a report released today.
"Although the worst recession in seven decades likely ended in the current quarter, its negative effects will linger well into the next decade," said David Shulman, senior economist for the forecast, in one of several essays accompanying the report’s statistical forecasts.
The report includes forecasts for housing prices, housing starts, unemployment, mortgage rates, disposable income and other factors affecting housing markets.
Unlike many past recessions, the latest one was spurred by consumers and businesses taking on too much debt rather than imbalances in the "real" economy, Shulman writes in his essay, "The Long Goodbye."
Because of that, not only will financial institutions be less willing to lend, but consumers and businesses will be less willing to borrow, Shulman predicts.
"This process differs from normal recoveries where there is a natural inclination to borrow and spend after a period of Fed tightening that induced recession in the first place," Shulman warns. This time around, the Fed started easing monetary policy well before the beginning of the recession, but the economy is only now showing "hopeful signs of recovery."
In other essays accompanying the report, economists say incentives for homebuyers are needed to bring housing starts back in line with historic trends.
The UCLA Anderson Forecast predicts 2.3 percent growth in real gross domestic product (GDP) during the fourth quarter. But it’s the need to restock depleted inventories of goods — not increased demand — that will drive much of that growth. The report predicts businesses will build up their inventories by $12 billion during the fourth quarter, an amount equal to nearly 1.5 percent of real GDP.
Unemployment yet to peak
But unemployment isn’t expected to peak until next year, hitting 10 percent before falling back slightly to 9.7 percent in 2011. The report projects unemployment will average about 9.2 percent this year — more than twice the 4 percent seen at the turn of the century on the eve of the dot-com bust.
The picture is even bleaker for California, with unemployment expected to hit 12.2 percent in the fourth quarter of this year, and not falling below 10 percent until the end of 2011.
California not only saw explosive growth in new-home construction during the boom, but many of the biggest subprime lenders that have since met their demise were based in the state.
"California’s excess in housing and finance contributes to the now more lofty levels of unemployment as workers formerly employed in these sectors search for jobs elsewhere," UCLA Anderson Forecast senior economist Jerry Nickelsburg wrote in another essay, "Will California Watch the Take-Off From the Tarmac Once Again?" …CONTINUED
On the bright side, Nickelsburg said, "the bubble in employment associated with the bubble in home prices has now fully adjusted to pre-1999 levels."
Real disposable income, which enjoyed annual growth of between 1.3 percent and 5.1 percent from 2000 to 2007, is projected to grow at a more anemic 0.6 percent this year and 0.4 percent in 2010.
Housing starts
While homebuilding has driven some past recoveries, this time around construction is expected to lag.
The report forecasts that single-family housing starts, which peaked during the boom at 1.7 million units in 2005, will bottom out this year at 452,000 but remain below the 1 million mark until 2011. Single-family housing starts are projected to rebound to 666,000 next year and 1.02 million in 2011.
In fact, at the current building rate, "we are under-building by 1 million units, laying the foundation for the next housing mania," if supply is outstripped by demand, warns Edward Leamer, director of the UCLA Anderson Forecast, in another essay, "Bail Out Homeowners, End the Recession?"
Leamer thinks that rather than bailing out homeowners, the government should focus on creating buyers. While falling prices can stimulate demand, with housing that’s not always the case, he warns.
"Lower prices create the hope and expectation of still lower prices later, and buyers often choose to wait it out to get the best deal," Leamer wrote. "Falling prices cause tighter lending standards because of the elevated risk of default. Thus lower prices create lower sales, and we get overshooting in the downward direction."
The recession has increased the number of occupants per home, calling for programs that encourage renters to buy, Leamer said.
The number of housing units classified by the U.S. Census Bureau as vacant has increased by 3 million since the end of 2005 — the equivalent of two normal years of housing construction, Leamer said.
Income limits on the $8,000 federal first-time homebuyer tax credit have limited its effectiveness, Leamer said. A state tax credit of up to $10,000 offered on new-home purchases in California was "good for homebuilders, but not so good for the housing market" because new homebuyers selling an existing home are "filling one vacancy but creating another," Leamer wrote.
Mortgage rates
If there’s a silver lining to a slow recovery, it’s that fears of inflation — and higher interest rates on mortgages — have subsided in some circles.
In the near term, the consumer price index is forecast to spring back only modestly from a projected -0.4 percent this year to 1.5 percent in 2010 and 2.2 percent in 2011. That compares to the previous low for the century of 1.6 percent in 2002, and a high of 3.8 percent in 2008, when oil prices soared. …CONTINUED
But the Federal Reserve’s massive injections of liquidity into financial markets, along with increased government borrowing and rising deficits, do pose a long-term inflation threat, the report said.
"Market participants know full well that there is more than enough liquidity in the system to ignite a persistent inflation; not today but perhaps within a few years," Shulman wrote.
In order to deal with this threat, UCLA Anderson Forecast economists believe the Fed will gradually shrink its balance sheet and begin to slowly move away from its zero interest-rate policy in the third quarter of 2010.
The UCLA Anderson Forecast projects that mortgage rates will rebound from historic lows but not soar into the stratosphere. Rates on conventional 30-year mortgages will rise from an average of 5.16 percent this year to 5.56 percent in 2010 and 6.01 percent in 2011 — about where they were last year, the report said.
Rising mortgage rates can put downward pressure on housing prices because they reduce homebuyers’ purchasing power.
But the report projects that the median sales price of a new home, which peaked at $243,700 in 2007, will bottom out at $210,700 in 2010 before rebounding slightly in 2011, to $212,100.
Once a recovery is under way, there will be "lingering effects" from the "incredibly low lending standards" of the housing boom, Leamer wrote.
Too many single-family homes were built in places like the "exurbs" when what was needed were multifamily homes in other locations.
Building in places like Southern California’s Inland Empire "created homes for a class of buyers that no longer exists because the subprime mortgage market is gone for good."
Instead of stopping foreclosures on those homes, programs are needed that will allow families to stay in their homes as renters, Leamer said.
In a counterpoint essay included in the report, University of California, Berkeley, economics professor Brad DeLong argued for the federal government to "buy up every single mortgage and transform them into standard 30-year fixed-rate mortgages."
The government has already nationalized Fannie Mae and Freddie Mac, DeLong said, and there’s "a strong case" for further intervention in housing finance to bolster the home construction sector.
"I think we should face the fact that home mortgage finance is broken, that the risk tolerance of the private financial system is impaired and that we will not get the flow of finance to potential homebuyers through private banks working again any time soon," DeLong said.
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