and A retrospective (?) on the economic crisis Jeff Fuhrer Exec. - - PowerPoint PPT Presentation

Current economic conditions and A retrospective (?) on the economic crisis

Jeff Fuhrer

• Exec. VP and Director of Research

Federal Reserve Bank of Boston October 1 2009

Plan for the talk Part I: Review economic conditions and their implications for the outlook Part II: Look back on the financial crisis (to date)

– Innovative Fed actions and market responses – Is deflation a concern? – Is inflation a concern? (Balance sheet issues)

Part I Economic conditions and outlook

• 800
• 600
• 400
• 200

200 400 2000:Jan 2002:Jan 2004:Jan 2006:Jan 2008:Jan

3-mo. avg. chg., total employment 3-mo. avg. change, private employment

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Global Insight

Employment is declining less and less rapidly

We are emerging from a very severe recession

Housing market progress: It’s really happening

250 300 350 400 450 500 550 600 300 500 700 900 1100 1300 1500 1700 1900 2000:Jan 2001:Jul 2003:Jan 2004:Jul 2006:Jan 2007:Jul 2009:Jan Thousands Thousands

Stock of 1-family houses for sale (right scale) Single-family housing permits (left scale)

Source: Census Bureau

Improvements in outstanding inventory Small improvement in construction

With reductions in inventories and some improvement in sales, I/S is clearly improving

Source: Census Bureau

300 500 700 900 1100 1300 1500 2 4 6 8 10 12 14 2000:Jan 2001:Jul 2003:Jan 2004:Jul 2006:Jan 2007:Jul 2009:Jan

Months supply of homes for sale (left scale) New single-family homes sold (right scale)

…and house prices have flattened in many locations

Some hopeful signs in recent investment data

40000 45000 50000 55000 60000 65000 70000

2008:Jan 2008:May 2008:Sep 2009:Jan 2009:May

Shipments Orders

…improving orders

for capital goods suggest an improvement in capital spending next year

Source: New sales, permits, shipments and orders: Bureau of the Census; Existing sales: Nat’l Assoc. of Realtors

Commercial real estate is still a serious concern

• 12
• 10
• 8
• 6
• 4
• 2

2 4 6 8 1990 - Q1 1993 - Q1 1996 - Q1 1999 - Q1 2002 - Q1 2005 - Q1 2008 - Q1 Quarterly Return

NACREIF Total Return on CRE

Total Office Retail

Equity markets have responded favorably of late

600 700 800 900 1000 1100 1200

20081001 20081112 20081224 20090204 20090318 20090429 20090610 20090722 20090902

• 55% above March trough
• 17% above beginning of 2009

9/29

This helps to offset the significant loss to household wealth from fallen home prices

Source: S&P 500:New York Times; House prices: S&P Case Shiller

10000 20000 30000 40000 50000 60000 70000 1990:Q1 1993:Q1 1996:Q1 1999:Q1 2002:Q1 2005:Q1 2008:Q1

Household Net Worth

HH net worth down

• ver $12.2T

through June

A caveat: Despite the equity rally, overall household net worth remains well down

Source: Board of Governors, Flow of Funds Accounts

…this is likely to restrain household spending in 2010

The largest concern going forward: Unemployment is likely to remain elevated

4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 2003:Q1 2005:Q1 2007:Q1 2009:Q1 2011:Q1 2013:Q1 Civilian Unemployment Rate Macro Advisors Global Insight

Full Employment Estimate

Slow employment growth and slow wage growth will challenge the consumer

1 2 3 4 5 6 7 2000:Q1 2003:Q1 2006:Q1 2009:Q1

Employment Compensation index, private industries

Total compensation Wages

Source: Bureau of Labor Statistics

High unemployment may also bear implications for inflation Disagreement on this: Too high or too low?

0.5 1 1.5 2 2.5 3 3.5 Jan-07 Jan-09

Blue Chip Forecast Survey

CPI inflation, 2 years out

Bottom 10 Median Top 10

Summary of conditions The economy is recovering, likely slowly Underlying fundamentals are still challenging

– Household net worth remains low – Employment and wage growth remain weak – Foreign growth remains weak

Expect a gradual recovery over the next several years, with elevated unemployment Inflation

– Balance sheet, deficit suggest higher inflation – Lingering excess capacity suggests lower inflation

Part II A look back (and forward) at the crisis

What caused all this?

Many causes

– Over-priced residential real estate – Over-priced commercial real estate – Over-building in residential real estate – Heavy leverage in all of the above—borrowers in precarious positions – A significant decline in house prices (a result of the over-building above) – Households in trouble due to job loss, falling prices, default – Financial firms in trouble due to losses on mortgage-related securities – Similar problems at many foreign financial institutions – Some missed supervisory opportunities – Reliance on ratings agencies for new, untested products – Contagion from mortgage-related to all other securities – Loss of confidence among consumers and businesses—PANIC – Loss of short-term credit at major financial institutions – Pull back in hiring, spending, etc.

What caused this? Housing and Debt: Over-building, Inventory overhang

300 500 700 900 1100 1300 1500 2 4 6 8 10 12 14 2000:Jan 2001:Jul 2003:Jan 2004:Jul 2006:Jan 2007:Jul 2009:Jan

Months supply of homes for sale (left scale) New single-family homes sold (right scale)

What caused this? Housing and Debt: Price rise and fall

50 100 150 200 250 1990:Jan 1993:Jan 1996:Jan 1999:Jan 2002:Jan 2005:Jan 2008:Jan

• Jan. 2000 = 100

Composite 20 Boston Las Vegas

As prices fell and unemployment rose, delinquencies and foreclosures surged

Subprime ARMs showed the most dramatic rise in foreclosures… 0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 1998:Q1 2001:Q1 2004:Q1 2007:Q1 90 days delinquent Foreclosure initiated Prime, 90-days Prime, foreclosure

Losses at financial institutions soared, especially for mortgage-related securities

2000 4000 6000 8000 10000 12000 14000 0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.00 1991:Q1 1994:Q1 1997:Q1 2000:Q1 2003:Q1 2006:Q1 2009:Q1

Commercial Banks

Delinquency rate (left) Charge-offs, $millions (right) The losses are ongoing, and imply significant risk going forward

Some mortgage lenders disappeared

Financial markets freaked out

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0

Spread, 3-mo. $ Libor over 3-mo. OIS "Spread, 1-mo. $ Libor over 1-mo. OIS"

Normally secure short- term lending dried up But note the recent improvement

Widespread loss of confidence; Real activity plummeted

0.0 20.0 40.0 60.0 80.0 100.0 120.0 2007:Jan 2008:Jan 2009:Jan Michigan sentiment index Conference Board sentiment index Confidence measures

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1 2 3 4 5 4.0 5.0 6.0 7.0 8.0 9.0 10.0 2002:Q1 2004:Q1 2006:Q1 2008:Q1 Unemployment Rate 4-qtr. % chg. In real GDP (right) Real activity measures

Policy Responses The Fed

– Lowered the funds rate to zero—can’t get any lower! – Pursued liquidity policies (short-term lending) – Rescued individual firms (good or bad?) – Tried some substitutes for conventional policy (purchased MBS)

The Treasury

– Pumped capital into the banking system – Insured deposits, secured lending – Provided fiscal stimulus package – Bailed out auto companies

Fed Responses, itemized

Term Auction Facility (TAF)

– Lend to banks, but remove stigma of discount window borrowing

Commercial paper (CPFF)/MMMF (AMLF) facilities

– Help commercial-paper and ABCP-based MMMF’s to meet redemptions, continue funding (over $300B)

ABS facilities (TALF)

– Facilitate new-issue AAA ABS purchases, up to $200B – ―Legacy securities‖ (with PPIP program)—CMBS, RMBS

MBS, Treasury purchases (LSAP: up to $1.25T, $300B)

– 30-year conforming rates down 1-1.25 ppts., refis up

FRMLFFA (Facility for Restricting Multi-Letter Fed Facility Acronyms)

Provide short- term liquidity Provide longer- term credit, macro stimulus Maintain sanity

Summary The economy is in better shape than it was The recovery is likely to be characterized by

– High unemployment for an extended period – Risk of falling inflation—but some disagree

The crisis: A post-mortem

– Many causes – Hard to predict many of the consequences – Some appropriate policy responses – Some are debatable