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The Economic Outlook Presented by: Augustine Faucher Director of Macroeconomics October 24, 2007 Growth, but Slow Growth... Average monthly change in payroll employment, ths Source: BLS 225 200 175 150 Trend 125 100 75 50 25 0 04 05 06 07YTD 07Q3 2 ...Through This Time Next Year Real GDP growth, % change year ago 4.0 December 2006 outlook 3.5 October 2007 outlook 3.0 Potential growth 2.5 2.0 Sources: BEA, Moody's Economy.com 1.5 05 06 07F 08F 09F 10F 3 The Subprime Financial Shock Is a Major Event... TED spread, difference between 3 mo. Euro $ and T-bill 1.6 1.4 1.2 LTCM Gulf war 1.0 0.8 0.6 Orange County Peso crisis Tech bust Subprime financial shock Thai baht 0.4 0.2 0.0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 4 ...And It Continues to Reverberate... TED spread, difference between 3 mo. Euro $ and T-bill 2.5 Subprime financial shock 2.0 1.5 1.0 0.5 0.0 Jan-07 Mar-07 May-07 Jul-07 Sep-07 5 ...And May Not Be Over... $ mil, Source: Moody’s Economy.com 2,500 Jumbo IO Alt-A Subprime 2,000 1,500 1,000 500 0 Debt outstanding, 2007Q1 Serious risk of default, 2007Q1 Defaults, Investor 2007-2008 losses, 20072008 6 ...Given the Risk in the Banking System Residential RE assets of large commercial banks 2,000 36 Source: FRB Share of assets % (R) 1,800 34 1,600 32 1,400 30 1,200 28 $ bil (L) 1,000 26 800 24 600 22 97 98 99 00 01 02 03 04 05 06 07 7 The Cost of Capital Has Risen... CMBS inv grade to 10-yr Treasury spread, percentage points 2.25 Sources: Lehman, FRB 2.00 1.75 1.50 1.25 Average 1.00 0.75 0.50 98 99 00 01 02 03 04 05 06 07 8 ...And Credit Is Less Ample High-yield bond issuance, $ bil MA 16 14 Source: Lehman Brothers Total Caa 12 10 8 6 4 2 0 00 01 02 03 04 05 06 07H1 07q3 9 The Subprime Financial Shock Spooks Investors... Bond Issuance, $bil, annualized 1,000 Jumbo Alt-A Subprime 800 600 400 200 0 '01 '02 '03 '04 '05 '06 '07q1 '07q2 '07q3 10 ...Inducing a Mortgage Lending Crunch... Net % of banks tightening mortgage loan standards 40 Sources: Senior Loan Officer Survey, Moody's Economy.com 30 20 10 0 -10 -20 90 92 94 96 98 00 02 04 06 11 ...In These Housing Markets... Non-conforming share of 2006 originations, U.S. = 50% >=60% 60% - 40% =<40% Sources: 2006 HMDA, Moody's Economy.com 12 Housing Demand Slumps... Home sales, ths, SAAR 9,000 Sources: Realtors, Census 8,500 8,000 7,500 7,000 6,500 6,000 5,500 00 01 02 03 04 05 06 07 13 ...And Mortgage Loan Defaults Soar... Default rate, % of residential mortgage debt, $ 0.9 Sources: Equifax, Moody's Economy.com 0.8 0.7 0.6 0.5 0.4 0.3 0.2 00 01 02 03 04 05 06 07 14 ...In Much of the Country... Change in mortgage default rate, 2005Q4-2007Q3, ppt. >=0.7% U.S. = 0.54% 0.3% - 0.7% =<0.3% Sources: Equifax, Moody's Economy.com 15 ...And More Are Coming Mortgage debt outstanding facing first payment reset, $ bil 60 Source: First American LP 50 Prime Unsecuritized Alt-A Agency Option Subprime 40 30 20 10 0 07 08 09 16 Already Swollen Inventories Will Swell More... # of excess housing units, ths 1,000 New unsold Existing vacant for sale 800 Sources: Census, Moody's Economy.com 600 400 200 0 04 05 06 07 17 ...Forcing Lower Construction and House Prices... What it would take to reach a bottom by year-end 2008 0 Peak-trough % price decline Baseline outlook -10 -20 -30 Job growth 1 0.5 0 -40 -50 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 Housing starts, mil units 18 ...In Much of the Country Projected peak-to-trough % decline < -15% -15 < -5% -5 < 0% No correction Source: Moody’s Economy.com 19 Negative Housing Wealth Effects Kick In... 20 Sources: Realtors, Census, Moody's Economy.com 15 9.0 8.5 8.0 7.5 10 7.0 House-price growth 6 mo. lead (L) 5 0 6.5 6.0 5.5 Core retail sales growth 3 mo. MA (R) 5.0 4.5 -5 4.0 -10 3.5 05 06 07 08 20 ...As Equity Withdrawal Fades... Gross equity extraction, $ bil, Source: Moody's Economy.com 850 750 650 550 450 05 06Q1 06Q2 06Q3 06Q4 07Q1 07Q2 21 ...Weighing on Lower-Mid Income Homeowners… Personal saving rate 16 12 Homeowner no HELOC 8 4 Renter 0 -4 Homeowner HELOC -8 -12 Source: Moody's Economy.com -16 90 92 94 96 98 00 02 04 06 22 …Who Will Pack It in If the Job Market Weakens Change in employment, 3 mo. MA 250 200 150 Non-housing related 100 50 Housing related 0 Source: BLS -50 05 06 07 23 Businesses Remain Highly Profitable... Corporate profit margin 13 12 11 10 9 8 7 Source: BEA 6 60 65 70 75 80 85 90 95 00 05 24 ...And Highly Liquid Ratio of liquid assets to short-term liabilities, nonfinancial corporations 50 45 40 35 30 25 20 Source: Federal Reserve Board 15 60 65 70 75 80 85 90 95 00 05 25 Trade Swings from Negative to Positive Trade balance contribution to real GDP growth 1.00 0.75 0.50 0.25 0.00 -0.25 -0.50 -0.75 -1.00 00 01 02 03 04 05 06 07H1 26 …As Global Growth Remains Broad-Based Recovery Asia Colombia 10 South America Annualized % change Hong Kong Korea 6 Philippines Malaysia Czech Republic Sweden U.S. Mexico 4 New Zealand Australia France 0 Norway Hungary 2 Denmark -2 Spain Euro Zone Italy 0 Brazil U.K. Belgium Portugal 2 -2 India Argentina Canada 8 Recession China Chile Europe North America Expansion Real GDP growth, 2007Q2 12 4 6 Germany Japan Netherlands 8 Russia 10 12 Struggling % change year ago NOTE: Size reflects relative GDP Confidence Doing Better in Asia, South America Business confidence, 4 wk. MA, diffusion index 50 South America 40 Asia Pacific 30 20 U.S. 10 0 Europe -10 J'07 J A S O 28 China and India Still Going Strong Industrial production, 4 mo. MA, % change year ago 20 18 China 16 14 12 10 8 6 India 4 2 00 01 02 03 04 05 06 07 29 Growth Strong But Variable Across Europe Real GDP, % change year ago, 2007H1 Greece Spain Austria Germany U.K. Euro zone Switzerland Netherlands France 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 30 Policymakers Respond Federal funds future contract for December 2007 5.50 Source: CBOT 5.25 5.00 4.75 4.50 4.25 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 31 Watch the CP Market... Commercial paper outstanding, $ bil 2,300 Source: Federal Reserve Board 2,200 2,100 2,000 1,900 1,800 1,700 1,600 Jan-06 Jul-06 Jan-07 Jul-07 32 ...The ARM Share... ARM share of originations, % 40 35 30 25 Source: MBA 20 Jan-07 Apr-07 Jul-07 Sep-07 33 ...Business Confidence... Global confidence, present conditions diffusion index 40 Source: Moody's Economy.com 30 20 10 0 -10 Subprime financial shock Iraq invasion -20 -30 03 04 05 06 07 34 ...Consumer Confidence... ABC/Washington Post consumer survey, index 5 0 -5 -10 -15 -20 06 07 35 ...And UI Claims Initial UI claims, ths, 4 wk. MA 350 350 Source: BLS 325 325 300 300 275 Sep-06 275 Dec-06 Mar-07 Jun-07 Sep-07 36 www.economy.com [email protected] 37