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Economic Recovery At Risk? March 16, 2010 Dwight Johnston Agenda • • • • • The Trade Job outlook – clear as mud Second dip ahead Scenarios Risks Most Likely (From Jan. 2009) • • • • • • Economic recovery will fall far short End of recession won’t feel like it But job losses should abate Housing still in bottoming process Best case – Economy bottoms in ‘09 Greatest risks are to the downside Keys to 2009 (From Jan. 2009) • Don’t lose sight this is the biggest credit event in history – no quick rebound • Remember that the investor base for most credit products decimated – rebuilding will take years – “Shadow banking” gone • Govt. intervention knows no boundaries • Generational change in consumer psychology – Boomers lower expectations • After this deep recession ends – series of mini-recoveries and mini-recessions The Trade – Simple Version • Global traders borrow in $ - sell $ to buy euro etc. to invest in Greek bonds • Market values plummet; liquidity issues • Forced to sell good assets to buy $ to repay loans/margin • Higher $ pressures other global trades – force out of positions • Risk – Banks that provided loans – Financial Meltdown II Financial Landscape Has Not Changed • “Extend and pretend” – can banks continue to out-earn future losses? • Commercial R.E. still to come; Foreclosure losses still a work in progress • “Too big too fail” problem even bigger • Nothing fundamental has changed • Risk appetite surges – spreads Census Hiring Will Muddle Picture – Nonfarm Payroll Numbers Need a Big * (Nonfarm Payrolls Change – Thousands) Projected Ja n-0 Ap 6 r-0 Ju 6 l-0 Oc 6 t-0 Ja 6 n-0 Ap 7 r-0 Ju 7 l-0 Oc 7 t-0 Ja 7 n-0 Ap 8 r-0 Ju 8 l-0 Oc 8 t-0 Ja 8 n-0 Ap 9 r-0 Ju 9 l-0 Oc 9 t-0 Ja 9 n-1 Ap 0 r-1 Ju 0 l-1 Oc 0 t-1 0 400 300 200 100 0 -100 -200 -300 -400 -500 -600 -700 -800 400 300 200 100 0 -100 -200 -300 -400 -500 -600 -700 -800 Jobs in 2010 – Volatile Numbers • Census hiring will add 1.2 million parttime/full-time – most gone by year-end • Will census act as stimulus? • State & Local Govt jobs back at risk – 12 million at stake • A new jobs bill? • Shocking stat – ‘99 workers 129mm; demo gains 29mm; ‘10 workers 129mm California – Almost Michigan Low UR California 4.6% High UR Current 12.5% Orange Co. 3.0% 10.1% LA/Long Beach 4.0% 12.5% San Bern/Ont/ Riverside 4.5% 15.0% California Not Likely to Lead • Too much of California’s growth was construction based and r.e. profit-based • Unemployment woes severe for some time • Port business could be a plus but California not in control • Budget woes not conducive to attracting new businesses • While not a leader, will make a great follower – human resources, desirability, reputation for innovation GDP – Government Driven Progress Percent Chain Weighted SAAR – Annualized Change YOY 8 7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 Projected 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Second Dip Ahead • The stock market is not the economy • Do not under-estimate the lack of stimulus – fiscal and monetary • At end of 80’s recession consumer debt 46% of GDP – Today it’s 96% • This was a monumental collapse of asset prices – leaving behind a mountain of debt How Low Can We Go? Current Price ‘07 San Diego $565,000 Required Price Change -29.3% -$165,000 River/SB $390,000 -41.0% -$160,000 LA $570,000 -39.5% -$225,000 The O.C. $720,000 -34.0% -$245,000 Source: Burns Real Estate Consulting Great Progress! – Sort Of Peak Price Mostly 2007 Actual Decline Current Price San Diego $565,000 -38.0% $350,000 O.C. $720,000 -40.0% $430,000 LA $570,000 -44.0% $320,000 San B/Riv $390,000 -60.0% $156,000 Source: Burns Real Estate Consulting Housing Fundamentals – Good to Great • Most statistics support a bottoming process is occurring – Psychology boost • First time buyers very active • Investors active (record 28%)– good and bad • Affordability best in years! • Mortgage rates best in years! (at risk) Housing Fundamentals – Bad to Terrible • “Bottom” – depends on jobs • More pain in higher end likely • More govt. support risks spread of walk away incentive • Foreclosures only delayed? – Shadow inventory at record 3.4 million homes • How negative would end of Fed mortgage buying be? (Fed buys 75%) Strategic Default – Now Trendy • 1,000,000 walk-aways in 2009 • Articles now balanced but more emphasis on positive aspects of default • Wider acceptance in polls • Risks will grow the longer home prices remain flat in depressed areas with high prices Underwater Homes – Incentive to Walk Away • • • • California – 36% Nevada – 70% Florida – 48% Arizona – 51% Suggestion for new NBC show Desperate Congresspersons • Mid-term elections • Son of stimulus - infrastructure? State jobs? • More taxpayer money to cover mortgage losses on modifications • Fannie and Freddie folded into one; Rate control? - private market dead – watch out for commercial real estate programs • More Fed meddling in securities markets – Mortgage Rate Conundrum Who Will Replace the Fed? 7 6 5 4 3 2 1 Ten Year 9 n0 Ju ec - FNMA MTG 08 Spread D Ju n0 8 0 Buyers Cushion Mortgage Rates • • • • Big inflows into bond funds Banks add mortgages with 0% funding Pensions etc. add duration Rise in rates would change the picture – big extension risk • Buyers become sellers • Ultimate return to historical average would boost mortgage rates by 75 b.p.s Long-term Rates Still Low, But…… 5 4.5 4 3.5 3 2.5 2 1.5 1 1/26/2009 0.5 2/10/2010 0 FFunds 3m 6m 12m 2Y 5Y 10Y 30Y Long-term Problem – Short-term Just Annoying Range of Expectations for 12/31/2010 (March 2010 Bloomberg poll – 87 economists) Low Median High GDP 0.00% 2.90% 4.50% UR 7.50% 9.40% 11.50% CPI 1.00% 1.80% 5.00% Fed Funds 0-0.25% .75% 1.50% 2-Year 1.00% 2.00% 3.30% 10-Year 2.50% 4.00% 5.50% Three Scenarios – Crossroads? • Low Rate Case – Bad assets drag on credit; consumer shift intensifies; 2nd & 3rd dips – Japanese scenario 20% • Most Likely – Housing “process” continues; credit market conditions stable; U.S. continues recovery; true job growth still weak - Caution! Long-term rates might rise 70% • High rate case – Monetarist case. Dollar will weaken and Fed’s money binge will produce reduced foreign demand. Rates will surge on Treasury needs. 10% Fed Funds Scenarios 5 4.5 4 3.5 3 2.5 2 1.5 1 0.5 Rate Path # 1 Rate Path #2 Oc t-10 Jul -10 r-10 Ap Jan -10 Oc t-09 Jul -09 r-09 Ap Jan -09 0 Rate Path #3 Ten-Year T-Notes 7 6.5 6 5.5 5 4.5 4 3.5 3 2.5 Rate Path # 1 Rate Path #2 Oc t-10 Jul -10 r-10 Ap Jan -10 Oc t-09 Jul -09 r-09 Ap Jan -09 2 Rate Path #3 Final Thoughts • Assume 2010 will look like second half 2009 • Worry about bubbles and second dips – series of mini-recessions/mini-recoveries • With luck, economy can build on small gains – Benefits from weak dollar; census hiring begets more hiring; foreclosures abate and construction starts; real optimism returns – not just “less bad” • Lots of smart people (not on Wall Street) believe economy will exceed expectations Just for Credit Unions • • • • Be careful with mortgages Loan performance no better/no worse Vast differences locally Credit unions could continue to benefit from positive press - capitalize • Brainstorm – What will your credit union look like in permanently low rate environment Q and A Dwight Johnston – [email protected] Daily Market Comment & Longer-term Commentary available at www.wescorp.org