Friday, December 9, 2011

The Long Slump, UCLA Anderson Forecast, December 2011

“But for a lot of people, I know it doesn’t feel like the recession ever ended. The unemployment rate remains
painfully high, and more than two-fifths of the unemployed have been out of work for longer than six months,
by far the highest ratio since World War II.”1
Ben S. Bernanke

Let’s face it, despite a modestly growing GDP,
the labor market remains mired in a long slump. Next
year will mark the fourth year in a row with an unemployment
rate exceeding 9%, the worst performance
of the postwar era. (See Figure 1) Indeed, the broader
U-6 series, which takes into account part-time workers
seeking full time employment and discouraged
workers, has consistently been above 16%. Put simply,
there are currently 25 million Americans looking
for full-time work. Moreover the employmentpopulation
ratio remains below the level reached
at the official bottom of the recession in 2009. (See
Figure 2) Unfortunately, although we are forecasting
modest job growth on the order of 150,000 jobs
a month, total payroll employment will still be about
three million jobs below the late 2007 peak. (See
Figure 3) Given the decidedly weak labor market, it
is not a coincidence that real personal income is still
below the level reached in 2008. (See Figure 4)

Figure 1 Unemployment Rate, 2005Q1-2013Q4F
Source: Bureau of Labor Statistics and UCLA Anderson Forecast

Although recent data has improved and the notion
of a double-dip recession now appears to be off
the table, we continue to forecast real GDP growth at
a below trend rate over the next five quarters. Specifically
we are forecasting a 2% growth rate for the
current quarter and a sub-2% growth rate for most of
2012. (See Figure 5) However, for 2013 we envision
growth to exceed 3% as several of the contractionary
forces discussed below abate.

Policy in a Trap: The Ghost of David Ricardo

Pimco’s Bill Gross asked the following question
in his latest missive to investors, “Can you solve a
debt crisis with more debt?”2 The answer is usually
you can, except when sovereign debt in excess
of 80-90% of GDP becomes a barrier to growth.3 In
that case, the concept of Ricardian Equivalence may
come into play.4 David Ricardo, the great early 19th

Figure 2 Employment/Population Ratio, 1948 – October 2011, Monthly Data
Source: Federal Reserve Bank of St. Louis

Figure 3 Payroll Employment 2005Q1-2013Q4F
Source: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 4 Real Personal Income, 2000 – September 2011, In $Billions, Monthly Data
Sources: Federal Reserve Bank of St. Louis

Figure 5 Real GDP Growth, 2005Q1 – 2013Q4
Source: U.S. Department of Commerce and UCLA Anderson Forecast

century English political economist offered up the
theory that the issuance of government debt is essentially
equivalent to a promise to increase taxation in
the future. Realizing that, taxpayers save more today
to meet their projected tax obligations. When debt
is low, taxpayers do not worry about the prospect of
future taxation because they rightly believe that it will
remain outstanding forever and hence never be paid
off. As a historical matter, most folks have not had
kitchen table conversations about how high deficits
will increase their taxes in the future.

However, when debt is high, there is a very
real prospect that it will have to be paid off in the
future and the funds to make the required payments
will come from increased taxation and reduced
government spending. All of a sudden, the
deficit becomes real! (E.g. Greece) A similar process

Figure 7 Federal Funds vs. 10 Year U.S. Treasury
Yields, 2005Q1- 2013Q4F
Sources: Federal Reserve Board and UCLA Anderson Forecast

occurs in corporate finance where a modest increase
in leverage will actually lower the cost of capital.
However, once leverage is deemed to be excessive by
the financial markets, the cost of capital skyrockets.
Closer to home, the Obama Administration’s
proposals to stimulate the economy with social
security tax cuts and infrastructure spending today
to be financed by tax increases in the future is an
example of Ricardian Equivalence. In this case, the
government is explicitly promising taxpayers that
their taxes will go up in the future; no guesswork is
required. For the American consumer already reeling
from home and stock price declines, the prospect of
future tax increases would weigh on current spending.

Similarly, the Ricardian result holds true, to a lesser
extent, with financing the stimulus with future cuts in
long-term reductions in entitlement programs.
Thus, it is unlikely the economy would receive
the stimulative effects of the fiscal policy that normally
would be predicted by the standard econometric
models. In other words, fiscal policy as we have
known has come to a dead end. This eventuality is
a result of the high-deficit fiscal policy of the past
decade and the projection of mega-deficits as far as
the eye can see, Super Committee or not. (See Figure
6) In fact, the high deficits will occur against a backdrop
of declining real federal purchases, but rapidly
increasing transfer (entitlement) payments.

Similarly, the Fed has been following a full
throttle expansionary monetary policy since 2008.
The Federal Funds rate has been set at zero since
early 2009 and will remain there through 2013. (See
Figure 7) With the policy rate set at zero the Fed has
engaged in two massive quantitative easing programs
and recently put in place an “operation twist” to lower
long-term interest rates.

Another quantitative easing program looms on
the horizon. However, it remains to be seen whether
further policy measures will stimulate the economy.
To be sure the earlier policies likely put a floor under
the 2007-09 recession and planted the seeds for
recovery; it is not clear whether or not the policy has
been all that efficacious of late. Remember the implementation
of the second round of quantitative easing

Figure 6 Federal Surplus/Deficit,
FY 2000 – FY 2021F
Sources: Office of Management and Budget and UCLA Anderson Forecas

Figure 8 Global Stock Market Performance,
2011 through Nov. 25

Sources: The Wall Street journal

in September 2010 triggered inflationary fears with
a run-up in commodity prices that worked to depress
consumer spending. It appears that the Fed might be
pushing on a string, the bane of monetary policy.
Another factor inhibiting monetary policy is the
notion that very low interest rates can be contractionary.

I know this goes against the grain of Keynesian
theory, but there may be a new kind of paradox
of thrift at work. A year ago we wrote about the
phenomenon of how low interest rates actually can
encourage savings and reduce consumption.5 How
so? With very low interest rates, pension plans require
increased contributions to meet their actuarial obligations.
The same principle holds true for defined
contribution plans where a target level of savings has
to be reached in order to fund the desired amount of
retirement income.

Because the retirement planning
for most Americans never contemplated a 2% 10-Year
U.S. Treasury bond, the average American facing retirement
over the next 10-15 years is between a rock
and a hard place. Indeed, for those already retired,
low interest rates act as a depressant on consumption.
Thus, while low interest rates work to stimulate
purchases of homes, consumer durables and business
equipment, there is a very real drag coming
from reduced everyday consumption for current and
prospective retirees. Because we are in a whole new
world with respect to interest rates, it is still too early
to tell how powerful in suppressing demand the new
paradox of thrift is.

The Crisis in Europe

The economic situation in Europe continues
to deteriorate with the Eurozone placing its member
countries in straight jacket similar to the gold
standard rules of a century ago. Without the ability
to devalue their respective currencies, the troubled
countries of Portugal, Italy, Ireland, Greece, Spain
and perhaps France are forced to deflate their domestic
economies. Austerity is the rule of the day and it is
likely that the continent will be in recession next year.

With that, U.S exports to the Euro region will
slow and similarly for Asian and Latin American
exports thereby depressing activity world-wide. Thus,
the global economy will grow more slowly in 2012
than 2011. And this assumes that we avoid a full
blown banking crisis in Europe that could bring with
it a world-wide restriction in credit analogous to the
Lehman Brothers collapse of 2008.

Therefore, it is not an accident that most of the
world’s stock markets have suffered declines this
year. In fact, even with the August and November
swoons in U.S. share prices, the U.S. stock market
has held up far better than its counterparts around the
world. For example, as of late-November, the U.S.
market was down 8% year-to-date, while Germany
was down 21%, France down 25%, Japan down 20%,
China down 16%, and Brazil down 21%. (See Figure 8)

Figure 10 Real Consumer Spending,
2005Q1 – 2013Q4F

Sources: U.S. Cepartment of Commerce and UCLA Anderson Forecast

As a result, we forecast that after increasing
11.3% in 2010 and an estimated 6.6% this year, we
forecast that real exports will increase by only 3.4%
in 2012 and rebound to a healthy 7.7% in 2013.(See
Figure 9) The recently announced $40 billion airplane
orders announced by Boeing certainly augers well for
export growth later in the decade.

The Domestic Economy

Despite the scare coming from the recent decline
in stock prices, consumer spending, especially
on automobiles is continuing to grow. (See Figures
10 and 11) To be sure, the recent gains in consumer
spending might not be maintained, but, unlike the
sluggishness earlier in the year, it will remain a
source of modest strength. Moreover, automobile
sales are being buoyed by pure replacement demand
as the fleet is reaching the limits of aging. Furthermore,
housing starts have bottomed and while this
sector won’t be a major source of growth in 2012
we suspect that 2013 will bring with it a rebound in
construction as the backlog of excess supply is eaten
into. (See Figure 12)

Although investment in equipment and software
will continue to grow in 2013, it will come off of its
heady double-digit pace of the past two years. (See
Figure 13) We are forecasting growth of 6.7% and
7.1% in 2012 and 2013, respectively. Nevertheless,
this sector will be growing three times faster than the
overall economy.

Of course as we have noted for many years, the
state and local sector is undergoing a fundamental
restructuring as real spending continues to decline.
(See figure 14) Because of the prevalence of defined
benefit plans, this sector is being especially harmed
by the very low interest rates we are experiencing.
Last month, Rhode Island, under the weight of a huge
unfunded liability, radically reformed its pension
plans that included cuts for existing beneficiaries.
Put bluntly, the laws of arithmetic are overcoming

Figure 9 Real Exports, 2000 – 2013F,
Percent Change
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 11 Automobile Sales, 2005Q1 – 2013Q4
Sources: UCLA Anderson Forecast

Figure 12 Housing Starts, 2005Q1 – 2013Q4F,
in thousands, SAAR
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 13 Real Investment in Equipment and
Software, 2000 -2013F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 14 Real State and Local Government
Spending, 2005 – 2013F, Percent Change
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

the laws of politics, even in the very unionized and
very Democratic state of Rhode Island

The United States is facing an unemployment
crisis in a slow growth economy. A modestly growing
GDP on the order of 2% will not be sufficient
to lower the unemployment rate much below 9%
through 2013. Furthermore, government policy seems
to be incapable of noticeably improving the situation.
Indeed the Federal government will be reducing
purchases during the forecast period. The economy
will be sustained by modest increases in consumption
and business investment along with the beginnings of
a housing recovery in 2013.

1. Bernanke, Ben S., Remarks, At the Town Hall Meeting with Soldiers and Their Families, Fort Bliss, Texas, November 10, 2011, Board of
Governors of the Federal Reserve System.
2. Gross, William H., “Pennies from Heaven,” Pimco Investment Outlook, November 2011.
3. See Reinhart, Carmen M., and Kenneth S. Rogoff, “This Time is Different,” Princeton, Princeton University Press, 2009.
4. See Ricardo, David (1820), “Essay on the Funding System,” in “The Works of David Ricardo on the Life and Writings of the Author, J.R.
McColloch, London, John Murray, 1888. For the modern version of Ricardian Equivalence see, Barro, Robert J., “Are Government
Bonds Net Wealth,” Journal of Political Economy, 82:6, 1095-1117 and “On the Determination of the Public Debt,” Journal of Political
Economy, 87:5, 940-971.
5. See Shulman, David, “Risky Business,” UCLA Anderson Forecast, December 2010.

Thursday, December 1, 2011

Letter to the Star Ledger, December 1

The article “State’s corporate tax subsidies don’t pay off,” (Nov. 27) is absolutely correct in arguing that taxpayers pay a high price to generate a few jobs.

However, the author is wrong when she says the tax subsidies should be used instead to pay for more government.

If New Jersey is to make some headway in solving our unemployment crisis, it would be far better to lower all corporate taxes and lighten the regulatory burden on business.

It is no accident that New Jersey lagged behind in the past decade as years of Democratic administration policies exacted their toll.

David Shulman

Saturday, November 19, 2011

The Dumb Party and the Evil Party

We Americans are blessed with two major political parties; the dumb party and the evil party. Without question the Republican party is the dumb party. Never have I seen such a collection of wack-job candidates for the presidency and never have I seen such intolerant audiences at the debates. I am truly ashamed.

Look at the field, you have Newt Gingrich, a politician who has more baggage than Samsonite. Then you have a cranky old man in the person of Ron Paul. There is the lovely Michele Bachmann who makes a pretty good impersonation of the wicked witch in The Wizard of Oz. There is Rick Santorum who is so up tight that he looks like he is holding a pea in his butt. What I can I say about Herman Cain, a candidate who talks well but is just not ready for prime time. Forget about the sexual harassment allegations, he just doesn't know what's happening in the world. Then there is the distinguished governor of Texas, Rick Perry. He can't remember what agencies he wants to eliminate. Now Mitt Romney is a very bright guy, but he has taken two sides on all too many important issues so it is hard to tell what is core beliefs are. Jon Huntsman is the class act in field, but in the year of wack jobs, his nomination is not going to happen.

Most alarming is the field's elevating tax policy to a religion. Face it, tax increases will be necessary to solve our fiscal mess and any deal that offers up five or six dollar of spending cuts for every dollar of tax increases should be welcomed with open arms.

So much for the Republicans being dumb; the Democrats are evil. Why? They lie to the people. It is evil to make promises to people that can't be kept. They promise an entitlement state that they can't deliver on. It is cruel to offer a great pension to a 50 year old that won't be there when the employee retires. It is evil to say they support manufacturing and then come up with a host of rules making it impossible to manufacture. They support energy independence, except it can't be accomplished with domestic drilling and a pipeline infrastructure. They chase the chimera of "green tech" knowing it won't supply more than a few percent our energy needs in 2020.

Yes folks, we will have quite a choice to make in 2012.

Thursday, November 10, 2011

Obama the Job Killer

In delaying the Keystone XL pipeline to 2013, President Obama proved once and for all that he does not care about jobs, except perhaps his own. In kowtowing to the environmental lobby the $8 billion infrastucture project that would transport oil from the Canadian oilsands to the Gulf coast, President Obama is holding about 23,000direct jobs hostage to his political whim. Furthermore, upon completion we would have significantly improved our energy security. We would substitute Canadian oil for middle-eastern oil, a great trade-off, but not in the eyes of our President.

Let us hope that we will soon have a more enlightened leadership in the White House.

Wednesday, October 12, 2011

Shulmaven on CNBC

I appeared on CNBC today discussing the Occupy Wall Street demonstrations and the unemployment crisis facing our nation. The interview was carried by a MSNBC blog.

The full URL:

Thursday, September 29, 2011

Zakaria Supports Shulmaven on Infrastructure Projects

Washington Post columnist Fareed Zakaria endorsed the Shulmaven proposal to fast-track environmental approvals and Davis-Bacon Act waivers for new infrastructure projects.He like Shulmaven understands we face a jobs emergency. This list grows.

full URL :

Friday, September 23, 2011

Stalled, UCLA Anderson Forecast, September 2011

“Developments this summer have indicated we are on a dangerous new phase. The stakes are clear: we risk seeing the fragile recovery derailed.”1

Christine Lagarde, Managing Director, International Monetary Fund

The economy has stalled. To be sure, it has not
gone backward into recession, but there is certainly
no forward momentum and our outlook is far worse
than just three months ago. In fact, given the surprisingly
weak revised data for the first half of the year,
we expect that in the five quarter period ending in the
first quarter of 2012, economic growth will average
a decidedly weak 0.9%. (See Figure 1) If there ever
were an economy operating at “stall speed”, this one
is it.

We first introduced the concept of “stall speed”
in September 2007 and again discussed it in September
2008. In fact, we used the same “Stalled” title in
September 2008. What is it about September? The
concept of “stall speed” involves an economy growing
so slowly that any modest shock can trigger a
full-blown recession, just as when an airplane’s velocity
slows to such an extent where it can no longer

Figure 1 Real GDP Growth, 2005Q1 – 2013Q4F

Source: U.S. Department of Commerce and UCLA Anderson Forecast

We are not, however, forecasting a new recession.
Why? Simply put, the three sectors that would
normally put the economy into recession are already
depressed; those being housing, consumer durables
and inventories. Even if housing starts drop to new
lows, this sector of the economy has shriveled so
much that it would only have a modest impact on
economic activity. For example, it is one thing for
housing starts to decline from an annual pace of two
million units to one million units and quite another
for starts to decline from 600,000 units to 300,000

Thus, if we are to have a new recession it
would have to come from a collapse in exports, a generalized
decline in consumer spending with a resultant
decline in business investment. All plausible, but
we are not forecasting that eventuality.
Instead, we forecast economic growth to gradually
rebound in mid-2012 with the economy growing
at a modest 2.5% - 3% clip The factors driving the
return to growth include modest gains in exports,
consumption and equipment and software investment.
In that environment, employment growth will become
more meaningful with gains averaging about 150,000
jobs a month and the unemployment rate falling to a
still very high 8.6% by the end of 2013.

Nevertheless, recession or not, the employment
situation remains horrible. Job growth has stalled and
we forecast that the unemployment rate will soon
rise to 9.5%, above August’s elevated rate of 9.1%.
(See Figures 2 and 3) Thus, even by the end of 2013
we will not be back to the employment levels of late
2007. Indeed, the unemployment rate is being masked
by an unprecedented decline in the employment/
population ratio which is back to where it was in the
early 1980s. (See Figure 4) Simply put, while many
workers have left the labor force by going back to
school, retiring, or staying home to raise children --
all too many have left the labor force and have simply
given up.

Figure 2 Payroll Employment, 2005Q1 – 2013Q4

Source:Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 3 Unemployment Rate, 2005Q1 -2013Q4F

Source: Bureau of Labor Statistics and UCLA Anderson Forecast

Therefore, in terms of the labor market,
we are not in an economic recovery, but rather
we remain mired in one long slump. This view is
consistent with the consumer confidence surveys and
the very low esteem the public has for the elected
branches of government.

Government Policy Response

From the beginning of the financial crisis in
August 2007, the Federal Reserve has thrown all but
the kitchen sink at the economy to forestall what they
thought to be the start of a new great depression. We
have witnessed a raft of special programs and two
major attempts at quantitative easing. Policy rates
have been set at zero since 2009 and the Fed has told
us that they will remain at zero through mid-2013,
truly an unprecedented step. (See Figure 5) With
the Fed anchoring the short end of the yield curve,
long-term interest rates have come in as well, with the

Figure 4 Employment/Population Ratio, 1948 –August 2013, Monthly Data

Sources: Federal Reserve Bank of St. Louis

Figure 5 Federal Funds vs. 10 Year U.S. Treasury
Yields, 2005Q1 – 2013Q4F

Source: Federal Reserve Board and UCLA Anderson Forecast

10-year U.S. Treasury bond actually breaching 2%.
Make no mistake, the last time we have seen government
yields this low was during the Great Depression.
To be sure, the Fed can do more, such as embarking
on another bond buying spree in the form of
a third quantitative easing program, but to us, it looks
like they are just about out of policy bullets. Furthermore,
it is not clear that the second round of quantitative
easing even worked.

To be sure, it elevated stock
prices for a while, but it also seems to have ignited
a commodity price surge that lowered real incomes
and sapped consumer confidence with gasoline prices
temporarily breaking through the psychologically
important $4 a gallon price barrier. Nevertheless,
because of the Fed’s dual mandate, they will have to
act. Our best guess is that the Fed will engage in an
“Operation Twist” where they will emphasize the purchase
of long maturities, to bring down already low,
longer-term interest rates.

Fiscal policy is caught in a trap. The July downgrade
of U.S. credit by Standard & Poor’s signaled
what we already knew. The plain fact is that the
federal government will be in an extended period of
fiscal consolidation, a fancy way of saying that longterm
budget deficits will be significantly reigned in.
(See Figure 6) Thus, it is highly unlikely that we will
see a fiscal stimulus program anywhere near the $800
billion appropriated in 2009. Nevertheless, assuming
a credible long-term fiscal consolidation program
can be put in place, admittedly a big assumption, the
federal government could step up near-term spending
on infrastructure and selectively cut payroll taxes.
However, given the lack of comity in Washington,
D.C., we are assuming only modest policy
adjustments. Specifically, for modeling purposes
we are assuming a continuation into 2012 of the 2%
payroll tax cut and the extension of emergency unemployment
benefits, reauthorization of the Surface
Transportation Act, and regulatory changes to make it
easier for homeowners with “under-water” mortgages
to refinance.

Why the Downward Revision to the Outlook?

Our case for recovery rested on the belief that
strong growth in exports coupled with continued
strength in business investment along with a modest
recovery in consumption and housing would generate
a subpar recovery on the order of 3% growth rate in
real GDP. It hasn’t quite turned out that way. To be
sure, exports are still growing, but not as fast as we
thought. (See Figure 7) Weakness in Europe, where
about one-third of our exports go, is casting a pall
over the sector. Furthermore, both Canada and Japan
suffered a decline in real GDP in the second quarter.
As a result, real exports are now expected to run $50-
$60 billion a year below what we previously thought
in 2012 and 2013. Business investment is remaining
strong, but the boost we expected from high-technology
capital goods is not as strong as we thought.

Figure 6 Federal Surplus/Deficit,
FY 2000 – FY2021F

Sources: Office of Management and Budget and UCLA Anderson Forecast

Figure 7 Real Exports, 2005Q1 -2013Q4

Source: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 8 S&P 500, Sep 2010- 2 Sep 2011, Daily Data


The situation in Europe is especially ominous.
The PIIGS (Portugal, Ireland, Italy, Greece and
Spain) are facing huge budgetary cutbacks to generate
the cash needed to service their debts. The European
banking system remains weighed down with not
only weak sovereign credits, but private credits that
have yet to be marked to market. As a result, a new
round of bank recapitalizations will be required. The
European bank stress tests were not quite as stressful
as they should have been. In the meantime, U.S.
money funds withdraw assets from European banks
conjuring up the nightmare of September 2008 when
Lehman Brothers failed. We are not there yet, but the
German stock market highlighted the nervousness by
dropping 20% in August. Thus, until Europe sorts itself
out, the global economy and U.S. exports remain
at risk.

We knew that consumer spending would remain
weak, but the recent 18% decline in stock prices from
the 2011 high to the August low has made us very
nervous about the high-end consumer. (See Figure
8) Remember that 5% of the households account for
40% of all household income and that has been the
force driving consumer spending on up-scale goods.
Before getting too carried away with the decline in
stock prices, we should recall Paul Samuelson’s famous
quip that “the stock market forecast nine out of
the past five recessions.”

Nevertheless, with the deleveraging process
far from complete, volatility in equity prices are
especially worrisome. Yes, consumer debt remains
$136 billion off its 2008 high, but that decline can be
accounted for by roughly the same amount of bank
loan charge-offs. (See Figure 9) That means that until
the debt is settled, the consumer still believes he/she
owes the full amount to the financial institution. The
loan is “dead” on the bank’s books, but could very
well be alive on consumer’s personal books. It’s no
fun being hounded by collection agencies.

We were right early on in the middle 2000s that
housing was in a bubble. However, for the past three
years we have been forecasting a recovery in housing
starts. It has yet to come. Thus, once again we are
ratcheting down our view. We now forecast housing
starts of 612,000, 709,000 and 967,000 units in 2011,
2012 and 2013, respectively. (See Figure 10) Last
quarter, for example, we were at 1,311,000 units for
2013. Quite a comedown. Furthermore, the reduction
in conforming loan limits from $729,750 to $625,500
on October 1st, though well justified on public policy
grounds, probably will exacerbate housing activity in
high cost areas over the near-term.

Figure 9 Total Consumer Credit Outstanding, 2000 – June 2011, In $ Billions, Monthly Data

Sources: Federal Reserve Bank of St. Louis

State and Local Governments in Fiscal
Consolidation Phase

Of necessity, rather than virtue, state and local
governments have been operating in a fiscal consolidation
phase since 2008. The tax receipts aren’t there
and unlike the federal government, the states find it
extremely difficult to run sustained deficits. To be
sure, there are exceptions, notably California, Illinois
and New Jersey, but even these three states have
taken the knife to their spending budgets. As a result,
by 2013, real state and local government spending
will have declined for six straight years. (Figure 11)
As we have noted before, the process of fiscal
consolidation is ongoing and it will be worsened
by changes in the healthcare law that will mandate
higher Medicaid spending. Because Medicaid gener-
ally accounts for between 15-30% of a state’s spending,
increases here are certainly non-trivial.

When combined with unfunded public employee pension
and post-retirement healthcare benefits, it is not hard
to see why state and local governments will find
themselves cash strapped for many years to come.
Indeed, the very low interest rates fostered by
the Fed will exacerbate the stress on pension plans.
Put bluntly, there isn’t a pension planner alive today
who thought the benchmark 10-year U.S. Treasury
bond would be yielding close to 2%. With actuarial
yield requirements at 7.5%-9%, the normal pension
arithmetic does not compute. Another way of looking
at the problem is that it represents the mirror image of
the Federal government’s obligations to fund Medicare
and social security.

Figure 10 Housing Starts, 2005 – 2013F

Sources: Bureau of the Census and UCLA Anderson Forecast

Figure 11 Real State & Local Government
Expenditures, 2000- 2013F

Sources: Department of Commerce and UCLA Anderson Forecast


As we noted at the outset, the economy is
stalled. Growth will be minimal over the next few
quarters and thereafter there will be enough strength
in exports and business investment along with modest
increases in consumption to propel the economy
forward at a 2.5%-3% pace. Fed policy will be as
accommodative as it can get, but fiscal policy is hampered
by the realities of the budget deficit and political
gridlock. In this environment, job growth will be
sluggish and unemployment will remain at recession
levels. The big risk is that fiscal and monetary problems
in Europe spill over into a generalized credit
crisis thereby triggering a global recession.

1. Lagarde, Christine, “Global Risks are Rising, But There is a Path to Recovery,” Remarks at Jackson Hole, August 27, 2011.
2. See Shulman, David, “A Near Recession Experience,” UCLA Anderson Forecast, September 2007 and “Stalled,” UCLA Anderson
Forecast, September 2008. For a technical discussion see, Nalewaik, Jeremy J., ,”Forecasting Recessions Using Stall Speeds,” Finance
and Economics Discussion Series 2011-24, Board of Governors of the Federal Reserve System.

Tuesday, September 13, 2011

Does Obama Really Care about Jobs?

After President Obama's speech last week I was hopeful that we were close to some significant Federal action on the jobs front. (See my earlier post). But after seeing how the president wants to pay for his $447 billion program, I fear that all he really wants is a political issue. Put bluntly, jobs are secondary to him keeping his own job. He wants a fight, not a program.

The so-called "pay fors" are completely a non-starter with the House Republicans and some Senate Democrats. The president has trotted out his old income redistribution stand-byes of limiting tax deductions for high income earners, taxing a portion of hitherto tax exempt state and local interest, and increasing taxes on oil companies, hedge fund partners and corporate jet owners. It is obvious that income redistribution has a higher priority than employment for this administration. To be sure taxes are going to have to raised on high income earners, but that should be done in the context of deficit reduction. To use those revenues to fund a temporary jobs program, makes long term deficit reduction even more difficult.

If the President wanted to show his bona fides on the jobs issuue he should have offered up an array of liberal favorites in the health, education, environmental and entitlement areas. That would prove that among all other liberal goals, increasing employment is the first priority. As a result the unemployed will once again witness a food fight on Capitol Hill.

Saturday, September 10, 2011

Obama Jobs Program: Good, but Less than Meets the Eye

President Obama unveiled his $447 billion jobs program last Thursday. Most of the elements make sense and it will be far better than the $800 billion stimulus package put together by the then House Speaker, Nancy Pelosi in 2009. Several economists done cartwheels over the program, most notably Mark Zandi of Moody's, arguing that the program has the potential to increase economic growth by a full two percentage points next year. Trust me, Mark is either dreaming or totally in the tank for the Obama Administration.

In its essential elements the program envisions a 3.1% cut in payroll taxes for workers, up from the current 2%($175 bil.) a 3.1% cut in payroll taxes for businesses for incremental payrolls up to $50 million(($65 bil.)an extension of emergency unemployment benefits( $49 bil.) teacher and public employee retention($35 bil.), modernizing transportation infrastructure ($50 bil.) fixing schools($35 bil) and a few other things. First, most forecasters already modeled in the existing 2% payroll tax cut and the extention of emergency unemployment benefits. Second, not all of this will pass. Third, no forecaster has made any allowance for the contractionary effects of increasing taxes and/or cutting other spending to pay for the $447 billion program. Remember the President said the program will be paid for. If it is paid for concurrently, there is no Keynesian stimulus. Nevertheless, as I have been arguing for over a year, at least the Administration is trying to do something about the scourge of mass unemployment facing our country. Net net, it will help but not a whole lot.

Why? There was no mention energy development in the speech a private sector way of creating jobs. There was no mention of fast-tracking environmental approvals for the transportation project which means it will take forever for them to get started and of course all of this will be subject to costs and the rulemaking asociated with the prevailing wage requirements of the Davis-Bacon Act.

Buried in the speech there was a ray of hope on entitlement reform. The President admitted with respect to Medicare,"with an aging population and rising healthcare costs, we are spending too fast to sustain the program." He later added, "We have to reform Medicare to strengthen it." A very big admission and it opens the way for an entitlement deal later in the year.

Saturday, September 3, 2011

Hiding from the Numbers

Yesterday brought with it horrible data on employment. Job creation stalled with ZERO job growth reported for August. The unemployment rate remained at 9.1% and hourly wages and hours worked were actually down. Ugly numbers. But where was President Obama? He was nowhere to be seen. If the numbers were good he would have been in the Rose Garden promoting his economic policies. He shouldn't really do that either. Good data speak for themselves.

Our President unfortunately forgets that his task is to level with the American people. He failed yesterday. A great leader does not hide from bad news he discusses it in a straight forward manner. For example, in 1940 when the French Army collapsed in the face of the Nazi onslaught, Winston Churchill went on the air with "The news from France is bad."

The lesson here is simple, don't hide from the American people.

Tuesday, August 23, 2011

Bloomberg Endorses Shulmaven View for Infrastructure Projects

Bloomberg News has joined Mort Zuckerman of US News and Noam Sheiber of The New Republic in endorsing the Shulmaven view of fast-tracking environmental approvals and waiving the prevailing wage requirements of the Davis-Bacon Act for new infrastructure projects. Their editorial calls for a $100 billion program. Hopefully President Obama will see the light.

Full url:

Sunday, August 21, 2011

An Open Letter to President Obama on Jobs

Dear Mr. President:

I hope you are enjoying your working vacation in Martha's Vinyard. You sure could use a break from Washington and the emerging bear market on Wall Street. You told us that you will address the nation on the need to create jobs after Labor Day. I hope you come up with some good ideas in the clean ocean air. We surely can use them because we have a real employment emergency that is draining both the economy and the spirit of our nation.

Given the emergency, I assume that you are open to a few new and some old ideas about job creation. All the ideas you mentioned on your midwest tour such as ratifying the free trade agreements, passing the new patent law, extending the social security tax cut and extending unemployment benefits are mostly helpful, but they really won't do a whole lot in the short run.

So here are a few ideas that might move the dial.

1. We need an all out domestic energy program. That means more offshore drilling, establishing clear rules and best practices for hydraulic fracturing drilling technolgy that has the real potential to limit our dependence on foreign oil and approving the privately financed Keystone XL Pipeline that will bring Canadian oil to our gulf coast. Note that all of the above does not involve tax dollars. On the public side keep up and step up the research into energy alternatives, but have no illusions about all of the "green" jobs it will create.

2. Spend big on infrastucture. The $50 billion infrastructure bank is small potatoes and may take awhile to launch. Spend $200 billion, but fast track or eliminate the environmental approval process and waive the prevailing wage requirements of the Davis-Bacon Act. With very low interest rates and high unemployment, now is the time to borrow and spend for worthy projects.

3. Give employers a 5% tax credit for increasing their wage bill subject to FICA employment taxes. I think this would work far better than your current payroll tax cut.

4. Have Treasury sit down with the business lobbies and cut a deal on corporate tax reform to present to the Congress. I fear the normal process might take forever.

5. Fund the above with a combination of a one-time lower tax rate for repatriating foreign sourced corporate earnings that are idling overseas, a higher gasoline tax and a down payment on entitlement reform. By the way, if you can get it, going big on a grand bargain for reducing our structural deficit is good idea, but you have to convince yourself and your friends in Congress that the real heavy lifting has to be on the spending side.

None of this will be easy, but when you are President all the easy stuff gets decided before it gets to you. Enjoy your vacation and come back with a real program.


David Shulman

Tuesday, August 2, 2011

The Debt Ceiling Deal: Looking for Cuts in All of the Wrong Places

At last the debt ceiling deal is done. Our nation won't default and there will be about $2.2 trillion in cuts,although there maybe some tax increases included in that number. However $2.2 trillion represents a small downpayment on the $8 trillion that will ultimately be required. Yes, $8 trillion. The much discussed $4 trillion grand bargain was also only a downpayment on what is needed. Moreover with the economy softening much of the $2.2 trillion will be washed away with lower tax collections and higher automatic spending. Thus don't be surprised if we see both tax cuts and spending back on the agenda in the Fall.

The real problem with the deal is that the cuts are in the wrong places. Too be sure much Nancy Pelosi's stimulus package of two years ago had to be undone, but our nation still needs infrastructure, research and yes, defense spending. In my opinion we will come to regret the steep cuts in the defense budget.

What should have been cut are the three big drivers of the longer term deficit: medicare, medicaid and social security. The Republicans made a huge mistake in not offering up some tax increases to achieve cuts in these areas. Unfortunately we will have to wait until 2013 until painful cuts have to made in the major entitlement programs. What I am writing about is not politics, but rather arithmetic. Bluntly put, medicare, medicaid and social security are not sustainable. Indeed it is likely that in a few years we will say the same thing about Obamacare.

As an aside an elegant deficit reduction plan would have kept the taxes embedded in Obamacare and delayed implementation of the spending for three years. But the President and the Democrats really don't care about deficit reduction, just as the refusal of the Republicans to to accept modest tax increases demonstrate that, they too, do not care about deficit reduction either. The Simpson-Bowles Commission had it right and President Obama's biggest political mistake was his failure to endorse the their recomendations.

Thursday, July 14, 2011

Letter to The Wall Street Journal, July 14, 2011

Your front-page article "Canada Has Plenty of Oil, But Does the U.S. Want It?" (July 8) highlights the fact that the U.S. environmental lobby and its helpers in Congress are truly the "party of no."

It seems that the environmental lobby is against developing the Canadian oil sands, drilling offshore, drilling in the Alaskan wilderness, hydraulic fracturing, mountain-top coal mining, electric transmission lines connecting solar power to the grid in the California desert and nuclear power.

To be sure, there are and always have been environmental issues associated with energy development, but I wonder where the environmental lobby is going to get the power to air-condition its plush offices in Washington, D.C. We may just as well mail in the keys to our nation to Saudi Arabia if we are going to say "no" to all energy development.

Full url -

Saturday, July 9, 2011

The End of a Dream

As a child of the space age I am especially saddened that with the final voyage of the space shuttle Atlantis we are witnessing the end of the manned space program. I vividly remember watching the first moon landing on a grainy black and white TV in my Fort Bragg orderly room on a hot July night in 1969. If you asked me then what the future would bring, I would most certainly have said that by 2011 we would be launching star fleets to Mars and Venus. We dreamed big things back then. Now our dreams seem pitifully small and we can't even do little things like fixing roads and bridges.

I think the political process grossly underestimates the need a society has for heroes and big projects. I was at astronaut John Glenn's ticker tape parade in 1962 after he returned from space. Glen was a real hero. Although President Kennedy was not as popular when he was in office than he is today, the space program was among his most popular efforts.

It was the space program that inspired millions of students to become scientists and engineers and we have been living off of that legacy for decades. The astronauts were far better roll models for kids to look up to than the reality television of today.

I know that latter thought proves that I am a curmudgeon, but trust me, with this last flight, we are losing something real.

Wednesday, June 29, 2011

Hiding in Plain Sight: Mass Unemployment

Last night I attended the annual Loeb Awards dinner sponsored by the UCLA Anderson School which honors the best that business journalism has to offer. You can call it the Pulitzer Prizes for business journalism. All of the main characters from The Wall Street Journal, The New York Times, The Washington Post, Bloomberg, CNBC, etc were there.

To be sure all of the awards were relevant and they honored stories, among others, on the BP blowout in the Gulf, the scandal at Remington Firearms, and a significant book on hedge funds, but just like last year there was nary a mention on the unemployment crisis facing America. We are now in the third year of the worst unemployment crisis since the 1930s and nobody seems to care.

It seems that politicians of both parties and the journalists who cover them are in a conspiracy of silence. Maybe no one has any real solutions or maybe too many of the unemployed are out of sight and out of the minds of the policy elites, but make no mistake our country is being destroyed worker by worker. Unless there will be a dramatic change, this is one story that will end very badly.

Thursday, June 16, 2011

The Outlook for Commercial Estate: Asset Prices Ahead of Fundamentals, UCLA Anderson Forecast, June 2011

The bull market psychology of the mid-2000s has returned to commercial real estate with prices for quality properties just 13% below their bubble peak in 2006. (See Figure 1) Near record low cap rates (the cash yield before capital expenses for real estate) of below 5% for quality office buildings in Manhattan and Washington, D.C. and for Class A apartments in broader geographies are becoming more the rule than the exception. In contrast assets in less than desirable markets are trading at 7-9% cap rates. Indeed the Manhattan office market has become so frothy that developers are now talking about starting 25 million square feet of space this decade, the highest level since the 1980s.

Similarly, though still well below their 2007 peak, the publicly traded real estate investment trusts (REITs) have tripled off their financial crisis lows of March 2009. (See Figure 2) Moreover, bankers who as recently as twelve months ago were shunning real estate loans have aggressively returned to the market. Simply put a near zero federal funds rate and 3% 10-Year U.S. Treasury yields have lit a fire underneath the high quality end of the real estate market.

Figure 1. Green Street Advisors Commercial Property Index, Dec 97 – April 11

Source: Green Street Advisors

Figure 2. Dow jones Real Estate index, I-Shares, June 2006 –27 May 2011, Weekly Data


Indeed the long moribund commercial mortgage backed securities (CMBS) market is showing signs of recovery. Although issuance remains low, spreads for existing securities have dropped enough to enable new securities to be created. (See Figure 3) However, the Dodd-Frank financial reform legislation requirement for issuers to retain an interest in the securitization may limit a full revival of this sector of the market.

Figure 3. CMBS Issuance, 1999-2011E, In $billions

Source: FBR Capital Markets and UCLA Anderson Forecast

Despite the ebullience discussed above, all is not well in the commercial real estate capital market. When you go beyond “A-List” properties regional and community banks are probably sitting on about $200 billion in 20% or more “under-water” real estate loans. The nation remains littered with vacant office buildings, warehouses, hotels and strip centers in fringe locations. Indeed even higher quality assets in what are perceived to be second and third tier cities find it difficult to attract a bid from institutional investors. Of course the longer interest rates remain abnormally low the likelihood increases that the search for yield will ultimately find its way to assets that the institutional investor community are currently shunning.

Thus as long as the interest rate environment remains benign, commercial real estate capital markets will continue to do well. At least until the over-leveraging excesses of a few years ago return. However, the very low interest rate environment is not likely to remain with us for long. After all that environment is a result of the emergency conditions of the financial crisis. As we mention elsewhere in this forecast report, we expect both long and short term interest rates to raise, with 10-Year U.S. Treasury yields approaching 5% in 2013 and with that the very low cap rates of today will give way to a pricing correction.

Figure 4. Federal Funds vs. 10 Year U.S. Treasury Yields, 2000Q1 – 2013Q4F

Sources: Federal Reserve Board and UCLA Anderson Forecast

Lack of Supply Underpins Fundamentals

The financial crisis of 2007-2009, for all practical purposes, halted commercial construction. (See Figures 5 and 6) Since the 2007 peak total commercial construction declined by 64%, new starts by 80% and multi-family housing starts also suffered a peak to trough decline of 80%. To be sure, the collapse in demand coupled with the completion of starts occurring during the boom, sent vacancy rates soaring. (See Figure 6) But with no new supply, even modest increases in demand will work to gradually lower vacancy rates over time and with that rents will increase and in the case of apartments, because of some very special factors, rents are already rising noticeably.

Figure 5. Real Commercial Construction Spending, 2000Q1 – 2013Q13F
Source: IHS Global Insight and UCLA Anderson Forecast

Figure 6. Multifamily Housing Starts, 2000Q1 – 2013Q4F

Sources: U.S. Department of Commerce, and UCLA Anderson Forecast

But Weak Demand is the Problem

Although supply is not a problem; demand is. Simply put the economy is growing far too slowly to meaningfully reduce vacancy rates for all product types (especially office buildings), with the exception of apartments. (See figure 7) Even with employment increasing at a rate of 200,000-250,000 jobs a month; it will take a few years to return to the peak achieved in late 2006. (See Figure 8) And the all-important financial activities sector for the office sector, employment in 2013 will still be well off the prior peak. (See figure 9) This is hardly an environment for robust rent increases, especially for the suburban office market which is still suffering from the collapse of the single family home market. Remember all too many suburban office buildings are tenanted by financial service companies tied to housing (e.g. real estate brokers, title companies, mortgage brokers, lawyers, architects and banks).

Furthermore the on-going restructuring of the legal services business will weigh on demand for prestigious central business district office space. (See Figure 10) Simply put the business model of the legal profession is facing challenges from computerized document searches, outsourcing to India and a corporate rebellion against the “billable hour. Indeed several large law firms have created a non-partnership track for lawyers and have set up satellite locations in low cost locations such a Wheeling, West Virginia and Dayton, Ohio.

Figure 7. National office Vacancy Rate, 1991Q1 -2010Q1

Source: REIS
Figure 8. Nonagricultural Employment, 2000Q1 – 2013Q4F
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 9. Financial Activities Employment, 2000Q1 -2013Q4, SAAR

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 10. Legal Services Employment, 1990-Apr 2011, Monthly Data, In Thousands.

Source: Saint Louis Fed

The bright side of commercial real estate is the apartment market where the shock of dramatically lower prices has altered consumer psychology with respect to single family home purchases. (See Figure 11) A rush to buy has been replaced by a reluctance to buy and that reluctance is being reinforced by tighter credit standards. As a result the homeownership rate is falling to the benefit of rental apartments with the national apartment vacancy rate dropping from 8% to 6.2% over the past year. (See Figure 12) Moreover with much of the single family home vacancies sitting in the exurbs, the glut of vacant single family homes make them far less competitive with closer-in apartments.

According to a recent national survey net effective rents on move-ins and renewals are rising 4-4.5%, well above the 1% increase reported by the official consumer price index. It is because of the combination rising rents and low cap rates; we are forecasting a doubling multi-family starts from early 2011 to late 2013. As actual rental rates get reflected in the official consumer price index, the rate of increase in the so-called core CPI will vault above the Fed’s informal 2% target thereby inducing a tighter monetary policy. It is ironic that the seeds for higher cap rates will have its origins in rising residential rents.

Indeed with house prices at near record affordability levels and after a few years of rising real rents, consumers will once again learn the virtues of homeownership. In response ownership housing starts will return to more normalized levels and full apartment buildings will face a decline in occupancy rates.

Figure 11. S&P Case-Shiller 20 City Home Price Index, Jan. 2000 – March 2011, Jan. 2000=100

Source: Standard & Poor’s

Figure 12. Home Ownership Rate, 1997 -2010Q1, Percent

Source: U.S. Census Bureau and The New York Times

The demand for retail oriented real estate can be characterized as a tale of two consumers. The higher end consumer, benefiting from rising stock prices and employment stability is back while the lower end consumer is being ravaged by high unemployment, high gas prices and weak home prices. After all, 5% of the households account for 40% of aggregate household income. Simply put the Nordstrom shopper is spending while the Wal-Mart shopper isn’t.

Although retail sales have recovered, the growth rate in sales is well off the path of the mid-2000s. (See Figure 13) Consumers are still in a retrenching mode as the savings rate normalizes from the near zero level of five years ago. (See Figure 14) In addition e-commerce inexorably gains share over store-based retailing year after year. Witness the bankruptcies of Blockbuster and Borders as prime examples of the impact of e-commerce on store-based retailing. As a result, retail real estate which was the investment “darling” of the last decade faces a far more difficult future going forward.

Figure 13. Retail & Food Service Sales, Ex Autos, 1992-Apr 2011, Monthly Data, In $ billion.

Sources: Federal Reserve Bank of Saint Louis

Figure 14. Personal Savings Rate, 2000Q1 – 2013Q4F

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Reflecting a weaker than normal rebound in consumption, warehouse demand is slowly recovering from the massive inventory liquidation that took place during the recession.(See Figure 15) Inventories are now rising and will likely receive an impetus from the tragic tsunami/earthquake in Japan. Why? One of the many lessons coming out of Japan was the realization how fragile the global supply chain is. While “just-in-time” inventory control is still the order of the day, there will be a role for “just-in-case” supply management with a resultant increase in the level of inventories.

Figure 15. Real Business Inventories, 2000Q1 – 2013Q4
Source: U.S. Department of Commerce and UCLA Anderson Forecast

Furthermore, because much of what is held in storage is imported, the rise in imports is an encouraging signs. (See Figure 16) Real imports have recovered all of the lost ground that occurred during the recession and are now making new highs. This factor certainly augers well for coastal-based warehouse-distribution facilities.

Figure 16. Real Imports, 2000Q1 – 2013Q4F, Quarterly Data

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Nevertheless the widening of the Panama Canal in 2014 has the potential to remake corporate logistical maps. No longer will Asian exporters be forced to use a ship-to-rail-link through west coast ports to reach the consumer markets of the Midwest and East. New competition for west coast ports will arise in Houston, Texas; Savannah, Georgia; and Charleston, South Carolina as shippers diversify their alternatives. Simply put, the west coast ports will lose their pricing flexibility.


It’s a happy time for quality commercial real estate in major markets and for apartments in general. As long as interest rates remain low investors will continue to pay historically high prices for those types of real estate. However, because demand growth remains tepid, market prices are increasingly vulnerable to even a modest rise in interest rates. In the meantime with the exception of rental housing new construction will remain muted over, at least, the next eighteen months. Thereafter a modest rebound in the other sectors of commercial real estate will likely occur.

Saturday, May 14, 2011

The Real National Debt

Congress is going through its near annual ritual of increasing the official debt ceiling on our national debt, which consists of treasury bonds and bills. The current ceiling is $14.3 trillion, far from trivial at roughly equal to our GDP, but well below the unfunded liabilties of social security and medicare. To be specific the trustees of both programs reported yesterday that social security has an unfunded liability of $17.9 trillion and medicare's unfunded liability is a frightening $38.3 trillion. Thus the two retirement programs have roughly 4X the liability of the official debt.

Thus any real budget solution has to involve radical changes in these two popular programs.(Note: I am a beneficiary of both programs.) Simply put benefits will have to be radically reduced over time and taxes to support both programs will have to be raised. I know that doing both is anathema to both political parties, but sooner or later we will need to have some real adults in the room. Too bad they can't be found.

Thursday, April 14, 2011

The Great Deficit Debate: Opening Positions or Something More Serious

At their best Congressman Paul Ryan's and President Obama's plans for deficit reduction represent opening positions in a very serious debate. At their worst, they are both political documents highlighting the governing philosophies of each political party. If something serious is to happen taxes are going to have to be increased and the three major entitlement programs of medicare, medicaid and social security have to be radically reformed. But remember in this debate Ryan is more right than Obama because there is no amount of increased taxation that is capable of defusing the debt time bomb our country faces. Simply put the Congress wrote checks that the economy can't cash. Thus if either party is serious there has to be a real conversation about means testing, end of life care( yes, the infamous "death panels") and market oriented reforms. We will soon see how serious serious they are. Remember the Bowles-Simpson Commission proposal has all of the elements needed to make a start at a serious discussion. Unfortunately both Ryan and the president aren't there yet.

Tuesday, March 15, 2011

Crisis of Faith

Although we fancy ourselves to be of the modern world, we, like our ancient ancestors, are idol worshippers. To be sure we do not bow down to golden calves or Baal Peor, notwithstanding the Second Commandment, we have our own modern versions of idol worship. Many of us worship one or more of the false gods of environmentalism, market fundamentalism, secular liberalism, and technology, to name just a few.

With the nuclear meltdown in Japan coming within a year of the BP oil spill in the Gulf of Mexico our faith in large scale technology has been shattered. Moreover the failures of Tokyo Electric, BP and their respective regulators in government hardly gives one confidence in the large bureaucracies that increasingly run our lives. This lack of trust will make for more volatility in our economy and politics.

Friday, March 11, 2011

On the Mend, UCLA Anderson Forecast, March 2011

The U.S. economy is getting better. Slowly, in fits and starts, real GDP is growing and employment is increasing. We are forecasting real GDP growth of 3.8% in the current quarter and through 2013 the economy will grow at a 3% clip. In this environment payroll employment will increase at a pace of 1.9 million in 2011, 2.6 million in 2012 and 3.0 million in 2013. Nevertheless, because employment fell so far dsuring the recession, that growth will be insufficient to saurpass the employment peak reach in the first quarter of 2008.

Although the reported unemployment rate dropped to a recent low of 9.0% in January 2011, we believe the data was partially the result of a statistical anomaly caused by an unusually large decline in the labor force. Hence the unemployment rate will rise initially rise modestly in the second quarter before beginning a welcome decline to below 8% by the end of 2013. Implicit in our forecast is that oil supplied won't be disrupted by the turmoil that recently appeared throughout the Middle East.

Growth Drivers - Equipment and Software, Exports and Autos

The economy is being propelled higher by strong increases in corporate spending on equipment and software. The fuel for this spending is coming from extraordinarily low interest rates, a rapidly recovering stock market and investment incentives coming out of Washington D.C.. Indeed independent of policy, investment is being spurred by technological innovation in wireless and cloud computing along with new natural gas drilling technologies that are reshaping the Nation's energy map. As a result the real business investment share of GDP will increase from 12.8% in 2010 to 15.4% in 2013.

The capital spending surge is being reinforced by a much imporved export picture. The newly emerging economies of Asia are not only exporting to the United States, but are also importing American made airliners, machinery, medical devices and farm products, for example. Adding impetus to the export boom has been the weaker dollar which makes American exports more competitive in international markets. As a result real exports are on track to grow at an 8.5-9% pace over the next three years.

After suffering its worst collapse since the Great Depression, the motor vehicle industry is on the mend. Recall that automobile sales declined by 38% from 16.9 million units in 2005 to 10.4 million units in 2009. Sales rebounded to 11.5 million units in 2010 and now appear to be on the road to near 16 million units by late 2013. For the Detroit portion of the industry that appeared to be near death, this is a remarkable recovery. A key factor driving the automobile recovery is the fact that cars wear out and have to be replaced and with normalized replacement demand to be reckoned to be on the order of 13 million units a year,meeting pent-up demand has become a decisive factor. Just as in the case of corporate investment, automobile demand is being spurred by low interest rates and imporved stock prices along with a much imporved product line.

The Laggards: Housing (for now) and State and Local Government

Unlike automobiles, it takes a long time for housing to wear out. Housing continues to wallow in its modern day depression as low interest rates are being more than canceled out by the glut of new product created during the bubble years of 2004-2007, the tidal wave of foreclosures and increased credit standards being imposed by lenders. Moreover hte reemergence of real cash down payments in the housing finance system has offset the 30% decline in prices. Indeed fears of a further ratcheting down in prices along with the shock of witnessing an unprecedented collapse in the price structure have kept buyers out of the market. Put simply the investment value of home ownership has declined. Furthermore the usual factors associated with housing weakness of tepid job growth and high unemployment are suppressing demand.

As a result we are forecasting only a modest recovery in housing starts this year to 658,000 units up from 586,000 units in 2010. Thereafter, as the employment situation improves, we forecast that housing starts will exceed one million units in 2012 and approach 1.5 million units in 2013 as pent-up demand offsets rising interest rates. Remember as strongas this recovery appears, a run-rate of 1.5 million units represents demographic demand and no more. As an aside, we anticipate that multi-family construction will recover more rapidly as the glut of housing in fringe areas supresses new single-family construction in the exurbs.

As w have noted many times in the past, state and local government is undergoing a fundamental restructuring analagous to what happened in the manufacturing sector over the past 40 years. Simply put, promises were made with respect to public employee pension and post-retirement health benefits that have become financially infeasible. With state and local budgets being drained by employee benefits and the ever-growing Medicaid program, there are insufficient funds available to fund the remainder of government such as education, environmental, public safety and recreation programs. Thus even as tax receipts improve, state and local budgets will continue to be squeezed triggering new rounds of employee cutbacks, furloughs and pay cuts. As we have seen in other sectors of the economy, this process will take a long time and it will be accompanied by highly publicized "flashpoints" such as last month's dispute in Wisconsin over pensions and union bargaining issues.

A Whiff of Inflation

Although inflation has been quiescent and as recenmtly as November the Fed seemed to be more worried about deflation, there is now a whiff of inflation in the air. Commodity prices have rocketed higher with corn and wheat up about 60% from a year ago levels and with even greater advances for for iron ore, up 78% and cotton up 130%. Oil prices- up until the Libyan crisis spike- were still up 20% from the year ago level and for no apparent reason the European Brent market has consistently traded at an unpcredented $15 premium over the U.S. West Texas benchmark. It appears that aside from fueling the stock market, the Fed's quantitative easing policy has lit a fire under commodity prices.

Perhaps more important, under the radar apartment rents are rising as would be homeowners remain renters. Several of the larger apartment owning real estate investment trusts(REITs) are reporting year-over-year rent increases on the order of 2-3%, compared to the 1% reported in the official consumer price index. Historically REITs lead the official data by about six months. To be sure, renters represent only 36% of thepopulation, cash rents statistically enter into the owners' equivilent rent calculation that reflects the cost of homeownership. As a result, despite continued high unemployment, the core consumer price index on a sequential basis will hit the Fed's informal 2% target by mid-2012 and exceed it in 2013.

Higher Interest Rates Ahead

Since 2009 the Federal Reserve has been running an "emergency" Zero Interest Rate Policy (ZIRP). We anticipate that policy will be with us thoughout 2011 as the Fed remains more concerned about its employment madnate that its inflation mandate. However as the employment situation begins to improve and the inflation rate approaches their informal 2% target, the ZIRP policy will come to an end in early 2012. Before that eventuality the Fed will start unwinding its $600 billion quantitative easing program that is scheduled to end in May.

However, longer term interest rates will begin to antipate the change in policy. Perhaps as early as next quarter the 10-Year U.S. Treasury Bond will reach 4% and be on the road to a 5% yield by the end of 2013. Of course interest rates move far more violently that what are anticipated in econometric models, wo we won't be surprised to see a more dramatic move sooner. We note that from early November to early December 2010 the yield on the 10-year Treasury spiked from 2.5% to 3.5%.

The interest rate outlook is being exacerbated by the mega-Federal deficits as far as the eye can see. The Bowles-Simpson Deficit Reduction Commission offered a rough outline to partially alleviate the problem last December, but neither the President's budget nor the recent proposed cuts in discretionary nondefense spending bythe House Republicans come close to getting to the core of the issue. The big "elepahnts" in the room are the entitlement programs of Medicare and Social Security and until those programs are dealt with, the long run deficit outlook will be problematic. Remeber entitlements are the Federal equivilent of the state and local pension issue. Just to note our forecast assumes modest cuts in domestic discretionary outlays and defense along with increased taxation on high income earners in 2013. We have not, however, modeled in any significant entitlement reform.


Assuming the rolling crisis in the Middle East does not disrupt oil supplies, the economy is on the mend. Real GDP will be growing at a 3% clip over the next three years along with accelerating gains in empoyment. By the end of the forecast period in 2013, the unemployment rate will be below 8% and payroll employment will approach the prior peak. Along the way inflationary pressure will increase with both headline and core consumer price indicies exceeding 2% by mid-2012. That eventuality will bring with it an end to the ZIRP policy and 10-Year U.S. Treasury Bond yields will be at more nromal 4+% range.

Thursday, March 3, 2011

Gates Echoes Shulmaven

Today's Wall Street Journal is running story saying that Bill Gates will charge public spending on healthcare and public employee pensions is crowding out needed spending on public education. This position is in keeping with the longstanding position of Shulmaven where we argue that curbing healthcare costs and public employee pension benefits is a "liberal issue." See the lede below.

"Billionaire philanthropist Bill Gates will step into the national debate over state budgets Thursday with a call for states to rethink their healthcare and pension sytems, which he says stifle funding for public schools."

Saturday, February 19, 2011

The Battle of Madison

Governor Scott Walker's epic showdown with Wisconsin's public employee unions is being played out on the Madison streets I know so well. Walker is rightfully seeking to reign in runaway public employee health and pension benefits to help bring the state's $3.6 billion projected deficit into balance. To be sure he may have over-reached in seeking to rollback a host of collective bargaining perquisites that the unions have long enjoyed, but as Barack Obama taught us so well, "elections have consequences."

Walker is fighting the good fight against one of the most reactionary elements of our society, the public employee union leadership. Pure and simple they represent "producer" over "consumer" interests. Where the 21st Century calls for flexibility the union leadership clings to obsolete work and retention rules making it all but impossible to fire incompetent workers and to organize work in a cost effective way.

Perhaps what is surprising is that the so called "liberals" are standing with these hidebound reactionaries. Simply put if public employee pension and health (current and post retirement) spending along with Medicaid remain on their current tracks, the will be no money left for "the liberal project." All of the wonderful education and environmental programs that the liberal community desires will fall by the wayside as employee benefits and Medicaid gobble up state budgets.

So I salute Governor Walker and wish him luck in rounding up the the recalcitrant Democrats who fled the state to avoid a vote on his proposals.

Sunday, January 30, 2011

David Shulman's Crystal Ball

Reprinted by permission from REIT Wrap dated January 19,2011.

Editor’s Note: REIT Wrap contributor David Shulman writes that he’s not
especially bullish on REITs this year. Neither, however, is he bearish.
REITs, Shulman says, are likely to be little changed from year-end 2010 in
2011. Why does Shulman see REITs treading water this year? He lays out his
case and the reasons for it, below. As always, your feedback is
encouraged. And best wishes for a profitable 2011!

After plunging 41.51% in 2008, the price-only version of the MSCI U.S.
REIT Index (RMZ) jumped 20.97% in 2009 and another 23.53% last year.

Yes, the closely followed benchmark remains well below – nearly 40% -- its
February 7, 2007 all-time high of 1,233.66. Before you get carried away
with how far away the index is from its 2007 peak; I should tell you that
I view the RMZ 2007 high as the equivalent of the Nasdaq peak of 5,132.52
in March 2000. Said differently, I don’t expect the RMZ to test its
all-time high anytime soon!

What lies ahead for REITs this year? My best guess is that the RMZ will
trade in a broad range -- between 680 to 820 – and end 2011 roughly where
it began the year, at 760-ish. Why am I not as bullish as others?

Simply put, in terms of equity valuation, REITs are way ahead of
themselves trading at 17X 2011 estimated FFO and trailing EBITDA. Frankly,
REITs are quite expensive. Remember the Standard & Poor’s 500-stock index
is currently trading at roughly 8X 2010 EBITDA and 13X 2011 estimated
earnings. And, to top it off, REITs are still trading at a roughly 15%
premium to net asset value. Of course this state of affairs has been with
us for quite a while. So, why should it be different this year?

The answer is not complicated. The great bond bull market of 2007 to 2010
appears to be over. Ten-year Treasury yields have surged from 2.5% in
early-November to approximately 3.3% as of this writing.

Whether the bond market sell-off resulted from concern over the Fed’s
quantitative easing policies, higher deficits coming from the recent tax
deal, or higher growth in 2011 coming from the same tax deal is really
irrelevant. The fact remains that yields have dramatically backed up
causing the recent huge underperformance by REITs versus the broad market.

Rising rates and still tepid earnings growth for REITs are not a formula
for strong gains in share prices. This will be especially true against a
back drop of double-digit earnings gains expected for the S&P 500 in both
2011 and 2012. Said differently, the headwinds coming from the bond market
will more than offset the modest earnings gains of about 6% that most
REITs will report in 2011 even if those earnings exceed current estimates,
which I think they will.

Wearing my UCLA hat, I recently forecast 2+% GDP growth in 2011 and
just above 3% growth in 2012. Though those numbers are low compared to the
4% GDP growth forecasts coming from several of the major investment banks
following the recent tax deal; the UCLA forecast was put to bed prior to
the deal. It also only included a one full year extension of the Bush-era
tax cuts and it did not include the very important payroll tax cuts that
were added to the compromise. If I had to do a new forecast today, I would
mark it up to 3+% in 2011 and 2012;, still below where the Wall Street bulls currently are.

The economic environment will be improving going forward. Even the more
modest UCLA forecast calls for 150,000 jobs a month in 2011 and just above
200,000 jobs a month in 2012. That kind of labor market improvement will
certainly help real estate absorption going forward. Contrast that data
with the very tepid 100,000 a month job gains reported for 2010.

More important, sometime this year, real estate and REIT investors will
conclude that the era of extraordinarily low interest rates has ended.
Interest rates will start to normalize and that means instead of sub-3%
10-Year U.S. Treasury yields, 4+% though still low, will become the norm.
As a result, the scramble for yield that we witnessed over the past few
years will abate making REIT yields relatively less attractive. Put
bluntly, REITs, in my opinion, are not priced for a more normalized yield
world and it will take a year or two of rising dividends to help them
catch up.

Over the longer-term REIT investors should keep a keen eye on several of
the tax proposals made by the Bowles-Simpson Deficit Reduction Commission.
Their proposals to lower income tax rates and tax dividends and capital
gains at the new lower ordinary rates (23% to 29%) would be a boon to REIT
investors as REIT dividend taxation declines and corporate dividend
taxation increases.

On the other hand, the commission’s proposal to lower the corporate income
tax rate to 23% to 29% makes the REIT corporate tax exemption far less
valuable. When coupled with longer depreciation schedules for REITs
compared to C-Corps more than a few real estate companies might decide
that the REIT structure might not be as suitable to their needs as they
once thought.

Although the commission’s proposals are now out of the “new”
news, the long-term fiscal deficit faced by the United States makes it
almost inevitable that its ideas will be soon be revisited.

In terms of sectors: an improvement in economic growth will likely benefit
the hitherto lagging regions of the economy as the expansion broadens. It
won’t only be New York and Washington D.C., so I suspect that the much
maligned suburban office sector might surprise to the upside in 2011.

Moreover, the really new thing in the tax compromise, the payroll tax cut,
will help the Wal-Mart customer far more than the Nordstrom customer in
2011. With improving employment and a much needed pay raise coming from
the payroll tax cut, strip and power centers might outperform malls
this year. That’s a tough call, because the high-end consumer will benefit
from a continuation of the Bush-era tax cuts.

In sum, it is hard for me to be bullish about REITs in 2011. (No surprise,
I’m sure, to those who know me.) On the other hand, it is also hard for me
to be really bearish, despite high valuations. The economic environment of
modest growth and still low, albeit rising interest rates, makes it hard
to be outright bearish. There is still way too much money out there that
is looking for a home in real estate!


David Shulman was formerly the Senior REIT Analyst at Lehman Brothers. He
is now affiliated with Baruch College, the University of Wisconsin and the
UCLA Anderson Forecast. He can be contacted at

Monday, January 3, 2011

In Bloomberg Newswire, January 3, 2011

“If you look at Jerry’s history, in 1975 the first thing he did was cut Ronald Reagan’s budget,” said David Shulman, a senior economist with the Anderson Forecast at the University of California, Los Angeles. “The Democratic legislature didn’t like it, but his poll numbers were high. It wouldn’t surprise me if he did that again.”

Full URL: