My Latest USNEWS Blog, "Neither Democrats nor Republicans Have Debt Crisis Solution," August 22, 2012

For the full url see:

http://www.usnews.com/opinion/blogs/economic-intelligence/2012/08/22/seek-truth-from-facts

The Ryan Choice

Mitt Romney's choice of House Budget Chairman Paul Ryan as his running mate is a strong governing choice, but it represents very risky political choice. By this choice Romney has decided to play on President Obama's playing field by making this presidential election a choice on the future direction of the country, instead of a referendum on the sad state of the economy. You can bet on it, that the airwaves will be be filled with Obama ads showing Romney and Ryan throwing granny off the medicare cliff, while a few fat cats are toasting their tax cuts with glasses of champagne.

Nevertheless Paul Ryan is a strong campaigner and he, more than any of the other VP hopefuls, can articulate the case that the United States is on a fiscally unsustainable path.  This election will be about big things, not small bore stuff. No matter what President Obama says, he knows and most senior Democrats know, medicare, medicaid and social security have to be reformed. Simply put, the postwar entitlement state has run out of gas and the Democratic leadership continues to lie to the American people about it. The Republicans lie when they say the fiscal problems of the the United States can be solved without any tax increases. As an aside the big loser from today's announcement is Vice President Joe Biden. He will have his work cut out for him when he meets Ryan in their debate.

In terms of governing, should the Romney-Ryan team win in November they will be able to hit the ground running with respect to the budget. This would be an enormous advantage given the fiscal situation our Nation faces. Furthermore, as a complete outsider, it looks to me that Romney and Ryan really get along; they are both highly focused numbers people.

"Rebuilding the Housing Economy," UCLA Anderson Forecast, June 2012

After an agonizing six year decline where nearly $7 trillion of wealth was destroyed, the housing economy is now in the process of rebuilding. With average home prices declining by one-third, it has been a searing experience for most homeowners who never believed that housing prices would ever fall. (See Figure 1) As a result, with existing homeowners being foreclosed upon and potential homeowners either unable to meet more stringent purchase requirements or fearful of continued price declines, the homeownership rate declined from a peak of 69% in 2004 to 66% in 2011 and is forecast to drop to 65% by the end of this year. (See Figure 2)
Figure 1 Case-Shiller Home Price Index, 2000 – March 2012, Monthly Data, 2000 = 1.0. Source: Federal Reserve Bank of St. Louis and Standard & Poor's 

Nevertheless, there are many indicators offering evidence that the housing market has bottomed and a recovery is underway. Despite a regulatory logjam in the process, foreclosures appear to have peaked. (See Figure 3) Concomitantly, existing home sales are now on the rise. After peaking at 7.1 million home sales in 2005, the series declined to 4.1 million units in 2008 and is expected to exceed 5.0 million units in 2013. To be sure, about one-third of existing home sales are accounted for by either foreclosures or "short sales," yet, the steady rise in activity is indicative of recovery. (See Figure 4)

The recovery is underpinned by a gradually improving labor market, a rebound in household formations and record low mortgage rates, now below 4%. (See Figures 5, 6, and 7) For example, household formations averaged 1.33 million a year between 2000 -2007 and then collapsed to 327,000 in 2009. By last year household formations recovered to 1,072,000 and we forecast a robust 1.7 million run rate in 2013- 14.
Figure 2 Homeownership Rate, 1990 -2012E, Yearend Data, Percent
Source: U.S. Bureau of the Census and UCLA Anderson Forecast
Figure 3 Loans in Foreclosure and Past Due Mortgages, 2005Q1 – 2012Q1, Percent
Source: Mortgage Bankers Association and The Wall Street Journal
 Simply put there are too many young adults living in their parent’s homes, an untenable situation for all of the parties involved.

Nonetheless the recovery will continue to be gradual and uneven. Though improving, the job market remains far from healthy and higher down payment and credit score requirements are working against the stimulative effects of low interest rates. New to this cycle is the impact of exploding student loan debt that will keep potential buyers out of the housing market for years to come. (See Figure 8)
Figure 4 Existing Home Sales, 2000 – 2014E
Figure 6 Household Formations, 2000 – 2014E

Source: Bureau of the Census and UCLA Anderson Forecast

Source: National Association of Realtors and UCLA Anderson Forecast
Figure 5 Payroll Employment, 2000Q1 -2014Q4E
Figure 7 30-Year Fixed Mortgage Rate, 2000Q1 – 2014Q4E

Source: Federal Reserve Board and UCLA Anderson Forecast

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

At one trillion dollars, student loan debt now rivals credit card debt. And because student loan debt is not extinguishable in bankruptcy, it will impair the ability of younger people to buy homes in the years to come.

After peaking at nearly 2.1 million units in 2005, housing starts plummeted 73% by 2009 to 554,000 units. (See Figure 9) After remaining at roughly that level in 2010 and 2011, housing starts are expected to reach 755,000 units this year and exceed one million units in 2013. Although this looks like a steep recovery, at one million units housing activity would have only recovered from depression levels to recession levels. Remember that from 1991 – 2010 housing starts averaged 1.42 million units a year. As we noted earlier, household formations on the order of 1.6 million a year can easily support this long-run average.

The real drama taking place is in multi-family housing. We are now in the midst of a boom in multi-family construction, especially in rental apartments. Like housing starts in general, multi-family starts collapsed from its peak in 2005 of 354,000 units to a nadir of 112,000 units in 2009. Since then starts will have more than doubled to the 260,000 units forecast in 2012. (See Figure 10) We would not be surprised to see multi-family starts exceed 400,000 units in 2014.
Figure 8 Student Loan Debt, 2000Q1 -2011Q4
Figure 9 Housing Starts, 1991- 2014E, Annual Data

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

Source: Federal Reserve and The Wall Street Journal
Figure 10 Multi-Family Housing Starts, 1991 – 2014E

Source: U.S. Department of Commerce and UCLA Anderson Forecast
After all, the flip side of a falling homeownership rate is a rising rate of home renting.

The coming boom in multi-family starts is underpinned by a very low vacancy rate (below 5%), rising rents and a flood of institutional money coming into the sector. (See Figure 11) Although not reflected in the consumer price index where the rent regulated cities of New York and Los Angeles are over-weighted, rents on renewals are now rising at 4% and many of the publicly traded real estate investment trusts are reporting year-over-year rent increases on the order of 5% to 7%.

With 10-year U.S. Treasury yields below 2%, institutional investors are seeking out higher yielding alternatives and they are finding rental apartments to be increasingly attractive. Although going in, cash returns in the more active markets are at historical lows, around 4%-5%, rising rents offer the prospect of higher future income and capital appreciation. With a buying frenzy underway, investors can and do come up with very aggressive assumptions about future rents to justify new construction.

Of course this boom in multi-family construction will have within it the seeds of its own destruc-
Figure 11 Apartment Vacancy Rate, 2005Q1 – 2012Q1, Percent
Source: REIS Reports and Calculated Risk

tion. As rents rise, consumers will shift out of rental into ownership units. The American Dream of homeownership may be comatose, but it is not dead and the wakeup call will come in the form of higher rents.

As a result by 2014, supply will begin to outpace demand. New physical supply will be augmented by the renting of existing single-family homes by a growing number of investor groups. Although much of that supply is on the urban fringe, many observers forget that sub-prime lending financed and refinanced homes in central core areas. As rents increase those areas will become ripe for gentrification and become competitive with traditional rental housing.

When outlining our thesis to several real estate investors we heard a common objection which loosely stated is, "sure the money is there, but you’ll never get the zoning." Our counter to that argument is that the planning and zoning world has changed. Instead of discouraging density, governmental planners are now encouraging it. As examples we point to the passing of California’s SB 375 which more strictly links transportation with land use planning and the "transit village" concept now being employed in New Jersey. Yes, there will still be neighborhood fights, but there will be far fewer supply constraints than heretofore.

My latest USNews Blog, "The Downside of the Fed's Zero Interest Rate Policy"

For the full URL see:
http://www.usnews.com/opinion/blogs/economic-intelligence/2012/04/30/the-downside-of-the-feds-zero-interest-rate-policy

My latest blog in US News, "What Obama's, Ryan's Tax Plans are Really About"

For the full article see the URL below:

http://www.usnews.com/opinion/blogs/economic-intelligence/2012/04/12/what-obamas-ryans-tax-plans-are-really-about

"Curb Your Enthusiasm," UCLA Anderson Forecast, March 2012

With the economy creating 227,000 and 284,000
net new payroll jobs in February and January, respectively,
the employment situation is clearly improving.
Although that pace of job growth will not be sustainable
over the near-term, total employment is finally
climbing out of the gaping hole that was caused by
the recession of 2007-09. (See Figure 1) Concomitantly,
the unemployment rate improved from 9.0% in
October to 8.3% in February, but we expect it to fall
only modestly going forward as new entrants into the
long depressed labor force begin to seek work. (See
Figure 2)

We have argued elsewhere that the recent
improvement in the labor market and the consumer
economy has been, in part, driven by exceptionally
mild winter weather.2 In fact this past winter was the
fourth warmest on record with January and February
temperatures running between five and six degrees
warmer than last year.
Why is this important?

The seasonal adjustment factors used by government
statisticians take into account weather-related
impacts on the economy. Examples include slower
construction activity and plant closings caused by inclement
weather, as well as weaker retail sales caused
by the inability of consumers to brave sub-freezing
weather and snow to go out and shop. The Bureau
of Labor Statistics reported an unusually low number
of workers being kept from their jobs due to inclem-

Figure 1 Payroll Employment, 2005Q1-2014Q4

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 2 Unemployment Rate, 2005Q1 – 2014Q4

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

ent weather in February. Thus, with this winter being
almost balmy in the normally frigid Northeast and
Midwest, economic activity soared and the data was
put into overdrive by the normal seasonal factors that
are looking for depressed conditions.
Furthermore, the warmer temperatures -- along
with plummeting natural gas prices -- slashed home
heating bills on the order of 20%-40%, offsetting the
rise in gasoline prices. Thus, we suspect that once the
weather and the seasonal adjustment factors normalize
in March and April, the economic data won’t look
so ebullient.

Indeed, without the benefit of lower heating
costs, higher gasoline prices will begin to bite into
consumer spending. With oil prices staying over $100
a barrel and the global Brent price another $15-$20
higher, it seems highly likely that gasoline prices will
soon average over $4 a gallon. (See Figure 4) Of
course, over the near-term, oil prices will continue to
reflect political tensions caused by the Iranian nuclear
program.

Unfortunately, the stronger employment data
are not appearing to translate into stronger overall
GDP growth. Indeed, it can be argued that part of the
recent gains in employment are in response to prior
growth, not expectations for future growth. After
growing at 3% in the fourth quarter, we are forecasting
real GDP growth to slow to around a 2% annual
rate for most of 2012, with the point estimate for the
first quarter at 2.0%. Growth is expected to improve
from that level in both 2013 and 2014. (See Figure 3)
Figure 4 West Texas Intermediate Oil,
2005Q1 - 2014Q4

Sources: Investors' Business Daily and UCLA Anderson Forecast
Figure 3 Real GDP Growth, 2005Q1 – 2014Q4

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


Figure 5 Real Equipment and Software Spending,
2005Q1 - 2014Q4

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

Why is this happening?
Although the so-called “front end” consumer
portion of the economy seems to be doing better, the
“back end” business part of the economy is weakening.
Simply put, both investment and exports, which
led the economy earlier in the recovery, are now
slowing. (See Figures 5 and 6)

Europe in Recession

Europe is in recession. Euro-area real GDP declined
in the fourth quarter and is forecast to decline
by 0.5% this year. The recent Greek debt default/restructuring
highlighted the fiscal imbalances afflicting
Europe. Behind Greece, though not as troubled, stand
Portugal, Spain and Ireland. In response to the crisis,
the European Central Bank (ECB) embarked on a
massive quantitative easing program called the Long
Term Refinancing Operation (LTRO). In short, the
LTRO offers the European banks three year money at
very low rates. As a consequence, the ECB’s balance
sheet exploded. (See Figure 7)

With Europe accounting for roughly 20% of
U.S. and China exports, it is not surprising to see a
slowdown in this sector. As China and Asia slow as
well, U.S. exports weaken in those markets. Nevertheless,
the real risk coming out of Europe is not a
modest recession, but another financial crisis arising
out of the continent’s long-running imbalances. The
French presidential elections on April 22nd, might
renew the crisis if the less Eurocentric Francois Hollande,
who is now leading in the polls, defeats the
incumbent Nicolas Sarkozy.

Figure 6 Real Exports, 2005Q1 - 2014Q4

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

Figure 7 ECB Balance Sheet, 1999 - 2012, In Millions of Euros

Source:Eurostat

The Fed and Housing

Like its ECB counterpart, the Fed continues to
flood the banking system with liquidity with a near
promise to keep interest rates at roughly zero through
mid-2014. Our sense is that the zero rate policy will
end somewhat sooner, in late 2013. (See Figure 8)
In addition, the Fed is undertaking an “operation
twist” designed to lower long-term rates and that
has allowed 30-year fixed rate mortgage interest
rates to plum depths to 4% and below. The low rate
policy will be enabled by less than 2% year-over-year
increases in the deflator for personal consumption
expenditures, the Fed’s preferred inflation gauge. (See
Figure 9)

To be sure, housing prices as measured by the
Case-Shiller Index recently dropped to a new cyclical
low, but our sense is that 2012 will represent the
low point in the housing price cycle. (See Figure 10)
Why? Employment is up, interest rates are very low,
incomes are gradually rising and the long-stalled
foreclosure logjam is breaking. Yes, credit standards
remain tight, but as the economy heals more buyers
will come into the market. Prodding them will
be rapid increases in apartment rents that are already

Figure 8 Federal Funds Rate vs. 10-Year U.S.
Treasury Bonds, 2005Q1 - 2014Q4

Sources: Federal Reserve Board and UCLA Anderson Forecast

Figure 9 Personal Consumption Expenditures
Deflator, 2005Q1 - 2014Q4

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

Figure 10 Case-Shiller House Price Index, 1988 - 2012

Source: Standard and Poor's

Figure 11 Housing Starts, 2005Q1 - 2014Q4

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

occurring. In more than a few markets, rents are up
between 5%-10% and in practically all markets real
rents are rising.

As a result, multi-family housing starts have
more than doubled off the bottom and single-family
starts are beginning to rebound as well. We estimate
that total housing starts this year will rise to 741,000
units up from 611,000 last year and will approach one
million units in 2013. (See Figure 11)

The Fiscal Train Wreck

Fiscal policy is inexorably headed for two train
wrecks, one in the short-run and the other in the longrun.
The short-run largely involves taxes. All of the
Bush era tax cuts expire at the end of the year along
with the payroll tax cut of the past two years. Should
all of the tax cuts expire at once along with some
mandatory spending cuts, the U.S. would be faced
with a $400 billion fiscal contraction, the biggest
since the end of World War II.

This looming uncertainty will hardly be a tonic
for economic activity in the second half of this year.
Just to note for modeling purposes, we are assuming
that a gradual phase out of most, but not all, of the tax
cuts will be approved after the election. And yes, this
is a heroic assumption.

The other train wreck is the long-run deterioration
in the fiscal condition of the United States. Even
with a heroic compromise, the U.S. faces mega-deficits
as far as the eye can see. (See Figure 12) Unless
the long-term entitlement programs of social security,
Medicare, Medicaid and perhaps “Obamacare” are
brought under control, there really isn’t any solution
to the long-term deficit. In our long-term outlook we
assume that the U.S. will muddle through. We caution,
however, sometimes the world isn’t so kind.

Figure 12 Federal Surplus/Deficit, FY2000 –FY2022

Sources: Office of Management and Budget

Conclusion

Although the employment outlook has decidedly improved, the growth outlook remains sluggish with 2% GDP growth likely for much of this year. The recent data has been favored by an unusually warm winter that brought forward economic activity that would normally have occurred in the spring.Thus, the weather effect along with higher gas prices and weak exports temper our enthusiasm for the balance of the year. Morevoer the looming expiration of all of the Bush era tax cuts and the payroll tax cut will elevate economic uncertainty in the second half of the year.

My latest USNews blog, "What Government Can Actually Do About Gas Prices," March 19, 2012

For the full article go to the URL below:

http://www.usnews.com/opinion/blogs/economic-intelligence/2012/03/19/what-government-can-actually-do-about-gas-prices