News Column

U.S. Economy's Underlying Strengths Limit Recession Threat

March 28, 2008

Dr. Juan B. Solana

Empty pockets?

With total financial write-downs breaking through the $100 billion threshold, analysts are now estimating U.S. mortgage losses could reach the $380 billion to $400 billion mark. Consumers, businesses large and small, and policymakers are scrambling to identify areas of risk and loss created by the breach in the financial dike.

Consumers are experiencing a deterioration of their wealth due to declining stocks and home prices and increasing inflation pressures, resulting from rising energy and food prices. Meanwhile, businesses are confronting softening sales that put on hold any expansion plans.

Yet, analysts are mixed on whether the United States is headed for an official recession (defined as two consecutive quarters of negative growth). A recent UCLA Anderson School of Business forecast says "no" to the idea of recession, but others are less optimistic. To provide you with an objective look, this installment of Hispanic Business magazine's economic forecast assesses the economy's current balance sheet and its prospects for 2008.

Payrolls Falling, Unemployment Rising

The year started with net job losses of 22,000 in January and a further 63,000 in February, the largest monthly job loss in the past five years.

Health care was a bright spot, as it continued adding 36,000 jobs in February, contributing to the total of more than 360,000 jobs created in the sector in the past 12 months. Food services too created new jobs, averaging a net 12,000 jobs per month.

Overall job declines occurred in manufacturing, construction, and retail. Manufacturing employment fell in February by 52,000 jobs, with cumulative losses over the past 12 months of 299,000 jobs. Construction was another hard-hit sector with 39,000 jobs shed in February, making a loss of 331,000 jobs since September 2006. The financial sector saw a loss of 116,000 jobs since its peak in October 2006.

Unemployment of Hispanics increased by 22 percent since March 2007. Most of this loss was a result of weaker employment trends in manufacturing, construction, and retail, as well as weakness in the economies of California, Illinois, Nevada, New York, and Florida. In contrast, U.S. unemployment increased only eight percent during that time.

Deteriorating Consumer Wealth

During 2006 and portions of 2007, increased U.S consumption was linked to employment growth and the "wealth effect" of people spending freely due to the increasing worth of their homes and investments. In 2008, that trend reversed.

According to the S&P/Case-Shiller Index, released on Feb. 26, 2008, the National Home Price Index posted a negative 8.9 percent decline from it peak in the fourth quarter of 2006. Th at decline is the single largest in the 20- year history of the index.

According to the study, "Miami remains the weakest market, reporting a double-digit annual decline of 17.5 percent, followed by Las Vegas and Phoenix at -15.3 percent each." The report concluded that, "Charlotte, Portland, and Seattle are the only three metropolitan areas experiencing positive annual growth rates."

In addition to real estate, consumers are also concerned about their savings and investments closely attached to returns on the stock market. At press time, March 10, the S&P 500 was down 9 percent for the year, and 18 percent points below the recent high reached on July 19. Increasing stock market valuations were providing steam to consumers in late 2006 and early 2007, despite already decreasing home prices. Now, both sources of wealth are shrinking at the same time that the job market is weakening.

Washington In Action I: The Federal Reserve

After initial reluctance to cut benchmark target interest rates, the Fed has acted aggressively since August. The bank has provided liquidity and decreased interest rates with the goal of stabilizing the financial markets and also offering relief to consumers carrying large debt burdens. Although the Federal Open Market Committee decided on January 30 to lower its target for the federal funds rate 50 basis points to 3 percent, the financial markets do not yet appear to have found their bottom.

The Federal Reserve action is further constrained by increasing inflationary pressures coming from the food and energy sectors, along with a depreciated U.S dollar that has made imports more expensive.

Recent inflationary pressures, together with expectations of the larger budget deficit, have resulted in a perverse decoupling of long- and short-term interest rates, as the graph below shows. While lowered Federal interest rates were pressing downward both 30-year Treasury Bonds and 30-year mortgages, the expectation of higher inflation has started to propel long-term interest higher, despite further aggressive efforts by the Fed. The anticipation that lower mortgages rates was going to alleviate the distressed real estate market appears to be vanishing on inflation and budget deficit spikes.

Washington In Action II: Congress And The White House

In mid-February, President George W. Bush signed a $152 billion plan to stimulate the U.S. economy. The plan, cleared by Congress with unusual speed, uses tax rebates to place spending money in consumers' pockets.

Although consumers account for about two-thirds of the U.S. economy, $152 billion in spending represents just 1.5 percent of the $9,930 billion personal consumption expenditures at the end of 2007. The stimulus impact depends on whether the tax rebate checks are spent or saved. Assuming most is spent, then the stimulus will depend on the portion that is spent on domestic versus imported goods. Unfortunately, consumers will have to look hard on retail shelves for homegrown products. In addition, increasing gasoline prices (at $111 barrel of oil) will eat up part of the checks.


At the end of the fourth quarter of 2007, the U.S economy was growing at a 0.6 percent rate, much lower than the 1.1 per cent expected. Economic growth was only possible because the 0.9 percent contribution of the export sector to the economy. Otherwise, the economy would have shrunk by 0.3 percent. The year 2007 closed with a GDP growth of 2.2 percent, a notch slower than 2006 with 2.9% growth. The U.S. Federal Reserve lowered its most recent forecast for growth in 2008 for the second time in eight months to a range between 1.3 and 2 per cent, down from a projection of 1.8 to 2.5 percent range in October.

Other forecasts for the U.S. economy range from the perfect storm view with a high risk of a systemic crisis, as predicted by Prof. Nouriel Roubini of New York University's Stern School of Business, to the sunny UCLA Anderson Forecast that the U.S economy is not, and will not be, in a recession in 2008. The UCLA forecast, released March 11, indicates that although there will be one-quarter of negative GDP growth, there will not be recession. Further, it expects the housing drag on GDP to dissipate in the second half of the year and the return of a normal economy in 2009. In any case, assuming a crisis is avoided, there are only mediocre growth rates for United States on the horizon.

As we go to print, the Federal Reserve has made a radical policy move by expanding its securities lending program to $200 billion of Treasury securities. As collateral, financial institutions can provide federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS. The final goal is to provide liquidity to the financial markets, but gets the Fed closer to buying nonperforming mortgage securities. It addresses the symptoms of this financial mess but leaves intact the source of the problem: the unknown quality of the residential mortgage loans. The new Fed measures confirm that lowering interest rates was not an effective maneuver, in resolving economy slowdown. Th is moves the Fed closer to bailing out Wall Street. We should be vigilant that it is not done at the expense of Main Street.

Source: (c) 2008. All rights reserved.

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