Capital Commerce

News like today's terrible housing report makes me ever more sure a federal housing bailout is on its way. Here is what IHS Global Insight has to say about the day's news:

The November home sales report illustrates the ultimate risk in a situation where negative business cycle momentum persists for an excruciating length of time.  The home sales market has been in recession for over three years. Builders have been reducing supply since the first quarter of 2006, and housing starts and permits were further collapsed to record low levels in November.  The housing industry in the U.S. in the process of reducing capacity to dangerously low levels.

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The econ team at Goldman Sachs explains why the traditional drivers of an economic rebound won't help the economy much this time around, and thus we need a $600 billion stimulus package this year alone. Some excerpts:

1) Housing recovery. Prospects for a housing recovery large enough to replicate the usual US cyclical experience are extremely dim given the huge excess supply that hangs over the market. Note in this regard that homebuilding would have to rise by about 33% to add one percentage point to real GDP since the sector has shrunk to only about 3% of US economic activity. Although rebounds of this size have been commonplace over the years, the sector has not faced the extraordinary excess volume of unsold and unoccupied homes that currently exists—about one million units judging from the homeownership vacancy rate, with more in the foreclosure pipeline. Until this excess has been absorbed, a meaningful recovery from the current depressed level of starts is extremely unlikely, even though this level is well below the rate consistent with underlying demographics.

2) Rebound in consumer spending. As people buy new homes and exchange existing ones, they buy appliances and other durable goods to put in them. In turn, this suggests that the poor prospects for a rebound in housing activity could spill over to the consumer durable goods sector. Notably, the last two recoveries had weaker than average contributions from both sectors to real GDP growth (though in the 2001-03 cycle this was partly because the previous setbacks were not as extreme). In addition, if US consumers are determined to raise their saving rates—as they currently appear to be given the fact that they are pulling back in the face of sharp declines in energy prices—then purchases of durable goods, many of which are discretionary in nature, may face strong headwinds in the next couple of years. And, of course, there’s always the issue of credit availability. 

3) Robust hiring. As most observers of the US business cycle are well aware, the last two cycles have featured jobless recoveries. In an increasingly competitive environment where managing costs of production is at a premium, US firms have found ways to squeeze more productivity (and/or perhaps more hours, whether counted officially or not) out of their existing work forces. They have also learned the value of using temporary workers to meet increases in demand that might not prove to be lasting. As a result, we strongly suspect that companies will not be quick to hire new workers in response to increases in demand for their output, though we’d love to be proven wrong on this.

4) An inventory cycle. US firms’ careful attention to inventory management has been evident in the current recession, which began with the real stock of inventories uncharacteristically already in decline. With stocks continuing to shrink, this conceivably sets up a possibility that inventories could provide a more traditional cyclical boost. However, this would seem to require two conditions: (1) that US firms think their inventories are at bare-bones levels when demand starts to pick up and (2) that the improvement in demand appears sustained enough to warrant restocking shelves aggressively. Both seem like tall orders given the excess that overhangs the housing market and the d egree to which US consumers are retrenching and the seemingly structural reasons for that retrenchment.

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Brian Wesbury and Bob Stein give us reasons to feel good about the economy:

1) Between 1965 and 1982, the US economy was in recession one out of every three years, inflation hit double digits and the unemployment rate peaked at 10.8%. Since 1982, the US has been in recession just one out of 16 years, the unemployment rate bottomed at 3.8% in early 2000 and then at 4.4% in early 2007. In other words, a wobbly economy today feels much worse to the average American and politician than it did 30 years ago.

2) What’s important to recognize is that even at the bottom of the current recession, sometime in mid-2009, the living standards of the typical American will still be amazingly high. In fact, even an aggressive contraction in real GDP will leave per-capita real GDP above 2005 levels.

3) Now, we did not have 8% unemployment back in 2005, but that kind of jobless rate is not unusual for recessions. The unemployment rate peaked at only 6.3% in the recession early this decade but peaked at 7.8%, 10.8%, 7.8%, and 9.0% in each of the previous four recessions, respectively, dating all the way back to the 1973-75 recession.

4) Even the original manifestation of the economic problem – the massive overbuying and overbuilding of residential real estate – will eventually generate benefits once the economy starts to recover. Think about the young worker or family just starting out in 2005. Now think about a similar worker in 2010. The future worker/family will pay less for housing, and not because they get “teaser” interest rates on loans for houses they end up unable to afford. In addition, these very same investors have a chance to buy equities at extremely attractive valuations.

5) Most importantly, for the long run, we still live in a country blessed with a Constitution that limits the power of would-be tyrants and a culture that attracts and encourages entrepreneurs like no other place on earth.

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A must-read op-ed in the WSJ today:

For more than 30 years the entrepreneurship-venture capital-IPO cycle centered in Silicon Valley has generated new wealth, commercialized innovation, and created new companies and industries. It's also spun off millions of new jobs. ... It has been a system of amazing efficiency, its biggest past weakness being that it sometimes (as in the dot-com "bubble") creates too many companies of dubious viability. Now, this very efficiency may be proving to be its downfall.  ... From the beginning of this decade, the process of new company creation has been under assault by legislators and regulators. ... In the name of "fairness," preventing future Enrons, and increased oversight, Congress, the SEC and the Financial Accounting Standards Board (FASB) have piled burdens onto the economy that put entrepreneurship at risk.  ... According to the National Venture Capital Association, in all of 2008 there have been just six companies that have gone public. Compare that with 269 IPOs in 1999, 272 in 1996, and 365 in 1986. ... The most important government actions to foster business creation were the 1978 Steiger Amendment, which cut taxes on capital gains to 28% from 49%, and President Ronald Regan's tax cuts, which reduced them still further to 20%. These tax cuts unleashed the PC and consumer electronics booms of the 1980s, just as the Taxpayer Relief Act of 1997 restored the 20% rate and did the same for the Internet economy in the late 1990s ... If Mr. Obama is serious about getting the country out of this recession using something more than public make-work projects, he should restore the integrity of the new company creation cycle: rewrite full disclosure, throw out options expensing, make compliance with Sarbanes-Oxley rules voluntary, and if he won't cut it, then at least leave the capital gains tax rate alone.

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