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Despite housing hiccups, economy is strong: Fed's BarkemaBy Larry Dreiling
Despite the run-up in home foreclosures and a sharp decline in new home construction, the U.S. economy is showing surprising resilience with an outlook that includes strong exports, according to a top rural economics specialist with the Federal Reserve Bank of Kansas City. "The question is: How long will the good times last?" said Dr. Alan Barkema, senior vice president of the Regional, Public and Community Affairs Division of the KC Fed. Barkema spoke during the 30th annual Fort Hays State University Agricultural Outlook Conference, held recently at Hays, Kan. He told the more than 125 lenders, producers, students and political officials in attendance that some 70 percent of Americans are able to own their own homes, which he called an unprecedented level of home ownership on a global level. "However, since 2005, we've seen the market for home price appreciation slowing, with home prices declining in many markets. There's a principal downward shift in the housing price index and median sale price of existing homes nationally, depending on the index you examine," Barkema said. "We've also seen a sharp decline in new home construction. It's fallen 40 percent, reflecting GDP growth. This decline is a very narrow slide compared to the nation's entire GDP. When you see that kind of decline, it reduces GDP growth about a full percentage point." Home foreclosure worries The run-up in home foreclosures is based on the high number of sub-prime and alternative or "alt-A" mortgages, he added. "A lot of these mortgages over the last three years were made to individuals who could not qualify for conventional mortgages," Barkema said. "These were persons with somewhat tarnished credit--this was the sub-prime market--or those who could not otherwise fully document annual income. That was the Alt-A market. "By last year, fully one-third of the mortgages were in this half of the credit quality spectrum. Some of these mortgages were pretty exotic with adjustable rates that were low to begin with and then increased after time. These kinds of loans made borrowers vulnerable to either an increased interest rate or a decline in home prices." Barkema called the sub-prime lending crisis a "sort of a perfect storm," with borrowers unable to cash out equity or sell their homes at a higher price forcing lenders to foreclose. "Another situation is so many mortgages are no longer held by the originators and are being traded nationally and internationally," Barkema said. "As the pace of foreclosures has shot up, buyers of these mortgages are becoming concerned about the risk of the security they hold. Risk is being repriced, reevaluated and investors are shying away from this market." The high pace of residential foreclosures should continue for another year, Barkema said, before the backlog of sub-prime and alt-A mortgages is reduced. "This is creating issues of uncertainty in the financial markets as these mortgages are repriced throughout the markets," Barkema said. "The concern is these housing problems will also spill over into consumer spending. Consumer spending is the biggest part of the economy; so if homeowners can no longer find an equity cushion in their homes, or find they can't refinance their homes, then there could be risks of a downward decline in consumer spending going forward." A slowing economy? Despite the woes in the housing sector, GDP in the district of the Fed of the KC 10th District is growing at a healthy pace averaging 3.25 percent a year, though slowing has emerged. "It abruptly slowed in the first quarter of the year to barely one-half annual percentage point but the last two quarters we've seen strong growth, especially in the third quarter," Barkema said. "We've seen strong employment growth, but slowing in the last few months." A lingering question Barkema said many people ask him is whether or not the economy is slowing because it isn't strong enough to create new jobs or is the U.S. running out of workers? "Maybe it's the latter," Barkema said. "Baby boomers are just beginning to retire and, according to many of our business sources, finding an adequate supply of workers in the district is becoming more difficult to keep their businesses running. "The unemployment rate is growing a bit in the district to 4.7 percent, well below the level to trigger another round of inflation. When unemployment is too low, we simply see businesses poaching workers from one another, increasing wages and setting off another round of price inflation." The overall Consumer Price Index Barkema considers to be "pretty choppy, but the core index (minus energy) is more moderate and stable, at a bit over 2 percent annually. Still there is some risk of inflation nudging higher. The potential rate of growth is resilient to some shocks. Overall, though, inflation is fairly moderate. Energy prices and widespread problems in housing are the fundamental risks." Exports are healthy While many economic forecasters suggest there should be some slowdown, there also should be some offsetting strength in the export market. "The U.S. current account deficit crested at $800 billion last year and has improved. Our current account deficit, as percent of GDP, is increasing at 7 percent, which is worrisome. We believe this will improve," Barkema said. "As the dollar value has declined about 30 percent in the last five years, it has actually helped that turnaround since foreign buyers are able to purchase more U.S. goods. The decline in the dollar is a two-edged sword. It helps us export goods abroad, but leads to a lower standard of living in this country, as those products that we've become accustomed to buying from foreign suppliers have become more expensive. The lifestyle we've financed by borrowing from abroad is now beginning to erode." As the holiday buying season gets into gear, Barkema said consumer spending is strong--outside of automobiles. "Domestic auto manufacturers are struggling against foreign competition," Barkema said. "Sales of large automobiles, SUVs, are sinking like a stone. It's clear that higher energy prices have an effect on the economy. The higher the price of the energy is, the bigger the hit on the economy." Barkema's overall economic outlook is for 2 percent GDP growth this year, accelerating to 2.5 percent increase in real GDP in the next year. Core personal consumption expenditures are seen up 1.75 to 2 percent, with unemployment at 4.25 to 5 percent. Views on agriculture In agriculture, Barkema sees farm gate prices will be increasing net farm income to the highest levels on record. "More income is coming from the market rather than from supports, which is a healthy development," Barkema said. "Developing countries, with their rising incomes, are spending more on food. Grain inventories are declining as ethanol use is now up to one-third of the corn crop. After a time, there will be a move, eventually, to cellulosic ethanol; but for now, corn is crowding out soybean crops for ethanol." A major concern for Barkema is that farmland values are increasing at a faster clip in real dollars than they were in the run-up in land values in the late 1970s. "That run-up turned into a crushing bust in the early 1980s," Barkema said. "What is sobering is seeing the latest run-up in land values is in direct correlation to front part of the 1970s run-up. What the concern is here and now is will this current boom in agriculture find a better end than the one in the 1980s?" Barkema reminded attendees that the U.S. economy remains strong and resilient. "It's just that the in housing finance have increased downside risks in that otherwise strong economy. Incomes and asset values also are booming in U.S. agriculture, based on the ethanol market," he said. "I still have these searing memories of what happened in 1980s. If a technical correction occurs, we have to ask: Will this time be different than the 1980s? The answer is that prices adjust very rapidly, but the underlying changes in the structure of the economy take more time. With this shift in the economy, we're moving to a new equilibrium, but that equilibrium is not clearly in view." Larry Dreiling can be reached by phone at 785-628-1117 or by e-mail at ldreiling@aol.com. 12/3/07 Date: 11/28/07
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