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Current economic conditions and A retrospective (?) on the economic crisis Jeff Fuhrer Exec. VP and Director of Research Federal Reserve Bank of Boston October 1 2009 Plan for the talk Part I: Review economic conditions and their

  1. Current economic conditions and A retrospective (?) on the economic crisis Jeff Fuhrer Exec. VP and Director of Research Federal Reserve Bank of Boston October 1 2009

  2. Plan for the talk Part I: Review economic conditions and their implications for the outlook Part II: Look back on the financial crisis (to date) – Innovative Fed actions and market responses – Is deflation a concern? – Is inflation a concern? (Balance sheet issues)

  3. Part I Economic conditions and outlook

  4. We are emerging from a very severe recession Employment is declining less and less rapidly 400 200 0 -200 -400 3-mo. avg. chg., total employment -600 3-mo. avg. change, private employment -800 2000:Jan 2002:Jan 2004:Jan 2006:Jan 2008:Jan Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Global Insight

  5. Housing market progress: It’s really happening 1900 600 Stock of 1-family houses for sale (right scale) Single-family housing permits (left scale) Small 1700 Improvements 550 improvement in outstanding in inventory 1500 construction 500 1300 Thousands Thousands 450 1100 400 900 350 700 300 500 300 250 2000:Jan 2001:Jul 2003:Jan 2004:Jul 2006:Jan 2007:Jul 2009:Jan Source: Census Bureau

  6. With reductions in inventories and some improvement in sales, I/S is clearly improving 14 1500 Months supply of homes for sale (left scale) New single-family homes sold (right scale) 12 1300 10 1100 8 900 6 …and house prices have flattened in many locations 700 4 500 2 0 300 2000:Jan 2001:Jul 2003:Jan 2004:Jul 2006:Jan 2007:Jul 2009:Jan Source: Census Bureau

  7. Some hopeful signs in recent investment data 70000 … improving orders for capital goods 65000 suggest an improvement in capital spending 60000 next year Shipments 55000 Orders 50000 45000 40000 2008:Jan 2008:May 2008:Sep 2009:Jan 2009:May Source: New sales, permits, shipments and orders: Bureau of the Census; Existing sales: Nat’l Assoc. of Realtors

  8. Commercial real estate is still a serious concern 8 NACREIF Total Return on CRE 6 4 2 Quarterly Return 0 -2 -4 -6 Total -8 Office -10 Retail -12 1990 - Q1 1993 - Q1 1996 - Q1 1999 - Q1 2002 - Q1 2005 - Q1 2008 - Q1

  9. Equity markets have responded favorably of late This helps to offset the significant loss to household wealth from fallen home prices 1200 • 55% above March trough 1100 • 17% above beginning of 2009 9/29 1000 900 800 700 600 20081001 20081112 20081224 20090204 20090318 20090429 20090610 20090722 20090902 Source: S&P 500:New York Times; House prices: S&P Case Shiller

  10. A caveat: Despite the equity rally, overall household net worth remains well down 70000 Household Net Worth 60000 50000 HH net worth down 40000 over $12.2T through June 30000 20000 …this is likely to restrain household spending in 2010 10000 0 1990:Q1 1993:Q1 1996:Q1 1999:Q1 2002:Q1 2005:Q1 2008:Q1 Source: Board of Governors, Flow of Funds Accounts

  11. The largest concern going forward: Unemployment is likely to remain elevated 11.0 Civilian Unemployment Rate 10.0 Macro Advisors Global Insight 9.0 8.0 7.0 6.0 Full Employment Estimate 5.0 4.0 2003:Q1 2005:Q1 2007:Q1 2009:Q1 2011:Q1 2013:Q1

  12. Slow employment growth and slow wage growth will challenge the consumer Employment Compensation index, private industries 7 Total compensation 6 Wages 5 4 3 2 1 0 2000:Q1 2003:Q1 2006:Q1 2009:Q1 Source: Bureau of Labor Statistics

  13. High unemployment may also bear implications for inflation Disagreement on this: Too high or too low? 3.5 Bottom 10 Blue Chip Forecast Survey Median CPI inflation, 2 years out 3 Top 10 2.5 2 1.5 1 0.5 0 Jan-07 Jan-09

  14. Summary of conditions The economy is recovering, likely slowly Underlying fundamentals are still challenging – Household net worth remains low – Employment and wage growth remain weak – Foreign growth remains weak Expect a gradual recovery over the next several years, with elevated unemployment Inflation – Balance sheet, deficit suggest higher inflation – Lingering excess capacity suggests lower inflation

  15. Part II A look back (and forward) at the crisis

  16. What caused all this? Many causes – Over-priced residential real estate – Over-priced commercial real estate – Over-building in residential real estate – Heavy leverage in all of the above — borrowers in precarious positions – A significant decline in house prices (a result of the over-building above) – Households in trouble due to job loss, falling prices, default – Financial firms in trouble due to losses on mortgage-related securities – Similar problems at many foreign financial institutions – Some missed supervisory opportunities – Reliance on ratings agencies for new, untested products – Contagion from mortgage-related to all other securities – Loss of confidence among consumers and businesses — PANIC – Loss of short-term credit at major financial institutions – Pull back in hiring, spending, etc.

  17. What caused this? Housing and Debt: Over-building, Inventory overhang 14 1500 Months supply of homes for sale (left scale) New single-family homes sold (right scale) 12 1300 10 1100 8 900 6 700 4 500 2 0 300 2000:Jan 2001:Jul 2003:Jan 2004:Jul 2006:Jan 2007:Jul 2009:Jan

  18. What caused this? Housing and Debt: Price rise and fall 250 Jan. 2000 = 100 Composite 20 Boston 200 Las Vegas 150 100 50 0 1990:Jan 1993:Jan 1996:Jan 1999:Jan 2002:Jan 2005:Jan 2008:Jan

  19. As prices fell and unemployment rose, delinquencies and foreclosures surged 4.50 4.00 90 days delinquent Foreclosure initiated 3.50 Prime, 90-days 3.00 Prime, foreclosure 2.50 Subprime ARMs showed the 2.00 most dramatic rise in foreclosures… 1.50 1.00 0.50 0.00 1998:Q1 2001:Q1 2004:Q1 2007:Q1

  20. Losses at financial institutions soared, especially for mortgage-related securities Commercial Banks 10.00 14000 Delinquency rate (left) 9.00 Charge-offs, $millions (right) 12000 The losses are ongoing, and 8.00 imply significant risk going forward 10000 7.00 6.00 8000 5.00 6000 4.00 3.00 4000 2.00 2000 1.00 0.00 0 1991:Q1 1994:Q1 1997:Q1 2000:Q1 2003:Q1 2006:Q1 2009:Q1

  21. Some mortgage lenders disappeared

  22. Financial markets freaked out 4.0 Spread, 3-mo. $ Libor over 3-mo. OIS "Spread, 1-mo. $ Libor over 1-mo. OIS" 3.5 3.0 2.5 Normally secure short- 2.0 term lending dried up But note the 1.5 recent improvement 1.0 0.5 0.0

  23. Widespread loss of confidence; Real activity plummeted Confidence measures Real activity measures 120.0 10.0 5 4 100.0 9.0 3 2 80.0 8.0 1 Unemployment Rate 60.0 7.0 0 4-qtr. % chg. In real GDP (right) -1 40.0 6.0 -2 Michigan sentiment index -3 20.0 5.0 Conference Board -4 sentiment index 0.0 4.0 -5 2007:Jan 2008:Jan 2009:Jan 2002:Q1 2004:Q1 2006:Q1 2008:Q1

  24. Policy Responses The Fed – Lowered the funds rate to zero —can’t get any lower! – Pursued liquidity policies (short-term lending) – Rescued individual firms (good or bad?) – Tried some substitutes for conventional policy (purchased MBS) The Treasury – Pumped capital into the banking system – Insured deposits, secured lending – Provided fiscal stimulus package – Bailed out auto companies

  25. Fed Responses, itemized Term Auction Facility (TAF) – Lend to banks, but remove stigma of discount window Provide borrowing short- Commercial paper (CPFF)/MMMF (AMLF) facilities term liquidity – Help commercial-paper and ABCP- based MMMF’s to meet redemptions, continue funding (over $300B) ABS facilities (TALF) Provide – Facilitate new-issue AAA ABS purchases, up to $200B longer- – ―Legacy securities‖ (with PPIP program)— CMBS, RMBS term credit, MBS, Treasury purchases (LSAP: up to $1.25T, $300B) macro stimulus – 30-year conforming rates down 1-1.25 ppts., refis up Maintain FRMLFFA (Facility for Restricting Multi-Letter Fed Facility Acronyms) sanity

  26. Summary The economy is in better shape than it was The recovery is likely to be characterized by – High unemployment for an extended period – Risk of falling inflation — but some disagree The crisis: A post-mortem – Many causes – Hard to predict many of the consequences – Some appropriate policy responses – Some are debatable

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