Two Roadblocks on the Way to Recovery

06/11/2009 1:48 pm EST


Howard Gold

Founder & President, GoldenEgg Investing

Will the green shoots of economic recovery be strangled by the weeds in the garden? That's what investors are wondering now that the spring's vigorous rally appears to have stalled.

And it's not just the most immediate concerns-higher energy prices and long-term interest rates-that's caused hand wringing on Wall Street. There's growing concern that the more intractable problems, housing and jobs, may mute any recovery and put a lid on stock prices.

Because despite some "less bad" news, those two key areas show little improvement; indeed, by some measures, they're still deteriorating. And until they stabilize, we can't really say that the banking system or the economy is out of the woods.

The housing crash has virtually defined this recession-the fallout of a debt-fueled home buying binge in the first half of this decade. That credit bubble was pricked long ago, but the air continues to come out of the balloon.

According to Gary Shilling, the bearish editor of INSIGHT, "the prices of existing houses, as measured by [the S&P/Case-Shiller US National Home Price index], are now down 32.2% from their second-quarter 2006 peak." He expects home prices to fall another 7% before they bottom out some time next year.

The reason: a huge inventory of unsold homes-some two million, or nearly two years' supply, despite all the highly publicized auctions and foreclosure sales in place like Phoenix, AZ and the Antelope Valley outside LA. And the oversupply of more expensive existing homes-over $750,000-is a shockingly high 40 months.

Higher interest rates certainly won't help. The refinancing miniboom of earlier this year has cooled big times as fixed-rate 30-year mortgages now go for an average 5.59%, their highest in seven months.

And many people won't be able to refinance, anyway, as the depressed prices of their homes won't meet banks' more stringent loan-to-value requirements.

That could be a big problem over the next year or two because of the coming new waves of home defaults.

Prime, jumbo prime, home equity, Alt-A loans (somewhere between prime and subprime), and option ARMs become vulnerable as housing values sink and unemployment rises. They represent trillions of dollars of loans owned by banks, Fannie Mae and Freddie Mac, and Wall Street firms and other holders of mortgage-backed securities.

Some $2.4 trillion in Alt-A loans and hundreds of billions of dollars in option ARMs will face resets over the next few years, and delinquencies on those loans are "soaring," according to T2 Partners LLC.

"If something doesn't change soon," writes economist Mark Zandi of Moody's, "mortgage loan defaults-the first step in the foreclosure process-are on track to total an astonishing four million this year, representing nearly one in 12 first mortgages."
He estimates that one in five US holders of first mortgages live in homes that are worth less than what is owed on them, "putting them at grave risk of defaulting if anything else were to go wrong in their financial lives."

Like, say, unemployment.

Thursday's jobless claims came in at 601,000-24,000 fewer than the previous week's numbers and consensus estimates, reflecting some improvement, and stocks rallied in response. "Job losses are slowing, as are increases in the number of unemployed," according to Econoday.

But let's not get carried away. May's unemployment rate of 9.4%, announced last Friday, was "sharply higher than projected" and the highest since May 1983, Econoday wrote. Manufacturers bled 156,000 jobs in a single month.

The bottom line: "The number of unemployed people is going up," says economist James D. Hamilton of UC San Diego, who also writes the Econbrowser blog.

We're not far from double-digit unemployment already, and some economist look for the rate to keep rising into 2010.

Also, as Dirk van Dijk writes in

"Long-term unemployment has skyrocketed. There are now 3.95 million Americans who have been out of work for more than half a year, up from 3.68 million in April and just 1.57 million a year ago."

"While the duration of unemployment always goes up during a recession, it has been particularly pronounced in this one," he concludes. "If the long-term unemployed are people with mortgages, it is hard for me to see how they will continue to pay them."

This is where the two arms of the problem may come together to put a hammerlock on any recovery.

Joe Battipaglia, market strategist-private client group for Stifel Nicolaus and a longtime bear (he expects the Standard & Poor's 500 to trade between 650 and 1,000 for some time), says there's a negative feedback loop between housing and unemployment.

"Joblessness will continue to rise into next year. People of all income levels are being hurt," he says. "There's probably lingering aspects of the financial crisis that will plague the market this year, next year, and beyond that."

And usually increases in unemployment precede a housing bust, as in Southern California in the early 1990s when the post-Cold War "peace dividend" led to big layoffs in the aerospace industry-and a resulting drop in housing prices.

"Even if there is a quick end to the recession, the housing market's poor performance may linger," writes Yale University economist Robert Shiller in the New York Times.

"After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997."

That would push back any housing recovery until at least 2012-and this time the damage is much, much worse and far more widespread than in the past.

It's hard to argue against the big moves we've seen in the markets-or the growing sense of optimism in the country. Who wants to live in fear the way we did earlier this year?  Over the last few weeks, I've been writing about long-time bears and advisors with excellent track records who say we're in a new bull market.

Maybe so, and maybe the market sees something that the rest of us don't. But for now I can't help but agree with Professor Hamilton, who says: "What I don't see is the basic indication that something is increasing. Things aren't improving yet."

Until I see that, too, then I have to believe this recovery won't be the "v"-shaped one of the bulls' dream, but a "w"-for "weak."

Howard R. Gold is executive editor of The views expressed here are his own.

  By clicking submit, you agree to our privacy policy & terms of service.

Related Articles on MARKETS