No Relief in Sight

03/25/2009 12:00 pm EST


David Wyss

Adjunct Professor, Brown University

David Wyss, chief economist for Standard & Poor’s, doesn’t think the recession will end until at least the fourth quarter.

We expect this to be the longest and deepest recession since the 1930s. The economy won’t turn around, in our opinion, unless the slew of negative news ceases. We expect that to occur in the third quarter, when consumers likely begin spending again and housing hits bottom. The stimulus package should also start to encourage growth in late 2009.

Although we expect the official end of the recession to be dated some time in the third quarter, the average citizen will probably remain more pessimistic, especially since the unemployment rate is likely to continue to rise well into 2010. We now estimate a 3.9% drop in real gross domestic product (GDP) from the peak in the second quarter of 2008 to the bottom in the third quarter of 2009.

We believe the possibility of a longer and deeper recession is high. Payroll employment fell 4.4 million since its December 2007 peak, and the number of unemployed climbed to a record high of 12.5 million (8.1% of the labor force). Record lows were set for housing starts and new home sales.

The housing market continues to decline. Home prices continue to drop. In December, the S&P/Case-Shiller home price index fell 18.5% from a year earlier and is now down 27% from its July 2006 high. The National Association of Realtors estimates that 45% of January sales were distressed properties—either in foreclosure or short sales, which means they were sold for less than the outstanding mortgage by agreement with the lender.

The January retail sales and February same-store sales suggest consumers are continuing to spend, most likely because of the deep discounts retailers offered. However, we forecast the saving rate rising to 6.2% and consumer spending falling 1%. Large-ticket items, especially those that require borrowing (such as automobiles), should be hit the hardest. Consumers are also trading down to cheaper alternatives.

But, we believe the bigger problem is the loss of wealth. Between lower home prices and the drop in the stock market, the net worth of the average household fell 17% in 2008. With baby boomers rapidly approaching retirement, most Americans are realizing that they can’t continue to live beyond their means any longer.

We think the major problem remains the financial market.

The Treasury is still using the Troubled Asset Relief Program (TARP) funds to recapitalize the banks. We think the program has worked better than has been suggested. The credit default swap (CDS) rate for the S&P 100 fell to 130 basis points (bps) from 156 bps at the end of November. The spread between the yield on speculative-grade bonds and US Treasuries has narrowed to 1,380 bps from more than 1,700 in October, still nearly double the 2002 recession peak. 

Banks continue to lend money—the volume of commercial and industrial loans held by banks is up 2.8% over the last year. However, that small increase does not offset the loss of funding through the securitization markets.

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