Smart People with Narrow Perspectives

This morning I sat in a room at the Phoenix Sheraton, built during the last upturn, and listened to the head of the San Francisco Office of the Federal Reserve, Janet Yellen, talk to a room full of old white men in suits. (Maybe 6 women). Always one to dress for the occasion, I wore jeans brought back from my trip to India and a trendy sweater over my gym top.

I live in a different world. These people want Janet Yellen to tell them exactly what month the real estate market will come back in Phoenix. Me, I am on Twitter and I read economics blogs. Nothing she said was unknown to me. I’ll give you my conclusions, but first, as they say on Marketplace, let’s do the numbers.

Here’s the Fed party line:

The economy has returned to growth after a year and a half of recession. It seems that it has entered a sustained period of expansion. Yellen sees meaningful upturns in consumer spending, manufacturing, and foreign trade. BUT the strength and durability of the expansion is in question because some of the rebound is from stimulus, and many financial institutions are still hobbled with bad loans. Households are burdened with debt, and wealth has been hit by the decline in house and stock assets. Worse, the unemployment rate of 10.2% is the highest since 1983. 7 million jobs have vanished.

Yellen admits it’s “not fun to ponder a subdued recovery, but a year ago there was a real possibility of an outright depression.
This has been the worst downturn since 1930s. Last year, economic output dropped 3%.”

Phoenix, she tells this audience of bankers and real estate people, has been particularly hard hit, going from unemployment of
2.9% in 2007 to 8.2% in 2009. Most construction jobs are gone. [Ed.note: it would be worse, but people are leaving Arizona in droves.]

But we can be heartened by the third quarter, during which investment in housing rose 25% off a horrible base, manufacturing rebounded from the cash for clunkers program, and exports surged.

A massive and concerted response by central banks all over the world averted a worse crisis. The Federal funds rate is  still close to zero, and much government spending hasn’t been spent yet and will make the next year better. Not to mention the consumer, who will have to replace those broken appliances at some point.

How strong will the upturn be?
With reservoirs of slack in the economy (jargon for large numbers of unemployed people), we really need a strong rebound to put so many unemployed back to work, so Yellen sees a less than robust recovery. As government financing diminishes, private demand must increase, and may be anemic.

The banks
It will take quite a while for financial institutions to heal. The credit crunch hasn’t gone away. Smaller businesses are feeling the pinch and won’t hire, and delinquencies on credit and rising unemployment keep financial institutions rocked back on their heels.

The consumer is done for
We may be witnessing the start of a new era for consumers, as households are de-leveraging all over the world. Those countries with greater debt before the crisis have seen greater declines in consumer spending: the US Savings rate was 1%,  now averages 4% and might rise as individual households are belt tightening. In the long run, this higher saving produces more capital for infrastructure, but may dampen the economy short term, as will joblessness and barely rising wages

As for real estate…
The outlook for the residential market is uncertain, but the prospects for commercial are bleak.
Coming off the wildest rise in residential real estate in the last 50 years, house prices peaked more than 50% above the level that could be supported by underlying rental values. The good news: housing prices are approaching ranges that are more in line with fundamentals, and appear to be edging up. Housing construction contributed to GDP for first time in 3 years during Q3

Phoenix was an exaggeration of the nation, with truly exceptional price jumps in 2004-5, so price declines here are 50% or more, about 1.5x that of the nation. But home prices in Phoenix are above their lows and 2009 will be the trough for permits.

Not so fast
The  housing market is nowhere near health. Arizona’s rising unemployment means our foreclosures are 3x the national median. Developers and creditorsare caught with an excess of raw land and finished lots, which takes the value for raw land off 50% across the country. Even though the outlook for housing has turned up nationally, the supply of credit for nonconforming mortgages is tight and there is no market for private mortgage-backed securities.

And commercial is “worrisome”
This sector’s problems stem from the credit crunch, not from lax lending standards. Office vacancies are 25%. Average cap rates have seen spreads double. And there’s no market for mortgage-backed securities here either. Large volumes of loans are coming up for renewals. Lenders and investors will renegotiate terms, and owners will modify, repay, or put up more equity. Federal regulators are so scared of the commercial downturn that they are issuing guidelines for sound practices for loan workouts.

So this recovery won’t feel like a recovery. And although it won’t have inflation mixed in this year, expect it down the line, because at some point the Fed will have to tighten. Right now, they’re still scared of deflation.

Takeaways: (mine alone) These people don’t get it.  They don’t understand the influence of outsourcing, offshoring, online commerce, and the gig economy on their real estate projects.  Worse, they don’t understand (yet) that a younger generation of more globally literate, tech savvy people are going to try to get off the grid and go for sustainability, not another upturn. I felt sorriest for the guy who has been developing high end resorts all his life and got up to ask a question: “when do you think the rich will start spending again?”

Decades, dude, decades. They’re the ones who quit spending and laid off people first. The rich aren’t stupid. That’s why they’re rich.

Posted via email from Not Really Stealthmode