© 2008 Northern Trust Corporation northerntrust.com The Northern Trust Experience A C C E S S. E X...

© 2008 Northern Trust Corporation northerntrust.com

The Northern Trust ExperienceThe Northern Trust ExperienceA C C E S S . E X P E R T I S E . S E R V I C E .

Paul L. KasrielDirector of Economic Research PH: [email protected]


How Housing Has Affected the Economic “Ecology”

The Northern Trust Experience


4

6

8

10

12

14

16

18

70 75 80 85 90 95 00 05

Dollar Volume of Single-Family Home Sales* / Nominal GDPpercent

* combined new and existing home sales

median = 8.4%

16.3%

This past cycle was accompanied by one of the biggest housing booms in the post-WWII era.


Three factors

were responsible for the strength of the recent housing boom



Y/Y % Chg. in Median Price of Existing Home minus Mortgage Ratepercentage points

Purchase of Existing Single-Family Home: Contract Interest Rate%

0500959085807570

10

5

0

-5

-10

-15

16

14

12

10

8

6

4

Low mortgage rates in absolute terms as well as relative to house price appreciation.



MBA: Total Loans: Percent of Dollar Volume of Loans which are ARMS

%

05009590

Source: Mortgage Bankers Association /Haver Analytics

50

40

30

20

10

0

50

40

30

20

10

0

The increased popularity of “affordability” mortgage products this past cycle.


Rating Agency Errors



Civilians Employed: 16 Years and Over

% Change - Year to Year NSA, Thous

05009590

Source: Bureau of Labor Statistics /Haver Analytics

4

3

2

1

0

-1

-2

4

3

2

1

0

-1

-2

The housing boom played a major role in increasing employment. The housing bust is now responsible for contracting employment.



Holding Gains on Residential Real Estate as % of Disposable Personal Income

050095908580757065605550

20

16

12

8

4

0

-4

20

16

12

8

4

0

-4

The recent housing boom created an enormous amount of “paper” household wealth …



Active Mortgage Equity Withdrawal as % of Disposable Personal Income

05009590

Source: Haver Analytics

8

6

4

2

0

8

6

4

2

0

…which, in this cycle, households could more easily and cheaply borrow against.



-4

-2

0

2

4

6

8

10

12

1960 1970 1980 1990 2000

Households: Net Sales* of Corporate Equities / Disposable Personal Income%

* Direct net sales by households plus net sales by mutual funds, broker/dealers and ETS.

This increased home-equity borrowing activity, along with corporate stock buybacks …



Personal Consumption Expenditures as % of Disposable Personal Income

050095908580757065605550

Source: Haver Analytics

96

92

88

84

80

76

96

92

88

84

80

76

… enabled households to increase their consumption to a record high in relation to their after-tax income.



< Households & Nonprofit Orgs: Net Financial InvestmentSAAR, Bil.$

Nonfinancial Business: Net Financial Investment >SAAR, Bil.$

050095908580757065605550

Source: Federal Reserve Board /Haver Analytics

400

200

0

-200

-400

-600

-800

400

200

0

-200

-400

-600

-800

Households and corporations have reversed roles in recent years with households having become net demanders of funds and corporations net suppliers



Households & Nonprofit Organizations: Owners Equity in Real Estate

% Change - Year to Year Bil $

0500959085807570656055

22.5

15.0

7.5

0.0

-7.5

-15.0

22.5

15.0

7.5

0.0

-7.5

-15.0

But now with home equity falling …



FRB Sr Loan Survey: Res Mortgages: Net Share, Banks Tightening

Haver Est, %

05009590


80

60

40

20

0

-20

80

60

40

20

0

-20

… with mortgage lending terms tightening …



Civilian Unemployment Rate: 16 yr +

SA, %

08070605040302010099


6.5

6.0

5.5

5.0

4.5

4.0

3.5

6.5

6.0

5.5

5.0

4.5

4.0

3.5

… and with the unemployment rate rising …



Real Personal Consumption Expenditures

% Change - Year to Year SAAR, Bil.Chn.2000$

05009590

Source: Bureau of Economic Analysis /Haver Analytics

6

4

2

0

-2

6

4

2

0

-2

… growth in real consumer spending is the slowest since 1991.



Households: Total Liabilities as % of Mkt. Value of Total Assets

0500959085807570656055

24

20

16

12

8

4

24

20

16

12

8

4

Household balance sheets are in the worst shape in the post-WWII era with household leverage at record highs …



Households: Deposits and Money Fund Shares as % of Total Liabilities

0500959085807570656055

160

140

120

100

80

60

40

160

140

120

100

80

60

40

… and household liquidity at near-record lows.



Private Construction: Residential

% Change - Year to Year NSA, Mil.$

050095908580757065

Source: Census Bureau /Haver Analytics

80

60

40

20

0

-20

-40

80

60

40

20

0

-20

-40

With the housing sector still contracting and the consumer sector weakening, economic activity in other sectors also will slow.



CEO Business Confidence Survey: Business Executive Confidence50+=Positive

NFIB: Small Business Optimism IndexSA, 1986=100 (I)

050095908580

Sources: CNFBOARD, NFIB /Haver

80

70

60

50

40

30

20

110

105

100

95

90

85

80

Large and small business sentiment has soured …



Real Private Nonresidential Investment: Equipment & Software

% Change - Year to Year SAAR,Bil.Chn.2000$

080706050403020100


12

8

4

0

-4

-8

-12

12

8

4

0

-4

-8

-12

… which is reining in capital spending.



National Office Vacancy Rate: Metropolitan Areas

%

05009590

Source: CB Richard Ellis /Haver Analytics

22.5

20.0

17.5

15.0

12.5

10.0

7.5

22.5

20.0

17.5

15.0

12.5

10.0

7.5

With unemployment increasing and retail spending slowing, commercial real estate vacancy rates are beginning to rise.



Architectural Billings Idx: Comm/Ind Sector, 3-Mo Moving Avg

SA,+50=Increase

0807060504030201009998979695

Source: American Institute of Architects /Haver Analytics

65

60

55

50

45

40

35

65

60

55

50

45

40

35

This augurs poorly for private nonresidential construction activity going forward.



Real State & Local Govt Consumption & Gross Investment


08070605040302010099


8

6

4

2

0

-2

8

6

4

2

0

-2

The next domino to fall will be state and local government spending, which accounts for about 11% of real GDP.



Real Exports of Goods & Services


08070605040302010099


15

10

5

0

-5

-10

-15

15

10

5

0

-5

-10

-15

The relative strong performing sector will be exports. With economic growth in the rest of the world slowing, however, our exports will face some headwinds.



< CPI-U: All Items % Change - Year to Year NSA, 1982-84=100

CPI-U: All Items Less Food and Energy > % Change - Year to Year NSA, 1982-84=100

08070605


6

5

4

3

2

1

6

5

4

3

2

1

Consumer price inflation has resurged in recent months, primarily because of sharp advances in energy and food prices.



CPI-U: Energy

% Change - Year to Year NSA, 1982-84=100

08070605Source: Bureau of Labor Statistics /Haver Analytics

40

30

20

10

0

-10

-20

40

30

20

10

0

-10

-20

Imports: Energy-Related Petroleum Products: Quantity

4-qtr MovingAverage Thous.Bbls

08070605

Source: Census Bureau /Haver Analytics

1260000

1240000

1220000

1200000

1180000

1160000

1260000

1240000

1220000

1200000

1180000

1160000

The rate of increase in energy prices is likely to abate as the demand for energy moderates because of the global economic slowdown.



increased demand from developing economies such as China and India

competition from biofuels

low inventories of grains, in part due to droughts and now, floods

CPI-U: Food

% Change - Year to Year NSA, 1982-84=100


7

6

5

4

3

2

1

7

6

5

4

3

2

1

Food price increases are less likely to moderate much because of …



Ratio of Consumer Goods Prices: CPI/PPI

08070605

1.02

1.00

0.98

0.96

0.94

0.92

0.90

1.02

1.00

0.98

0.96

0.94

0.92

0.90

Businesses are not able to pass on completely to consumers their higher input costs.



ECI: Compensation: Private Industry Workers

NSA, 12-Mo %Chg

05009590


5.5

5.0

4.5

4.0

3.5

3.0

2.5

5.5

5.0

4.5

4.0

3.5

3.0

2.5

With the unemployment rising and growth in employee compensation already slowing, there is little danger of a 1970s-style wage-price spiral.



Import Prices - Consumer goods ex Autos: Y/Y % Chg.

Import Prices - Autos: Y/Y % Chg.

CPI - Goods ex Food & Energy: Y/Y % Chg.


4

3

2

1

0

-1

4

3

2

1

0

-1

In addition to food price increases, the biggest threat to higher inflation would be a renewed weakening in the dollar.



Real Gross Domestic Product % Change - Year to Year SAAR, Bil.Chn.2000$

CPI-U: All Items % Change - Year to Year NSA, 1982-84=100

05009590858075706560

Sources: BEA, BLS /Haver

16

12

8

4

0

-4

16

12

8

4

0

-4

It is important to recall, however, that inflation is a lagging economic process.



Home Mortgages as % of Total Domestic Nonfinancial Debt

050095908580757065605550

36

32

28

24

20

16

12

36

32

28

24

20

16

12

Not surprisingly, the housing boom resulted in a mortgage debt boom, with home mortgage debt rising to a record high percentage of total U.S. nonfinancial debt.



Home Mortgages as % of U. S. Treasury Debt

050095908580757065605550

240

200

160

120

80

40

0

240

200

160

120

80

40

0

Home mortgage debt is now twice as large as U.S. Treasury debt held by the public.



S&P/Case-Shiller Home Price Index: Composite 20 % Change - Year to Year NSA, Jan-00=100

NAR Median Sales Price: Existing 1-Family Homes, United States % Change - Year to Year $

0500959085807570

Sources: S&P, REALTOR /Haver

20

10

0

-10

-20

20

10

0

-10

-20

Herein lies the problem – the collateral of the single largest debt class in the U.S. is experiencing perhaps its most severe decline in value in the post-WWII era.



2

4

6

8

10

12

14

1985 1990 1995 2000 2005

Existing Single-Family Homes: Inventory / Sales Ratiomonths' supply

median = 6.75 months

July '08 10.35

And with still large excess inventories of homes, there is no relief in sight for home prices.



10

20

30

40

50

60

70

1960 1970 1980 1990 2000

U.S Commercial Banks: Total Mortgage-Related Assets / Total Earning Assetspercent

Contrary to conventional wisdom, commercial banks have a record amount of mortgage-related debt on their balance sheets.



Loan Delinquency Rate: Consumer Loans: All Insured Comml BanksSA,%

Loan Delinquency Rate: Commercial Real Estate Loans: All Comml BanksSA,%

05009590


4.4

4.0

3.6

3.2

2.8

2.4

12.5

10.0

7.5

5.0

2.5

0.0

Although the largest credit problems are in the home mortgage market, distress is beginning to be signaled in the consumer loan and commercial real estate markets, too.



< Corporate Profits with IVA & CCAdj: Nonfinancial % Change - Year to Year SAAR, Bil.$

Merrill Lynch High Yield Corp Master II: Yield to Maturity >EOP %

080706050403020100999897

Sources: Bureau of Economic Analysis, Merrill Lynch /Haver Analytics

60

40

20

0

-20

-40

16

14

12

10

8

6

With nonfinancial corporate profits contracting and interest rates on high-yield corporate bonds rising, increased corporate bond defaults are likely.



Financial Sector Net Lending as % of Nominal GDP

0500959085807570656055

30

25

20

15

10

5

0

30

25

20

15

10

5

0

Current and expected credit losses are constraining financial institutions’ ability to create new credit.



The U.S. economy likely entered a recession early in 2008.

Because financial institutions will experience large losses across a wide spectrum of debt classes and because there is the likelihood of increased regulation, the financial system will be capital “impaired” through 2009.

Even though the Federal Reserve is offering “cheap” credit to the financial system, financial institutions will have diminished demand for the Fed’s offer because they will not have the capital to support lending to the private sector.

Thus, U.S. economic performance will be substandard through 2009 due to the relative lack of credit creation from financial institutions.

Conclusions and implications:



In the words of Mel Brooks: Hope for the best, expect the worst!


Thank You


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