1

“WHAT’S NEXT FOR THE FLEDGLING

ECONOMIC RECOVERY?”

Presented by

Barton Smith

Economics Professor Emeritus

University of Houston

November 16, 2010

2

THE RECOVERY SEEMS

PAINFULLY SLOW

3

GROSS NATIONAL PRODUCTAre We Headed For Even Slower Growth?

-8%

-4%

0%

4%

8%

Apr-07 Apr-08 Apr-09 Apr-10

Date

An

nu

ali

zed

Perc

en

t G

row

th

Source: BEA

Forecast for 4th quarter 2010

Mostly an inventory adjustment

4

U.S. MONTHLY EMPLOYMENT GROWTHGains/Losses in Employment

-800

-600

-400

-200

0

200

400

600

Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09

Monthly Change

12 Month Average

Ab

so

lute

Level

of

Em

plo

ym

en

t G

row

thIn

Th

ou

sa

nd

s

Date

Source: BLS

Lost 2.1 million jobs

Lost 8.0 million jobs

5

NATIONAL EMPLOYMENT GROWTH3 Month Average Annualized Job Growth

-7.0%

-3.5%

0.0%

3.5%

7.0%

Jan-

79

Jan-

82

Jan-

85

Jan-

88

Jan-

91

Jan-

94

Jan-

97

Jan-

00

Jan-

03

Jan-

06

Jan-

09

Perc

en

t A

nn

uali

zed

Gro

wth

Rate

Date

Usually, when job growth starts, it comes back strong

Source: BLS

6

INITIAL CLAIMS FOR UNEMPLOYMENT3 Month Average of Weekly U.S. Claims

200

300

400

500

600

700

Jan-

79

Jan-

82

Jan-

85

Jan-

88

Jan-

91

Jan-

94

Jan-

97

Jan-

00

Jan-

03

Jan-

06

Jan-

09

Initial Claims

30 Year Average

Weekly

Un

em

plo

ym

en

t C

laim

s

(Th

ou

sa

nd

s)

Date

New claims have been above 450,000 for 28 straight months

Source: Dept. of Labor

7

INDEX OF CONSUMER SENTIMENT30 YEAR AVERAGE = 87

50

60

70

80

90

100

110

120

Jan-

79

Jan-

82

Jan-

85

Jan-

88

Jan-

91

Jan-

94

Jan-

97

Jan-

00

Jan-

03

Jan-

06

Jan-

09

Ind

ex V

alu

e:

30 y

ear

avera

ge =

87

Date

9/11;

ScandalsS&L

Crisis

Double Dip

Recession

Subprime

Meltdown

Source: University of Michigan

Consumer confidence still hovers at recessionary lows.

8

REAL DOLLAR RETAIL SALESPercent Year-Over-Year Growth

-12.0%

-8.0%

-4.0%

0.0%

4.0%

8.0%

Jan-92 Jan-95 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10

Date

An

nu

al

Year-

Over-

Year

Gro

wth

Rate

This is the largest contraction in retail sales since the Depression

and the consumer is in no position to come roaring back.

Source: St. Louis Fed

9

MOST RECOVERIES SEEM

PAINFULLY SLOW,

ESPECIALLY THE RETURN

TO JOB GROWTH

10

THE WORST RECESSIONS

OF THE PAST 50 YEARSDeviations from GDP Peak: 1st Qtr = Peak Level of GDP

92%

96%

100%

104%

108%

1 2 3 4 5 6 7 8 9 10 11 12 13 14

1973-75 1980-82

2008-2010 Old Peak

Quarter From Peak Level of GDP

Perc

en

t o

f P

eak

Source: BEA

80s trough

70s troughRecent trough

Return to Old High

11

Length and Severityof

Past Recessions

Recession GDP Jobs GDP

Trough

Jobs

Trough

Jobs

Recovery

Lag

1974 24 mos 20 mos -3.2% -2.8% 5 mos

1980 36 mos 42 mos -2.2% -2.5% 8 mos

1990 18 mos 32 mos -2.4% -2.5% 16 mos

2000 3 mos 45 mos -0.3% -2.0% 46 mos

2008* 40 mos 35 mos -3.5% -6.1% N/A

Duration in Months / Severity in Percent Decline

Source: BLS/BEA

* Neither GDP or Employment Have Yet Returned to Old Peak

12

EXAMPLES OF THE LAG

BETWEEN GDP GROWTH

AND

EMPLOYMENT GROWTH

13

THE 1980-82 RECESSIONPercent Level In Comparison With

1st Qtr 1980 Peak

95.0%

97.5%

100.0%

102.5%

105.0%

1979 1980 1981 1982 1983 1984

Employment

GDP

Date

Year-

to-Y

ear

%

Ch

an

ge

Source: BLS/BEA

Lag

14

THE 1990-91 RECESSIONPercent Level In Comparison With

2nd Qtr 1990 Peak

95.0%

97.5%

100.0%

102.5%

105.0%

1990 1991 1992 1993

Employment

GDP

Date

Year-

to-Y

ear

%

Ch

an

ge

Source: BLS/BEA

Lag

15

THE 2008+ RECESSIONPercent Level In Comparison With

4th Qtr 2007 Peak

92.0%

94.0%

96.0%

98.0%

100.0%

102.0%

104.0%

2007 2008 2009 2010

Employment

GDP

Date

Year-

to-Y

ear

Perc

en

t C

han

ge

Source: BLS/BEA

GDP hasn’t returned

to old peak

16

THE ALTERNATIVE SCENARIO:

JAPAN’S LOST DECADE

17

“THE LOST DECADE”From Boom to Gloom – Japan’s Real Growth

-2%

0%

2%

4%

6%

8%

1975 1980 1985 1990 1995 2000 2005

Real GDP Growth

Avg Growth Rate in the 80sAvg Growth Rate in the 90s

Year

Perc

en

t G

ain

in

Real G

DP

Source: U.S. Census Bureau

18

“Every Recession Has Purposes

Which Must Be Fulfilled

Before Any Recovery is Sustainable”

19

WHAT’S BEEN ACCOMPLISHED&

WHAT HASN’T

0% 20% 40% 60% 80% 100%

Rebalancing of Macro Economy

Labor Productivity Growth

Public Sector Budget Control

Private Sector Savings

Banking Reform & Stabilization

Commerical RE Mkt Correction

Housing Mkt Stabilization

Home Price Correction

TA

SK

S T

O B

E C

OM

PL

ET

ED

Source: B. Smith

20

THE HOUSING MARKET

21

Housing Must Remain AffordableNational Median Home Price vs. Median Income

2.50

2.75

3.00

3.25

3.50

3.75

4.00

4.25

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

Price to Income Ratio

Year

Source: NAR / BEA

Rati

o:

Pri

ce t

o I

nco

me

Median home prices should not exceed 3X median incomes

22

MORTGAGE DELINQUENCY RATES

Percent 60 Days Delinquent

0%

10%

20%

30%

40%

50%

Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09

Alt A

Subprime

FHA/VA

Conv. Prime

Perc

en

t D

elin

qu

en

t

Date

Source: First American CoreLogic

The foreclosure problem will not be over until delinquencies fall

23

NEW HOME SALESSales As A Percent of American Households

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

Jan-63 Jan-68 Jan-73 Jan-78 Jan-83 Jan-88 Jan-93 Jan-98 Jan-03 Jan-08

Sales to Households

46-Year Average

Rati

o o

f S

ale

s t

o H

ou

seh

old

s

Date

Source: Bureau of Census

.8% is approximately equal to

the growth in households qualified to own a home.

Unfortunately, new home production must remain subdued for at least 2 more years.

24

COMMERCIAL REAL ESTATE

25

COMMERCIAL PROPERTY

National Price Index

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Commercial Property Price Index

Year

Ind

ex:

100 =

Jan

2001

Source: NCREIF, RCA, CBRE /B. Smith

Commercial property values

are 46% off their peak.

This is for properties sold. Most unsold properties haven’t been written down.

26

OVERALL REIT PERFORMANCEApril 2004 to April 2009

0.0

0.5

1.0

1.5

2.0

2.5

2004 2005 2006 2007 2008 2009 2010

Year

Ind

ex:

Ap

ril

2004 =

1.0

0

Source: Dow Jones

On average commercial REITs lost 64% of their value,

but since March, 2009 they are now up 140%.

That compares with a 70% rise in stock values.

27

Commercial Property Cap RatesNational Average of NOI to Transactions Price

Composite Index for Apts., Retail, Office

5.5%

6.5%

7.5%

8.5%

9.5%

1996 1999 2002 2005 2008 2011

Date

Perc

en

t C

ap

Rate

Source: NCREIF, RCA, CBRE, M&M

Today there is a dramatic difference between appraised and transaction cap rates

28

BANK STABILIZATION

29

U.S. BANK CREDITCommercial, Real Estate, and Consumer Credit

-8%

-4%

0%

4%

8%

12%

16%

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

Date

An

nu

al

Perc

en

t G

row

th

Source: St. Louis Fed

30

HOUSEHOLD SAVINGS RATE

31

U. S. PERSONAL SAVINGS RATE3 Month Moving Average

0%

2%

4%

6%

8%

10%

12%

14%

Jan-

59

Jan-

64

Jan-

69

Jan-

74

Jan-

79

Jan-

84

Jan-

89

Jan-

94

Jan-

99

Jan-

04

Jan-

09

Perc

en

t o

f

Dis

po

sab

le I

nco

me

Date

Source: St. Louis Fed

The savings rate needs to rise further, which is not good news for U.S. retailing.

32

FEDERAL GOVERNMENT

DEBT CONTROL

33

The Future Deficits

Are Very Troublesome

$0

$400

$800

$1,200

$1,600

$2,000

$2,400

$2,800

2007 2009 2011 2013 2015 2017 2019

Federal Deficit Additions to Debt

Source: OMB / CBO

Year

An

nu

al

Fed

era

l D

efi

cit

In B

illi

on

s

(Note that all projected deficits are greater than any deficit during the Bush Administration.)

Deficits during periods of economic health are intolerable.

34

STATE BUDGET

BALANCING

35

CHANGE IN STATE REVENUESPercent Real Dollar Growth

-20%

-15%

-10%

-5%

0%

5%

10%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Real Dollar Growth

Year

An

nu

al

Perc

en

t G

row

th

Source: Bureau of Census

Estimate

36

LABOR PRODUCTIVITY

37

LABOR PRODUCTIVITYMid 70s Recession and Recovery

61.0

62.0

63.0

64.0

65.0

66.0

1972 1973 1974 1975 1976

GDP/Employment

Year

Source: NAR / BEA

Gro

ss L

ab

or

Pro

du

cti

vty

Job Growth Never Begins Until Labor Productivity Reaches A New HIgh

38

LABOR PRODUCTIVITYEarly 80s Recession and Recovery

The Infamous Double Dip Recession

63.0

64.0

65.0

66.0

67.0

68.0

69.0

1978 1979 1980 1981 1982 1983

GDP/Employment

Year

Source: NAR / BEA

Gro

ss L

ab

or

Pro

du

cti

vty

Job Growth Never Begins Until Labor Productivity Reaches A New HIgh

39

LABOR PRODUCTIVITYRecent Recession and Recovery

94.00

96.00

98.00

100.00

102.00

2008 2009 2010

GDP/Employment

Year

Source: NAR / BEA

Gro

ss L

ab

or

Pro

du

cti

vty

Productivity Levels are Consistent With The Start of Job Growth

40

THE TRANSFORMATION

OF THE

AMERICAN ECONOMY

41

MOVING TOWARDS

A SUSTAINABLE, BALANCED ECONOMY

Historical Range of Component Shares of GDP

Consumption Investment Government Net Exports

Min 60.95% 10.35% 17.44% -5.86%

Max 71.97% 18.16% 28.14% 1.10%

Average 67.88% 14.63% 19.80% -2.31%

2009 70.63% 12.50% 19.67% - 2.53%

Goal 65.00% 17.50% 17.50% 0.00%

Source: BEA / B. Smith

Note: Averages in first table are based upon period from 1954 to present

This will require reduced government; increased savings;

expanded investment and less reliance on consumption.

42

HOUSTON’S FUTURE IS

CONTINGENT

ON THE NATIONAL RECOVERY

43

Houston ForecastLast Five Years/Next Five Years

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Employment

Population

Year

An

nu

al

Perc

en

t G

ain

Note: Yearly numbers are based on employment averages for the whole year.

Source: TWC / BLS/B. Smith

This implies continued weak growth through 2010

This growth requires the absence

of a double-dip recession