weekly_economic_commentary by pengtt

VIEWS: 3 PAGES: 5

									WEEKLY ECONOMIC COMMENTARY – WEEK OF DECEMBER 14, 2009

Prime Rate: 3.25%

1-Month LIBOR: 0.23%

Things continue to look up for the U.S. economy. Like most things in life, economic data is usually measured on a relative basis. Hence, it may feel like bliss when you stop banging your head against the wall, but only relative to the pain suffered when the pounding was taking place. Likewise, the economy looks like gangbusters relative to where it languished a year ago. Not coincidentally, the business, as well as the popular media, are quick to remind us that this past week marked the one-year anniversary of the infamous Bernie Madoff “Ponzi” scam. While the victims of Bernie’s swindle are hardly in a celebratory
This information is obtained from sources we deem to be reliable. However, it is provided solely for informational purposes only and should not be construed to be the opinion of Sovereign Bank. Sovereign Bank is not a registered broker-dealer or investment advisor, and this update does not constitute investment advice or a recommendation directed to you. Furthermore, this material should not be considered an offer to buy or sell any of the products made available by Sovereign Bank.

For additional information, please contact Sovereign Bank’s Treasury Group at (617) 757-5500

mood, the vast majority of equity investors have seen their portfolios recover nicely from an extremely downtrodden state of a year ago. Just how much of an impact improving balance sheets is having on economic activity is something that will be debated and studied by analysts and policy makers for years to come. But the evidence tracking the improvement is compelling, to say the least. As would be expected following a 60 percent advance in stock prices since early March, households recouped nearly 50 percent of the $5 trillion in lost value that the crash of 2008 wrought on direct holdings of equities during the second and third quarters. Of course, an even bigger blow to household wealth came from the real estate collapse, which wiped out more than $8 trillion of homeowners’ equity since the housing bubble burst in mid 2006. But even here, some improvement can be seen, as property values have turned up in many regions since the summer, restoring about $1 trillion of homeowner equity over the past two quarters. All told, the Federal Reserve reported this week that household net worth increased by $2.7 trillion in the third quarter, following a $2.3 trillion gain in the second. Despite these quarterly gains, there is still a long way to go before the $14 trillion of wealth destroyed between late 2007 and early this year is recovered. But as noted earlier, when you have been down so much for so long, anything moving up is highly welcomed. What’s more, even with the vast wealth destruction during the recession, household balance sheets do not look as battered as would be suggested by the experience. True, net worth relative to disposable incomes is considerably below the levels that prevailed at the height of the two major asset bubbles in the late 1990s and a few years ago. But as the chart below shows, for most of the previous forty years, the net worth/ disposable income ratio hovered between 4 and 5, and the 4.86 ratio at the end of the third quarter falls squarely within that range.

Unfortunately, the bubble years dramatically altered the way households allocate their paychecks between spending and savings. Encouraged by the illusion that house values and stock prices would rise in perpetuity and replace the need to save anything out of incomes, consumers spent virtually every penny of their earnings and borrowed heavily to boot. That mind-set, as hindsight has made painfully clear, ended up in a veil of tears when the asset bubbles deflated and households were left with a mountain of debt that still must be repaid. Not surprisingly, both sides of the balance sheet ledger are being addressed. After sliding to under 1 percent early last year, the personal savings rate has since ratcheted up sharply, averaging 4.5% over the first ten months of this year. Of course, to the extent that households opt to save more, they will spend less, which retards the main growth engine that will power the nascent recovery. A relevant question to ask therefore is how much
This information is obtained from sources we deem to be reliable. However, it is provided solely for informational purposes only and should not be construed to be the opinion of Sovereign Bank. Sovereign Bank is not a registered broker-dealer or investment advisor, and this update does not constitute investment advice or a recommendation directed to you. Furthermore, this material should not be considered an offer to buy or sell any of the products made available by Sovereign Bank.

For additional information, please contact Sovereign Bank’s Treasury Group at (617) 757-5500

higher will consumers push up savings before they feel comfortable with their financial situation. The answer to that question will determine not only how quickly the economy can recover from the worst recession in the post-war period, but also whether or not it will be sustained. Some analysts believe that the savings rate will have to return to the 8 – 10 percent range that typically prevailed at the onset of past recoveries. If that’s the case, the road ahead will be fragile and vulnerable to repeated setbacks whenever household wealth or job prospects are threatened. Indeed, the notion that the economy is poised to enter a long sub-par recovery hinges on expectations that consumer spending will be restrained for some time to come. It is hard to argue against that notion, given the ongoing headwinds that continue to impede spending. As noted, households are attacking the deficiencies on both sides of the balance sheet ledger. The rise in the savings rate to current levels – and likely further increases to come – is one half of the effort. The other is the legacy of debt that continues to be an imposing burden on finances. Indeed, it appears that households are addressing the debt side of the ledger more aggressively than the savings side, as they are paying down debt as never before. According to figures released by the Federal Reserve this week, consumer credit contracted in October for a record ninth consecutive month. The $3.5 billion decline was smaller than expected, and several previous months were revised to show a more tempered decline than originally estimated. But consumers have repaid 3.6% of outstanding non-mortgage debt over the past twelve months in a feverish attempt to undo the borrowing binge in recent years. In late 2007 and early 2008, they were increasing such debt at a 5.7% rate, highlighting a nearly 10-percentage point swing in borrowing that has taken a big bite out of spending. The paydowns have contributed to a lightening of household debt loads. According to the Fed’s latest flow of funds data, total debt, including mortgages, slipped to 124.6% of disposable incomes in the third quarter from 127.3% in the second and the record 130.1% set in early 2008. But the shrinkage is far from over if the goal is to bring debt burdens down to the 97% average of the previous twenty years. As is the case with the savings rate, a reversion to previous yardsticks would throw a major roadblock in the way of consumer spending, since so much of it relies on borrowing. Yet, that linkage may not be as tight as many assume. No doubt, the shrinkage of credit can deal a devastating blow to consumption if households cannot obtain funds to finance home purchases, autos and other big-ticket items. The virtual shutdown of the credit spigot at the height of the financial crisis late last year sent consumer spending into its worst tailspin in a generation. Even with the thawing of the credit freeze this year, credit is still hard to come by for a broad swath of households as well as small businesses. But if the credit contraction occurs when availability is becoming less of an issue, as is now the case, the impact on consumption may not be as obvious. In point of fact, the consumer credit figures are reported as changes in outstanding debt; the Fed does not provide information on gross flows, which would throw more light on the underlying causes of the changes. For example, a $1 dollar decline in outstanding debt could be the net result of a $3 increase in borrowing by some households offset by a $4 debt pay-down by others. That combination might have far different implications for aggregate spending than would a $10 increase in borrowing offset by an $11 pay-down. What’s more, if the pay-down is the result of a loan charge-off by the lender instead of an actual repayment, the result could be a net positive for spending, as the borrower in essence has possession of funds that would otherwise go to the lender. True, in most cases a loan is written off because the borrower simply does not have the means to repay it, which would clearly not boost spending. But that would still be less of a drag on overall consumption than a direct loan repayment, which diverts funds from the spending stream on a dollar for dollar basis. Significantly, banks have been writing down loans at a record pace. That’s particularly so on outstanding credit-card debt, where charge-offs soared to 10.24% in the third quarter, far higher than the 7.85% peak reached in the immediate aftermath of the 2001 recession. With outstanding revolving credit – the lion’s share of which consists of credit card debt – totaling $90 billion in the third quarter, that 10 percent write-off translates into a pay-down of more than $9 billion, which, in turn, exceeds the $7 billion net decline in outstanding revolving debt reported by the Fed for October.
This information is obtained from sources we deem to be reliable. However, it is provided solely for informational purposes only and should not be construed to be the opinion of Sovereign Bank. Sovereign Bank is not a registered broker-dealer or investment advisor, and this update does not constitute investment advice or a recommendation directed to you. Furthermore, this material should not be considered an offer to buy or sell any of the products made available by Sovereign Bank.

For additional information, please contact Sovereign Bank’s Treasury Group at (617) 757-5500

Interestingly, when the charge-off rate was rising towards its previous 7.85% record during the 2001 recession, consumer credit outstanding continued to rise throughout most of the period and never fell on a year-over-year basis. Not coincidentally, real personal consumption also rose in every quarter of that recession. That clearly has not been the case this time, as real PCE fell in four of the six quarters of the downturn, reflecting the much harsher impact that the credit crunch had on spending. But even as credit continued to contract in the third quarter, real consumption increased at a 2.9 % annual rate – the strongest since the first quarter of 2007. Could it be that the soaring loan charge-offs on credit cards – and the much larger dollar totals associated with mortgage loan write-downs – constituted a sort of stealth stimulus behind consumer spending? That may be a stretch to believe it is a major catalyst, but we should acknowledge that some impact on the margin may be unfolding. After all, the administration’s efforts to get banks and other lenders to modify mortgage loans are aimed at alleviating onerous debt burdens on households that stand as a major impediment to the recovery. But whatever is behind the revival in consumer spending, it is continuing to play out. Indeed, if the latest reports on retail sales are any indication, consumers will turn in an even stronger showing in the fourth quarter than they did in the third. To be sure, the jury is still out on the holiday shopping season, which is generating fuzzy and often conflicting readings. The main theme seems to be that more households are shopping than last year, but they are spending less. Collectively, though, that adds up to a rising tide for retail sales, which spurted by a stronger than expected 1.3 % in November, according to last week’s Commerce Department report. The gain, which was spread fairly broadly among most major sales categories, lifted the total 1.9 % above the year-ago level. That, of course, brings us back to the notion expressed at the outset of this commentary, namely that the strength or weakness of economic data may be skewed based on what they are compared to. With regards to retail sales, the relative performance compared to a year ago only seems strong because conditions were so weak then – we were still banging our heads against the wall. The pain has now stopped, leaving open the question of how fast the economy will heal. Stay tuned.

This information is obtained from sources we deem to be reliable. However, it is provided solely for informational purposes only and should not be construed to be the opinion of Sovereign Bank. Sovereign Bank is not a registered broker-dealer or investment advisor, and this update does not constitute investment advice or a recommendation directed to you. Furthermore, this material should not be considered an offer to buy or sell any of the products made available by Sovereign Bank.

For additional information, please contact Sovereign Bank’s Treasury Group at (617) 757-5500

This information is obtained from sources we deem to be reliable. However, it is provided solely for informational purposes only and should not be construed to be the opinion of Sovereign Bank. Sovereign Bank is not a registered broker-dealer or investment advisor, and this update does not constitute investment advice or a recommendation directed to you. Furthermore, this material should not be considered an offer to buy or sell any of the products made available by Sovereign Bank.

For additional information, please contact Sovereign Bank’s Treasury Group at (617) 757-5500


								
To top