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					U.S. , Midwest and Chicago
Economic Outlook 2009—
Implications for government

Rick Mattoon
Senior Economist and Economic Advisor
Federal Reserve Bank of Chicago
McHenry County Council of Governments
January 28. 2009
The macro outlook through the
first half of 2009 is challenging
 Financial markets   and operations are still
  under pressure
 Spillover to the “real” economy has been
  substantial particularly in labor markets
  and now retail sales
 Subpar performance has spread across
  the globe—eurozone in recession, China
  predicting less than double digit GDP
  growth
 This recession began in December 2007
What triggered the recession—
understanding the decline in housing and
the related financial crisis?
A  year ago the expectation was that
  housing would be very weak, but most of
  the trouble would be contained within
  housing related sectors—subprime was
  the problem
 Other sectors of the economy looked
  okay—particularly export oriented
  manufacturing, agriculture, commodity
  businesses
 Then things began to deteriorate…why?
Understanding the liquidity crisis
 “Deciphering the 2007-08 Liquidity and
  Credit Crunch” Markus Brunnermeir
  (Princeton), forthcoming, Journal of
  Economic Perspectives
 Big problems--The design of mortgage
  backed securities assumed housing markets
  were regional and not susceptible to a
  national decline. Mortgage backed products
  were based on other derivative instruments
  and a short, U.S. based time horizon.
Financial markets
 Three key factors:
  ◦ Subprime mortgages (average down payment in 2007
    was…)
  ◦ Mismatched maturities of off-balance sheet conduits
    (the overnight repo market)
  ◦ Leverage (Lehman was 30 to 1)
 Amplification mechanisms make things worse
  ◦ Liquidity spiral (asset prices and market liquidity
    drops and the ability to roll over short-term liabilities
    is impaired)
  ◦ Lending channel freezes—banks hoard assets
The multi-trillion dollar question
   Is this a liquidity issue?
   Is this an asset issue? (Merrill Lynch 22 cents/dollar,
    mortgage backed security sale)
   Two primary strategies in play—1)reverse auction to
    purchase bad assets from banks and get them off the
    books (appears to have been abandoned) and 2) direct
    purchase of equity in banks (and just about everyone
    else) to inject capital
   How will we value heterogeneous assets—what is the
    bottom of the market?
   Still need a housing recovery
   Good news is this appears to be a global strategy
   How is this affecting your business?
   The new “normal” won’t look like the old “normal”
Current economic conditions
 Employment
 Housing
 Financial markets
 Consumer spending


 Evidence….
Employment decreased by 2,600,000 jobs over the
past year—losses have been across virtually all
sectors—in November and December alone combined
job losses were over 1 million
The unemployment rate has been rising—some
predict peak at 9 to 10%
Michigan has the highest
state unemployment rate in the nation
Turning to housing…
 Have  we reached the bottom?
 Start of problems in commercial real
  estate…Chicago vacancies in the high
  teens, retail consolidation, back-office
  functions in suburbs are vulnerable
Residential investment as a share of GDP
is approaching previous lows
Residential investment fell off sharply beginning
in 2006
The supply of new single family homes is
extremely high
Home price declines are quite large
Housing starts have fallen sharply
Home price changes over the past year has been
mixed
Foreclosure filings are quite high in California,
Florida, Nevada and Arizona
Ray of light--Mortgage rates remain very low but…
Lending standards for mortgage loans
have tightened considerably
Turning to finance
 Stock market is off 40%+ from peak
 Hedge fund industry assets have been
  halved…record redemptions in
  December
 Asset spreads are better but still
  exaggerated
The stock market losses are significant
Corporate High Yield rates increased beginning in
June 2007
The “flight to quality” drove down Treasury yields
Consumer response
 Pullback…retail sales drop by 2.7% in
  December
 Savings increases
Consumer spending fell sharply in the third
quarter
Any good news?
             going away for now
 Inflation is
 Energy prices are declining—every 1 cent
  drop in gas prices= 1 billion available to
  consumers
 Productivity has held up
Inflation has reversed its upward trajectory
Removing the volatile food and energy
components from the PCE,
“core” inflation has entered the “comfort” zone
Adjusted for inflation -
current oil prices are well below early 1980s prices
Productivity growth remains solid
Any better news for the Midwest?
   Not really. Fallout from autos continues to be a problem.
   Last strong sectors have weakened…agriculture (falling crop
    prices, but higher fertilizer and other input costs) and export
    led manufacturing is hurt by weak world demand and
    improving value of the dollar.
   Less exposure to financial services is a plus, but a small one.
    (for example, the Tribune noted that 1.3 million square feet
    of space leased in Chicago is by firms directly impacted in the
    financial crisis—Bear Sterns, AIG, etc.)
   Less of a housing bust except in cities with high
    unemployment. Inventory of speculative housing is smaller
    so recovery can occur faster. Exception is condo market in
    Chicago where 25% of units purchased were by speculators.
What about the Chicago region?
 How has   Chicago performed in previous
  recessions?
 Does the city’s industrial structure offer
  any clues?
 How about real estate?
 On the positive side (longer-term)
  Chicago still has an enviable business
  mix—business and professional services,
  finance and convention tourism and is a
  talent magnet for the region.
                          Total Nonfarm Employment
                             Chicago MSA vs U.S.
                     (3 month moving average % change Y/Y)
3.0

2.0

1.0

0.0

-1.0
                                                                        Chicago-Naperville-Joliet
-2.0                                                                    U.S.
-3.0

-4.0
                       2002




                                            2005




                                                                 2008
       2000


              2001




                              2003


                                     2004




                                                   2006


                                                          2007
  Sourse: BLS/Haver Analytics
                               Index of Concentration
                          Chicago MSA vs U.S. (September)
                 Government (0.8)
               Other Services (1.1)
        Leisure & Hospitality (0.9)
Educational & Health Services (1.0)
  Professional & Business Svc (1.3)
           Financial Activities (1.3)
                  Information (1.0)
     Trade, Transp & Utilities (1.1)
               Manufacturing (1.0)
                Construction (0.8)
 Natural Resources & Mining (0.1)

                                        0.0   0.2   0.4   0.6   0.8   1.0   1.2   1.4
Sourse: BLS/Haver Analytics
From http://www.msnbc.msn.com/id/27844127
                                             Total Payroll Employment
                                          Professional & Business Services
                                                3MMA % change Y/Y
10.0

 8.0

 6.0

 4.0

 2.0

                                                                                                                                     Chicago-Naperville-Joliet
 0.0
                                                                                                                                     U.S.

-2.0

-4.0

-6.0

-8.0
                     1993

                            1994




                                                               1999

                                                                      2000




                                                                                                         2005

                                                                                                                2006
       1991

              1992




                                   1995

                                          1996

                                                 1997

                                                        1998




                                                                             2001

                                                                                    2002

                                                                                           2003

                                                                                                  2004




                                                                                                                       2007

                                                                                                                              2008
Impact on state and local
governments
 Impact is broad and deep
 Virtually all revenue sources are under
  pressure—in the 2001 recession while
  income taxes fell, property taxes held up as
  housing was a source of strength in the
  economy. Even sales taxes did okay.
 This time, property taxes, real estate transfer
  fees, sales taxes are all headed down
 Compounding problems are investment
  losses impacting pension accounts and
  dislocation in the bond markets making
  lending difficult
Any help on the way?
 Counter-cyclical aid  is likely—particularly
  to support Medicaid, unemployment
  compensation and possibly education
 Aid is focused on the state first…less
  direct assistance for municipalities
 Infrastructure money
 Backstop for the bond market
Will it be enough?
 Timing  is a key concern…cuts are already
  underway so stimulus will take time to
  help
 Big issues concern future liabilities for
  pensions and OPEB
 Tax structure is strained and possibly too
  property tax reliant
 Demographics won’t help—not a fast
  growth region
Questions?
 Rick Mattoon
 312-322-2428
 Rick.mattoon@chi.frb.org

				
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