November 17, 2008
Why a $220 Billion Stimulus Package will not work this year.
In past economic crises, particular regions or economic sectors within the United States have been affected, but since the Great Depression a crisis has never affected the whole country at the same time.
This time is different, the 2008 financial crisis is affecting the whole country, excepting only the very poor and some of the very rich. The main effects on individuals during 2008 are in four areas;
- Value of home
- Value of retirement savings
- Job security
- Access to finance and outgoings
The effects on households have primarily been financial, but the flow on effect from the financial effects has been a huge loss of consumer confidence and a resulting withdrawal of consumer spending.
Value of Home
This graph is created from Robert Shiller's data of home prices from the second edition of his book Irrational Exuberance, Princeton University Press, 2005. It shows from base 100 how home prices up to 2005 increased well out of proportion to increases in building costs.For most home owners, their home is their main saving towards retirement, with an expectation of downsizing to a smaller home at retirement to free up cash.
Thus a significant fall in house prices will have a major impact on the financial outlook and financial actions for most people aged 40 or over.
Such a fall has now happened as national home prices fell dramatically in 2007 according to NAR data, with the national median price falling nearly 6% to $217,000 in March 2007 from the peak of $230,200 in July 2006.
Since 2007 there has been a further dramatic fall in the median as shown in the graph. So that by September 2008, the median price was $192,000, a drop of nearly $40,000.In Britain there is a similar story, as it has been recently calculated that in Cardiff, the 2008 housing slump has cost the average family GBP30,000, say USD45,000 with the median house price in Cardiff (i.e. only within one city) falling from GBP215,000 to GBP185,000.
A separate graph shows how different the cycle of home value decline is in 2008, when compared to the last major decline in home value, which took place between 1990 and 1997. The comparison is of the percentage change of the Case-Shiller Home Price Index for the housing correction beginning in 2005 (red) and the 1980s–1990s correction (blue), comparing monthly CSI values to the peak value seen just prior to the first declining month all the way through the downturn and the full recovery of home prices.
The average house owning household is assumed to have had a reduction in their nominal wealth associated with the house value decline amounting to around 20%, or close to $45,000. The amount will be higher for families with a second home, perhaps a combined average of around $50,000 per household.
Many younger households will be facing negative or minimal equity in their homes, which will savage their consumer confidence even more.
Value of retirement savings
In the United States in 2001, the total value of pension funds was about $6.7 trillion, out of total OECD pension funds of about $7.5 trillion, i.e. the USA represented about 80% of total OECD pension investments, with about 50% of the total being invested in equities.
It has been hard to find more recent information on total pension investments but an estimate can be made.
In 2001 the Dow Jones Industrial Average was about 11,000. See The 2008 Financial Crisis and the Art Market - part 3 The Dow peak in 2007 was 14165, say 28% higher than in 2001, applied to say a 50% equity portion, plus an allowance for new savings, would imply US pension funds peaking at around $9 trillion in late 2007.
Since then there has been a 40% fall in the Dow. Applied to the say, 50% or $4.5 trillion invested in equities, this is a loss of value approaching $2 trillion. There are 110 million households in the United States, including those without access to pension funds. Adjusting for those without pension entitlements, the average pension fund investment loss per household between October 2007 and October 2008, might be close to $25,000.
To this must be added the decline in the market value of direct equity investments by households, direct commercial property investments, decreased values of small businesses for owners, and even an abnormal fall in the value of personal motor vehicles, due to reduced demand. The amounts can only be guessed, but might increase the average household loss of retirement investment value from the $25,000 pension fund loss to a total investment loss of $30,000 per household.
By a different measure, the value of equities listed in the United States in 1998 was about $13.5 trillion, when the Dow was about 10,000. A different source, Wilshire Associates, calculated the total U.S. market capitalization at approximately $15.35 trillion on May 23, 2007.
The current Wilshire estimate of total US market capitalization can be seen at http://www.wilshire.com/Indexes/Broad/Wilshire5000/Characteristics.html At October 31, 2008 the total market capitalization was $10.5 trillion.
Applying the 2007 Dow peak of 14165 to those figures, implies a total equity value at the peak of around $18 trillion. Thus current value represents a fall of $7.5 trillion or about $70,000 per household.
This would overstate the loss per household because of the need to eliminate corporate cross-holdings and US shares owned by foreign households. It does however suggest that $30,000 is a modest estimate of the investment losses per household.
Naturally, these are losses from a notional Dow peak, rather than a direct loss compared to the purchase price of the investments. Nevertheless, there will be a feeling by households of great loss over the last twelve months from the peak, which will take households some time to adjust to. The rate of adjustment being affected by when/if the Dow recovers over the next year and by how much.
Job Security
Today Citigroup announced 50,000 job reductions. Many other reductions have been announced which are not yet reflected in the statistics.
The unemployment rate in recent years is shown in the table. Currently the rate is 6.5%, but some predictions suggest it may rise to 10 percent.
| Year | Jan | Feb | Mar | Apr | May | Jun | Jul | Aug | Sep | Oct | Nov | Dec | Annual |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 1998 | 4.6 | 4.6 | 4.7 | 4.3 | 4.4 | 4.5 | 4.5 | 4.5 | 4.6 | 4.5 | 4.4 | 4.4 | |
| 1999 | 4.3 | 4.4 | 4.2 | 4.3 | 4.2 | 4.3 | 4.3 | 4.2 | 4.2 | 4.1 | 4.1 | 4.0 | |
| 2000 | 4.0 | 4.1 | 4.0 | 3.8 | 4.0 | 4.0 | 4.0 | 4.1 | 3.9 | 3.9 | 3.9 | 3.9 | |
| 2001 | 4.2 | 4.2 | 4.3 | 4.4 | 4.3 | 4.5 | 4.6 | 4.9 | 5.0 | 5.3 | 5.5 | 5.7 | |
| 2002 | 5.7 | 5.7 | 5.7 | 5.9 | 5.8 | 5.8 | 5.8 | 5.7 | 5.7 | 5.7 | 5.9 | 6.0 | |
| 2003 | 5.8 | 5.9 | 5.9 | 6.0 | 6.1 | 6.3 | 6.2 | 6.1 | 6.1 | 6.0 | 5.8 | 5.7 | |
| 2004 | 5.7 | 5.6 | 5.8 | 5.6 | 5.6 | 5.6 | 5.5 | 5.4 | 5.4 | 5.5 | 5.4 | 5.4 | |
| 2005 | 5.2 | 5.4 | 5.2 | 5.1 | 5.1 | 5.0 | 5.0 | 4.9 | 5.1 | 5.0 | 5.0 | 4.8 | |
| 2006 | 4.7 | 4.7 | 4.7 | 4.7 | 4.7 | 4.6 | 4.7 | 4.7 | 4.5 | 4.4 | 4.5 | 4.4 | |
| 2007 | 4.6 | 4.5 | 4.4 | 4.5 | 4.5 | 4.6 | 4.7 | 4.7 | 4.7 | 4.8 | 4.7 | 5.0 | |
| 2008 | 4.9 | 4.8 | 5.1 | 5.0 | 5.5 | 5.5 | 5.7 | 6.1 | 6.1 | 6.5 |
Access to Finance and Outgoings
Most households are in continuing employment with existing commitments to mortgage and car loan repayments. Thus, they have not actively been looking for finance and on a day to day basis their net income has been relatively constant, except for food and gas price increases in the first half of 2008.
Market commentators keep saying that the second half fall in gas prices is giving the consumer more to spend. However, I think this overstates the case. When gas prices were at a peak, and food prices were increasing, much consumer expenditure would have gone onto credit cards or been financed by withdrawals from household savings.
This view is supported by studies of the early 2008 financial stimulus which showed that it had less impact than was expected. A significant portion seems to have been used to repay debt.
The financial crisis has significantly worsened since then so it seems even more likely that households will aim to save any stimulus "windfall" or use it to repay temporary credit card debt from when gas prices were so high.
Household costs will increase in 2009. It has to be remembered that many local authorities are running deficits and will need to increase property and similar taxes. These will be an extra financial impost for consumers in 2009. It is highly likely that insurance rates will increase due to equity losses within insurance company reserves and hurricane losses. Credit card interest rates will be increased to cover losses.
The Auto Industry
Full-year 2007 sales dropped almost 3 percent from 2006, to 16.14 million vehicles (i.e. cars and light trucks combined), the lowest since 1998 and down from 16.55 million a year earlier. Industry-wide sales for December 2007 were off almost 3 percent at 1,390,000 vehicles.
Since then it has got even worse.Total light vehicle sales in October 2008 were 838,000 compared to 1,232,000 in October 2007, with the ten month YTD drop being from 13.58m in 2007 to 11.60m in 2008. The last time monthly light-vehicle sales were lower was 822,200 in January 1991.
It seems likely that with the worsening economic situation, and assuming say, 800,000 per month for November and December, total sales for 2008 may be a little over 13 million. That would be a reduction of 20% on 2007.
[Since writing the above, I now see a week later on Nov 25, there is an authoritative prediction of 850,000 for November, see Edmunds.com Forecasts November Auto Sales: Gas Prices and Heavy ... to make the Seasonally Adjusted Annual Rate (SAAR) for November expected to be 11.5 million.]
It is certain that 2009 will be worse than 2008. If 2009 was to average 900,000 vehicles per month, i.e. 60,000 a month higher than October 2008 sales, total sales for 2009 would be 10.8m, a further fall of 20% on 2008 sales and a reduction of 40% in two years.
Some portion of the October 2008 drop may be due to difficulties in buyers obtaining credit, but it seems more likely that much of the drop was due to buyers staying at home. There is now a large overhang of new and used vehicles to be sold, effectively at distressed prices.
Trade in values will be much lower, hence reducing available funds for deposits. Thus buyers are likely to prefer replacing with 2008 and earlier models at these lower prices, rather than paying for 2009 production at 2009 prices.
There is now much discussion about whether the big three should be loaned Federal funds, or file for Chapter 11. Their fear of the latter, is that no-one will buy a car from a bankrupt company.
Few commentators have observed that it is already effectively happening in the mind of the public, due to the ongoing media debates about Chapter 11. Who would risk buying a vehicle from the big three during the current debates about Chapter 11?
As an indication of how badly GM has been caught out with it planning, the following quote is dated Jan 3, 2008:
"GM Chief Executive Rick Wagoner said he expected the market in 2008 would be about as tough as the year just ended. "There are some obvious reasons for concern, but on balance I suspect '08 will be similar to '07 in total, although likely weaker in the first half and stronger in the second," Wagoner told reporters in an online chat." Other GM sales executives said the automaker expected that the current first quarter would be the weakest of the year with the U.S. economy managing to avoid recession.
For the industry to survive in its present form, 2009 sales would need to recover to 2007 levels of 16.14 million, or 1,350,000 per month. While the above estimate of 900,000 per month for 2009 may be too pessimistic, 1,350,000 per month is out of the question.
Thus, one way or another, the industry structure will be substantially different twelve months from now.
Conclusion
United States home owning households have seen combined falls of about $80,000 in average house values and pension/investment entitlements, mostly in the last twelve months. Consumer confidence levels are therefore very low.
A stimulus package in late 2008 of say $220 billion, if paid out to households as a grant or tax rebate would amount to about $2000 per household, an amount equivalent to only 2.5% of the $80,000 of house and investment losses per household.
For householders aged 40 or more, $2000 will seem a drop in the bucket compared to their losses and the need to save for their retirement. Realistically, only time will "heal" their spending habits.
Thus, given the adverse economic climate and the present lack of clear leadership, a stimulus package will not provide a significant economic impetus. Most households would instead "save for a rainy day" or repay some debt.
Unfortunately that is why the 2008 crisis needs to be regarded as a fever that has to run its course.
By now, most of the United States population realises that the next year is going to be very tough and are settling down to concentrate on survival for the next year or so. As with personal crises, it is a case of "time heals all wounds". Thus consumer confidence will gradually return in a year or so, once people in general have adjusted to the "new order".
Apart from the poor economic outlook, the equity market is also in disarray due to the constantly changing "bail-out" rules and the lack of visible leadership. The Dow Index is therefore currently unable to act as an optimistic beacon towards a better future.
What is needed most urgently is strong visionary leadership, acknowledging the coming difficulties of 2009, but giving an economic vision for 2010 and beyond, leading to what might loosely be called the "Promised Land".
Perhaps such a vision might include some elements of the Five Point Plan suggested in Part 4. See George Washington and the 2008 Financial Crisis - part 4
The general population will desperately want to believe in such a vision, even if some aspects seem unpalatable, provided they can accept the vision points the way to better times than those which will prevail in 2008/2009.
As there is now a lame duck presidency, such a vision cannot be promulgated until late January 2009, at the earliest.
Time will tell if the baton is taken up by the new president.
Afterthought
(Only for those with a sense of humor)
Although there are various contributing factors, the current financial crisis is essentially the result of poor Government stewardship and so, as with any corporation, the buck stops at the top .
Given the increasing size of the mess, please forgive one for wondering "a little tongue in cheek", whether the United States Constitution provides scope for the current President to be impeached for incompetent financial leadership or, alternatively, for telling "untruths" about the strength of the economy?President Nixon was to be impeached for lying to Congress, but his "untruths" did not cost the country any money. There were calls for impeachment of the President Clinton for un-Presidential like actions which are not condoned, but his "untruths" did not result in trillions of dollars of losses.
Thus what should be the future test for considering Presidential impeachment? Just a thought!
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