Is the Slow-covery in Trouble?

Last week, the Fed’s Open Market Committee said the pace of the economic recovery had “slowed” and that growth “is likely to be more modest in the near term than had been anticipated.  The Fed announced it was going to take some of the payments it has received from CMBS bonds and other assets it purchased as part of the stimulus, and reinvest them in Treasuries – effectively holding down mid-term interest rates –  in an attempt to stimulate the economy further. The Fed noted that high unemployment, modest income growth, lower housing wealth and tight credit were holding back household spending.

Sudeep Reddy of the Wall Street Journal explained succinctly how the Fed’s plan is supposed to work:

“After cutting short-term interest rates nearly to zero in December 2008, the Fed essentially printed money to expand its portfolio of securities and loans to above $2 trillion, from $800 billion before the global financial crisis. Its purchases of mortgage-backed securities and U.S. Treasury debt, aimed at keeping long-term interest rates down, were discontinued in March. The Fed began talking about an “exit strategy” from the unprecedented steps it took to prevent an even deeper recession.

But on Tuesday, the Fed shifted its stance. It said it would act to keep its securities holdings constant at around $2.054 trillion, the level on Aug. 4. Had the Fed not acted, its mortgage portfolio was set to shrink by $10 billion to $20 billion a month, as mortgages matured or were paid off early. Now, the Fed will reinvest those proceeds in U.S. Treasury securities of between two- and 10-year maturities.

Some Fed officials have been uncomfortable with the size of the Fed’s position in the mortgage market. To assuage their concerns, the Fed won’t be enlarging its mortgage holdings.”

Will this further stimulus work? No one knows. But this move is generally not being seen as a good sign for an economy we’ve been repeatedly told is recovering.

The idea that the “recovery” isn’t going so well has been common for months across the bleaker reaches of the economic blogosphere (such as the comments sections of the Calculated Risk blog, or the ZeroHedge blog, or David Rosenberg’s well considered newletters for Gluskin Scheff — where he suggests today that we may not be headed for a double dip because the recession may not, in fact, have ever ended).

However, concern about the pace of the recovery has recently been cropping up more frequently in the mainstream media – especially since the Fed’s announcement. For example, in Saturday’s New York Times, Jeff Sommer questioned whether a double dip recession is likely, asking, “Will the economy pick up momentum or slip back into recession?”

 After noting that Ben Bernanke had recently called the current economic outlook “unusually uncertain”, that Lakshman Achuthan, Managing Director for the Economic Cycle Research Institute agreed that “growth has definitely slowed” and that Bill Gross of bond manager Pimco said, in essence, that the momentum of the economy from the first to the second quarter was downhill, and that it’s possible we’re close to a double-dip recession, Sommer stated:

“Still, the economic signs are ambiguous. . . . What’s been lacking is broad consumer demand, a revival of the housing market and sufficient business confidence in large-scale hiring.  And, of course, there are deep structural economic problems — the highest ratio of public debt to gross domestic product since World War II, for example — that will need to be dealt with over many years.”

At the risk of stating the obvious, with so many folks worried about their jobs, or underemployed, or paying down debt, and so many companies sitting on money but not hiring, it’s simply not clear what new business developments are likely to spur sufficient “consumer demand, a revival of the housing market and sufficient business confidence” to lead to large scale hiring.  I have a sneaking suspicion that we ultimately will regret greatly allowing so many jobs to be outsourced, especially manufacturing jobs – ultimately our economic viability as a country boils down to whether we can produce things that others want to buy — and in doing so, whether we can keep our own citizens employed.

Keeping interest rates down to stimulate the economy seems to work in smaller economic downturns, where there’s pent-up demand and ordinary folks can afford to buy things.  But, where so many households are wildly overleveraged and worried about their futures, the Fed may simply be “pushing on a string” – trying to create demand that simply won’t be there until the overhang of debt is paid off by borrowers, or written off by creditors (who of course then have to recognize their losses), or both.  (Maybe there’s another way to create demand and deal with that debt, but if so I don’t see it.)

And until the huge amounts of debt are somehow cleared or something else makes businesspeople more confident about hiring (and employees more confident about getting and keeping jobs), the current levels of distress in the commercial real estate market seem likely to continue and perhaps increase.  According to Costar’s Commercial Repeat-Sales Indices, the largest metro commercial real estate markets have been “attracting significant institutional capital and forcing prices upward over the first two quarters of 2010 . . . while the broader market has continued to soften. . . . This divergence of the two worlds may soon change as we are now witnessing a pause and softening even within the investment or institutional grade primary markets.”

Doesn’t sound much like a CRE recovery.

CoStar goes on:

Many of the opportunity funds continue to seek out distressed properties, which are affecting the prices shown here, but the expectations of a tsunami of opportunities have not materialized and overall transaction volumes remain below normal.

Distress is also a factor in the mix of properties being traded. Since 2007, the ratio of distressed sales to overall sales has gone from around 1% to above 23% currently. Hospitality properties are seeing the highest ratio, with 35% of all sales occurring being distressed. Multifamily properties are seeing the next highest level of distress at 28%, followed by office properties at 21%, retail properties at 18%, and industrial properties at 17%.

Since current governmental policies seem to be encouraging a “delay and pray” approach to resolving bad real estate loans, this approach (which I don’t think can really be called a strategy) seems to be to hope for a broad economic upturn.   It seems likely that the distress in commercial real estate won’t improve significantly unless hiring picks up, and the trend seems to be going the wrong way.  PRI’s The Takeaway reported that, according to Newsweek and Slate columnist Dan Gross :

“An unemployment rate of 9.6 percent in America may sound bad, but it doesn’t include millions of discouraged American workers. . . The real unemployment rate is closer to 16.5 percent . . . . That’s the Bureau of Labor’s U6 number, which takes into consideration so called “discouraged workers” who have given up looking for work, as well as people who are working part time but would like to be working full time. Overall, according to Gross, the number means that there is ‘one out of six adults in this country whose talents and time and skills are not being utilized anywhere near to the extent of their abilities.’ ”

I hope I’m wrong, or missing something about the economy, but it seems to me that the “Slow-covery” is getting even slower. Instead of a long hot summer, we may be looking at a long cold winter of discontent.

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Attorney Advertising. This blog is a periodical publication of Maura O'Connor, a partner of Seyfarth Shaw LLP and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. You are urged to consult a lawyer concerning any specific legal questions you may have. The contents are intended for general information purposes only and represent the individual views of Maura O'Connor only. Any tax information or advice contained herein is not intended to be and cannot be used by any taxpayer to avoid tax penalties that may be imposed on the taxpayer.

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