When will the economy get better – Part II

By Scot Herrick | Personal Finance

Mar 17

Part I of When will the economy get better?” noted that it is sometimes easier for me to see how we are doing through charts and graphs. It referred people to the Calculated Risk blog and the excellent February Economic Summary in Graphs.

What the short article did not do was explain why I use these indicators to help me understand when the economy will get better. My viewpoint on the timing for recovery focuses on when employment will get better. We’ve seen ugly job losses and many are wondering how they will be able tell when the economy will get better.

The charts are good, but here is a non-economist view of what needs to happen to make employment better.

Higher employment comes after the economy is better

The unemployment rate will continue to rise well after the “bottom” of the recession. Employment is one of the last indicators of improvement in the economy. So while the stock market will recover and businesses too, people will still suffer from high unemployment rates. My personal opinion is that employment won’t get much better until 2010. It is one of the reasons I advocate having one-year’s take home pay in the bank as a buffer to poor employment conditions.

The reason employment won’t get much better has to do with housing prices, family debt, and the willingness of banks to lend money.

Housing needs to stabilize

This recession is fueled by the housing bubble that burst. You are all aware of the statistics that show housing prices coming down, foreclosures up, and people being “upside-down” in their mortgages where the mortgage is more than the house is worth.

Stability in this market means housing prices get back to the historical mean where housing price increases matched personal income increases. That relationship ended in about 2001 with low, low interest rates and caused the bubble.

Once prices stabilize, sometime in early 2010 in my opinion, people will still be significantly under water with mortgages taken out in the last several years. Total flexibility for homeowners won’t happen until people can sell their homes without a loss. Consider people offered a new job out of state – they can’t move right now because the job offer can’t make up for the loss in housing that would require them to come to closing with money. Note that breaking even at closing still means no down payment for another house in the new state.

“Stabilize” doesn’t mean a one month change like we saw in the housing starts today; we’ll need to see multiple months of improvement to see the trend.

The numbers I look at for this is the New Home Sales, Housing Starts, Existing Home Sales, Existing Home Inventory, Home Foreclosures, and the Case Shiller House Prices charts, mostly courtesy of Calculated Risk.

Family debt needs to drop

For years, people used their home equity as a financial ATM. The “savings rate” in America went to zero as we assumed housing prices would continue to rise and we could just refinance our way to a different lifestyle. That isn’t the case anymore. There is no equity in our homes to use as an ATM and the result is we need to live within our means and have savings to carry us over a rainy day. Or a rainy year.

As a result, for the first time in years, the savings rate in America is on the increase. While some pundits complained that middle class tax cuts will not “stimulate the economy” (and I was one of those critics), I now believe the tax cuts will help Americans get their own balance sheets in order. This is because the tax cuts will mostly go to pay off debt and increase savings. If we can get our balance sheets in shape faster, it will help get spending back into the economy.

Consumers have 70% of the economy through spending and any cold there is devastating to the health of the economy. Watching retail sales tells us how about consumer spending. Spending fell off a cliff in December, but January stabilized roughly with December’s cliff dive. Again, one month a trend does not make.

The charts I look at in this area are Retail Sales, the US savings rate, and the debt ratios on household debt.

Credit needs to open up

Credit and lending is much better now than in the fourth quarter of 2008 – but still twice as bad as normal. So your improvement here is great, but not relevant to most people – and businesses — when it comes to loans. Businesses need loans to finance receivables or inventory. Without these types of loans, businesses can go out of business in a heartbeat. Yet, that is the situation most banks have put businesses in – companies with virtually no debt don’t need banks in this environment and will be more successful than businesses with debt.

Even banks are loath to lend to each other. When they do, the rates they charge are about twice as high as normal. All of this is because the loans on the banks books are opaque – we can’t see the real value of the portfolio. That increases risk.

Then, when the value of the portfolio drops, banks need more capital – read “money” – to keep them afloat. That results in less money available for loans to businesses and consumers. This is why moving money to bailout banks doesn’t necessarily translate to lending – they need the bailout money to preserve the capital requirements. Frustrating, to be sure.

To evaluate how free and easy credit is, I turn to LIBOR (London Inter-Bank lending indicator), the A2/P2 rates for commercial paper, and the “TED Spread.”

It is not necessary to understand what each of these indicators mean, just that the lower the number, the less risky the lending environment.


We’re in tough economic times. But you will see the signs of stabilization and economic recovery if you watch these three areas for improvement. Without stability in housing, family debt reduction and banks willing to lend, employment won’t get better any time soon.

Now, I’m neither an economist nor a whiz-bang financial planner. But, I need solid information to help guide my personal financial situation. These are the indicators – as my newsletter subscribers have seen – that I use to guide me as to where we are in this economy.

  • Imee says:

    I really enjoyed your article… You’d be surprised at how few blogs I’ve read have faced the reality of the economy properly. I really think people are either too pessimistic or just have no clue whatsoever as to what is happening to the world’s economies. I agree with you on some points, because really, for the economy to get better, companies will still have to do business as usual, so money will flow and hopefully the economy will be back on track soon.

    • Scot says:

      @Imee — I am, by nature, optimistic and quickly move to looking for solutions to problems rather than focusing on the problem. The first place to look for solutions, however, is understanding the magnitude of the problem. Then, once you can have some solutions out there (for example, the stimulus package), you should have some indicators of how the solutions are working. Since most housing recessions are simple to understand (with some research), I use them to see if we can predict the turn.

      This recession is very different in that the debt problem of consumers and companies is immense. Plus, the financial companies got away with unregulated mayhem and we are paying for that now through bailouts and no lending. All this makes this one tough — and long lasting.

      Thanks for your comment!

  • Johanne says:

    Yes family debt needs to drop.

    “– companies with virtually no debt don’t need banks in this environment and will be more successful than businesses with debt.”

    I think businesses should remember the first rule of finance: “cash is king”. Opening up credit like before and relying too much in accounts receivables will only lead to another recession.

    • Scot says:

      @Johanne — businesses routinely finance receivables without issue in the past. So I am not as worried about that as other types of credit out there. Businesses will adjust.

      The more important issue is the consumer debt because consumer spending drives 70% of the economy. We need to drive the debt down and get spending in line with the new “my house is not my ATM” spending level. Companies will need to adjust to the new (lower) level of demand. It is a painful process…

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