With momentum in the nation’s financial, housing and labor markets waning in recent weeks, many economists have been racing to downgrade their forecasts for 2011. For many months, good economic forecasters have understood that the key to 2010 was the production of sufficient momentum to offset a sea of headwinds that we know will become more impactful next year.

For its part, Sage has generally been pessimistic about economic prospects and has built in a high probability of a double dip recession since late-2009. There are a number of things that could happen that would upend the ongoing economic recovery next year. Here are some highlights:

• The ’01 and ’03 Bush tax cuts lapse – as a result, the estate tax becomes draconian and many investors harvest capital gains toward the end of 2010, causing the market to swoon;
• short- and long-term interest rates begin to rise;
• State and local governments begin to slash spending in a non-election year, including in the area of preK-12 education;
• European markets become unsettled fearing that the roughly $1 trillion package to stem the risk of sovereign default has only served to postpone the inevitable;
• The dollar’s value rises along with gold and certain other commodity prices, making production more expensive and limiting U.S. export growth;
• Corporate profits fall short of expectations, causing the U.S. markets to become even more volatile;
• Investors get nervous and consumers become psychologically shaky causing the savings rate to rise again;
• Correspondingly, retail sales begin to slump, inventory investment declines and the emerging momentum in industrial production and durable goods orders is thrown into reverse;
• The federal government looks on helplessly as the 2009 stimulus package monies are steadily spent down and the budget deficit remains stubbornly high as federal revenues fail to rebound;
• Commercial real estate begins to pummel bank balance sheets, leading to further tightening of credit; and
• small business hiring remains frustratingly slow due to an ongoing lack of confidence among owners.

It should be noted that only a handful of these items would need to transpire to send the economy into reverse. There is evidence to suggest that some of these forces are already conspiring to slow economic weakness. As of this writing, the latest Economic Cycle Research Institute Weekly Leading Index indicates that the recovery lost momentum as early as late-April. The Conference Board’s index of leading indicators began to show signs of emerging weakness in June by posting its largest decline since March 2009. Both indicators suggest that the U.S. economy was beginning to limp as the third quarter began.

Economic Dynamics in the Corridor are Simply Different

Though the Baltimore-Washington Corridor has more than a few issues, the region now appears to be in the midst of a self-sustaining economic recovery. The difference between the U.S. economy and the Corridor’s economy is one part economic and one part psychological. Unlike much of the U.S., the Corridor’s economy possesses a key economic driver that is presently expanding briskly; namely defense and related activities.

The presence of this source of employment growth and investment has led many economic actors in the region to conclude that the Corridor’s future is bright, risks are relatively low and that the time to invest is now. In much of the nation, there is no analogous reason for economic decision makers to be similarly confident. Therefore, hiring and investment remain more subdued. Exceptions include Silicon Valley, parts of Texas, Northern Virginia and a host of natural resource rich communities in America’s heartland.

Data characterizing regional activity reflect ongoing momentum. For instance, during the second quarter of 2010, the direct vacancy rate in Annapolis was 12.2 percent, down from a year ago. At 12.9 percent, Columbia’s direct vacancy rate was also down from a year prior. Though vacancy around BWI remains elevated, it has fallen over the past six months. Notable recent office transactions include Computer Sciences Corporation leasing 42,681 square feet, Northrop Grumman leasing 26,149 square feet and ITT leasing 22,575 square feet, all in the BWI submarket.

Housing statistics also paint a picture of steady healing. The active inventory of unsold homes in Howard County is now below 6 months and is below 5 months in Montgomery County. These are indications of housing markets in equilibrium. The attainment of equilibrium, in turn, is associated with rising home values and construction levels.

In Prince George’s County, the active inventory of unsold homes is higher in terms of months of supply. However, the county has made enormous strides toward equilibrium over the past year and was arguably the leading beneficiary of first-time homebuyer tax credits while they were available.

This is not to suggest that the Corridor will experience the pace of growth that characterized the middle part of the prior decade. Challenges remain, including elevated commercial vacancy, tight credit, higher than usual unemployment, consumer shakiness, volatile financial markets, and a potentially slowing national economy. That said, few region economies are positioned to outperform the Corridor next year.

In a move reminiscent of the Great Depression, a growing number of U.S. homeowners appear to be renting out rooms in their homes in order to avoid foreclosure. With the nation’s unemployment rate still stubbornly close to a 26-year high and with foreclosures in their fifth year of increase, more Americans appear to be turning to on-line resources to help them rent out rooms. Approximately a tenth of all U.S. mortgages were delinquent during the first quarter of the current year and more than half of all loans modified under federal relief programs went into default again within one year, an indication of deep distress among many households. Along with Craigslist, one of more prominent websites assisting people with rentals is Airbnb.com. The company was started in 2009 and is now used in more than 5,700 cities in 148 nations.

Revenue is doubling every three months, with customers often being travelers who expect to remain in a particular location for a few weeks. Not surprisingly, some hotel operators aren’t happy about short-term rentals. Earlier this month, New York lawmakers passed a bill backed by the Hotel Association of New York City banning rentals of less than 30 days in apartment buildings, though individual homeowners were not impacted.

The housing downturn that began in 2006 has produced an array of negative economic impacts. Household wealth has been destroyed, construction, real estate and banking jobs have been lost in large numbers, many have been forced from their homes, real-estate related tax revenues have plummeted and government deficits have ballooned.

But one of the positive aspects of the downturn is that it made the value of good schools that much more obvious. That’s because communities with reputations for good schools suffered far less property value declines than adjacent areas. For instance, in Irvine, California, which often receives national attention for the quality of its schools, average home price per square foot has declined about 18 percent since its 2006 peak. But prices in the greater metro area surrounding Irvine have fallen 33 percent. The same is true for Edina, Minnesota, where prices per square foot are down about 14 percent since their peak versus 27 percent for the greater Minneapolis area. And in the town of Andover, Massachusetts, known for its brain power, prices are down 4 percent versus more than 16 percent for the Boston metro division.

This should be a fine year for the economy.  Sage in its typical fashion continues to take a cautious approach to forecasting.  Our model suggests that the U.S. economy will expand in the mid-two percent range this year, the global economy a bit more.  But the domestic economy could easily surprise to the upside. 

A cursory look at recent post-recession years may be instructive.  In 1983, the U.S. economy expanded 4.5 percent.  In 1992, the economy expanded at a 3.4 percent pace and in 2002 at a 1.8 percent pace.  Take the average of those figures and you get around 3.2 percent, which is better than our baseline forecast.  But look more closely at the numbers and you also see a disturbing trend.  Recoveries from recessions are becoming less dynamic, which means that the economy could underperform expectations, too.

Over the course of this year, this blog will chronicle the performance of the U.S. economy and point out a variety of influences.  It will also discuss key economic policy issues in the U.S. and in the nation’s Mid-Atlantic region, including in Sage’s home state, Maryland.

-AB

This week, two important institutions in the Baltimore area faltered, reminding us why we hate recessions.  From what I’ve observed, Bradford Bank was a lovely local institution led by fine people.  The fact that the bank ran into such significant economic/financial difficulty is testament to the fact that it was a lender; a participant in our community’s development.  I’m not suggesting that issues of liquidity and solvency aren’t important, only that I retain a fondness for local institutions led by locals and we’ve just lost another one.  That said, I’m fully aware of the value that the M&Ts, PNCs and Bank of Americas generate for a large metropolitan economy, but like many people, I have a tendency to root for the little guys, too.

We also lost a truly distinctive place at which to dine, the Brass Elephant restaurant in Mount Vernon (perhaps temporarily??).  When I was first married, this is one of the first places I took my wife in order to impress her with her new home.  Like many, I hope the restaurant comes back better than ever.

I’m also hopeful that I’m right that the recession is over.  Despite the ongoing departure of enterprises precious to us, the fact of the matter is that things could be much worse.  The economy has improved roughly a quarter before I thought it would, though I remain concerned that much of the uptick in activity recently is merely temporary and that economic demons are simply waiting for the federal government and Federal Reserve to look in a different direction (akin to 1937-38).

-AB

Many economists are tickled pink because the U.S. economy shrank at just a 1 percent annualized rate during the second quarter.  That was better than the consensus estimate of -1.5 percent.  Investors also seem pretty happy and as of this writing the Dow is racing toward 9,300, the S&P is above a 1,000 and the NASDAQ is above 2,000.

That said, I remain a bit of a skeptic.  I, too, think the recession will end later this year, but I believe the chances of another recession within three years of the end of the current one are above 50 percent.  So much of the current recovery is artificial and motivated by factors such as a 0 percent Fed Funds rate, $8,000 tax credit for first time homebuyers and of course cash for clunkers.

What happens when these inducements go away and tax increases come on top of that?  You should put a big red circle around the year 2012.

-AB

It’s true – the recession will be over in a few months.  A few economists actually believe that it is already over based upon a number of factors, including improving home, retail and auto sales.  I’m not one of them, but perhaps I pay too much attention to the labor market, which remains awfully weak.

Though economists differ regarding when the recession will end, there appears to be near unanimous agreement that the recovery will be a sluggish one.  I am in this camp.  There are a number of reasons for this – let me list a few:

·         Household balance sheets are still overleveraged and the debt service ratio remains high;

·         Commercial real estate’s downturn has just begun and many key sub-segments will require years to recover;

·         Unemployment will continue to rise during the initial months of economic recovery, probably rising to 10.5%-11% by sometime next year;

·         Housing prices continue to decline, due in large measure to rising delinquencies, defaults and foreclosures;

·         Corporate earnings, though improving and beating expectations presently, will not expand briskly in 2010 in many key industries, including those that serve consumers directly – I believe that consumer behavior has been permanently altered and that we will remain over-retailed from a supply perspective for quite some time;

·         The global economy, with the notable exception of China, remains weak, which will hamper export growth (though exports were up in May, a pleasant surprise);

·         Fears of shifting regulations, future tax increases and interest rate hikes will dampen business enthusiasm in 2010;

·         Immigration will not drive the economy forward as forcefully as it has in the past;

·         Income growth will remain weak, particularly since many of the manufacturing and distribution jobs that have been lost during this cycle will not be regained; and

·         State and local governments remain under significant fiscal duress – California and New York State come to mind, though as everyone around here knows, the State of Maryland has its own set of issues.

-AB

Wow – just like that and everyone is pessimistic again – all it took was one bad employment number (June, -467,000 nationally).  All of a sudden, the green shoots are dying and people are sincerely talking about another year of recession – as of this writing, the Dow is slightly below 8,300, down more than 5 percent year-to-date.  Oil is down to $63/barrel, a reflection of growing pessimism throughout the world (notable exception:  China). 

Though we have been among the most pessimistic analysts of the economy, we still believe the economy will find its way out of recession very late this year or early next year.  There are a number of indicators that suggest this, but one can imagine how intense the pressure has become to start shoving stimulus dollars out the door.  The VP has indicated that the administration “misread” how weak the economy was when he and the President entered office, and though that’s probably a poor word choice, this is now Obama’s economy and presumably he will work to turn it around sooner rather than later. 

-AB

I really am tired of playing the part of the pessimist.  Like other economists, I want to talk about green shoots and better times for America and the rest of the world in 2010 and beyond.  But I remain deeply troubled by the direction of things.  Unlike other pessimists, I am not totally fixated on what government is doing – after all, government was invited to the party by the private sector and no one should have been surprised that such a hulking guest has come to dominate the festivities.  I’m actually quite tired of people who insist on blaming government for everything and don’t see the fact that virtually all of us are to blame in some way.

It remains my contention that much of our difficulty emerges from household behavior – we have within the course of three generations shifted from functioning extended families capable of investing substantial time and resources to the raising of young people to dysfunctional nuclear families that allow too many children to meander through streets and schools without focus and without hope.  In 1970, 40.3 percent of U.S. households were characterized as married couples with children (U.S. Census Bureau).  By 2005, this proportion stood at just 23.1 percent.  By contrast, the “other family households” category rose in proportion from 10.6 percent in 1970 to 16.7 percent more recently.  The proportion of households comprised of “men living alone” rose from 5.6 percent to 11.2 percent over the course of this 35-year period. 

Not surprisingly, because of the inefficiencies inherent in broken families (e.g., maintaining two residences rather than one), these families are often incapable of marshalling the resources necessary to properly invest in young Americans.  The response to this lackluster family/household performance has been to scapegoat schools for everything from juvenile crime to globally embarrassing academic achievement.  My sense is that many schools and educators have improved due to intense scrutiny, but the outcomes remain less than satisfactory because students spend only a small fraction of their time in school buildings and much of their behavior is shaped by the community itself.  Others view the lack of school quality as part of a broader conspiracy to perpetuate generational poverty – toward what end one scarcely knows.

Poor behavior is also apparent in the boardroom and all Americans should be shocked at just how poor corporate leadership has been in recent times, from Enron and WorldCom to GM and Chrysler.  Deficiency ranges from all-out corruption to a fixation on the next quarterly earnings statement and nothing else ever after.  To deflect attention from the inadequacy of their performance, many of America’s most visible business leaders blame government for excessive taxation and regulation with one hand even while taking bailout money (financed with current and future taxes) with the other.

At the same time, too many Americans have convinced themselves that we are stylishly post-industrial and can extend prosperity while producing nothing that anyone can physically consume. American agriculture remains a blessed exception, though even here there is excessive reliance on government subsidy and involvement.

The fact of the matter is that for things to be right in America again, Americans have to get things right.  Ultimately, that means that Americans must produce for Americans and for others.  This is not a protectionist rant – rather we have to get smarter.  Here’s how:

·         Insist on fair trade and a floating currency with the Chinese – if they sell our bonds and interest rates go up, so be it – the time to end financial dependence on China, etc. has arrived;

·         Reorient the stimulus package to put more money into basic federal and private research and development with the goal of massively accelerating American innovation;

·         Have a frank dialogue regarding the role of unions in the modern economy and the extent to which they can increase productivity rather than acting merely as agents of redistribution;

·         Put money into high-speed rail on the East and West coasts, fix the air traffic control system before tragedy forces us to, and create a 21^st century electrical grid;

·         Reform Social Security and Medicare right now – we know we can’t afford it, why are we trying?

·         Implement tort reform to drive down the cost of healthcare today and forever – preserve exceptions to damage caps for truly malicious behavior;

·         Implement a buy American campaign at every level of government and society – I’m tired of seeing American flags pasted to the rear of Hyundais;

·         Accept the fact that marriage is a good thing and that the rearing of children in the context of stable family situations is to be encouraged;

·         Embrace legal immigration, particularly for those who would bring to America scientific and mathematical skill sets – the face of America changed with the last election, let’s use that to call out to the world’s brightest to come to our shores, making us stronger and their  respective nations of origin competitively weaker (nothing personal, just capitalism); and

·         Increase household savings – this has already happened in recent months – it needs to be part of a broader, longer-term phenomenon that will allow America to finance (and profit from) her own investments.

-AB

As has been the case with a number of economic data releases in recent weeks, simple interpretation of today’s jobs report is not possible.  While the number of jobs lost in May fell far short of the consensus estimate of negative 525,000, the unemployment rate rose above the consensus prediction of 9.2 percent (9.4%).

The latest employment report should hardly be viewed as good news.  The adult male unemployment rate in the United States is now 9.8 percent, a reflection largely of the significant declines in employment opportunities in goods producing industries like manufacturing and construction.  Anecdotal information indicates that an elevated proportion of recent college graduates are having difficulty securing employment, even if they are emerging from some of the nation’s more prestigious institutions.  This phenomen helps explains the relatively sharp increase in unemployment last month.  The implication is that the United States remains mired in a period characterized by flowed income growth and stressed industries.  The hope is that the pace of employment loss continues to wane in June and during the months ahead