Stocks rallied Wednesday after Federal Reserve Chairman Ben Bernanke suggested the central bank would go ahead with another round of stimulus -- aka quantitative easing -- if the economy continues to slump. In this scenario, the Federal Reserve would once again purchase assets to keep interest rates low in an attempt to support the economy and prop up asset prices.
So far, the Fed's actions have done more good for asset prices like stocks (see: S&P 500 chart since 2009) while doing less to help the economy (see: June jobs report). U.S. gross domestic product grew just 1.9% in the first quarter of the year. For 2011 as a whole, the Fed forecasts U.S. GDP growing at 2.7% to 2.9%, which is lower than the plus 3% forecast they made in April.
Today's guest, Gary Shilling, President of A. Gary Shilling & Co. and author of the Age of Deleveraging says another recession is brewing -- no matter what action the Fed takes. "Economic growth here and abroad is slipping, making a 2012 recession a distinct possibility," he writes in his July newsletter. And, "when you have slow growth it doesn't take much of a shock to throw you in negative territory."
Shilling says the shock to trigger the next recess is "another big leg-down in housing." (An asset class the Fed has not been able to reflate.) As those familiar with Shilling know, his forecasts are generally bearish. However, in his defense, Shilling was one of the few economists who correctly predicted the dangers of the subprime mortgage market and its impact on the broader economy.
The problem with the real estate market remains excess inventory. Based on Shilling's research, there are 2 million to 2.5 million excess homes in the country -- a supply that will take 4-5 years to work-off. The result: Housing prices will fall another 20% and underwater mortgages will balloon from 23% to 40%, he says.
With housing slumping again, Shilling says recession is coming to a town near you in 2012.
Another Recession Brewing?
I agree with Schilling 100% on that sentiment. I would say it differently than housing will cause the next recession though. Housing, the current ugly ducking, will be the noticeable symptom of many economic problems, so it will be easy to say real estate caused it.
But what will cause real estate to slide further? Schilling points to enormous supply, which indeed should pressure pricing lower. But there are other economic factors happening or could happen that will push real estate values lower too. Those factors over and above current supply are also negative for the economy in general.
1) Higher taxes! Illinois has increased both personal and corporate tax rates, which reduces net income, which reduces housing affordability and consumer spending, the two things needed desperately for the US economy. And we currently only have consumer spending supporting the economy.
If we continue to see tax and/or fee increases from Cities, Counties, States, and some day Uncle Sam, "it could be game over." The world as we know it isn't ready for any kind of combination in higher taxes of size, the kind needed to cure City, County, State and Federal deficits. Those kinds of tax changes are not priced into the world yet!
2) Lower government spending! We are in a cycle of gut wrenching changes at the municipal level, which if not solved by either another bubbling economy or higher taxes soon, will have to be solved by layoffs, lower pay and benefits, program cuts, and possibly bankruptcy. Muni budget resolution means people are going to lose, and in some cases a lot.
With roughly 19.8 million muni workers, the change across that front is too big to not have a serious impact. None of that is good for real estate affordability and values, or consumer spending.
3) Jobs creation! Bernanke thinks weak jobs growth is transitory. But where exactly is the jobs creation coming from? Real estate industries? No! Banking? No! Wall Street? No! Manufacturing? No! State and Local governments? No.
We have two negative factors that could intensify in the near future. First, we are losing great paying jobs while gaining lower paying jobs. That's a net negative even if unemployment remains stable. Second, if the economy started to sour, we could see layoffs or salary cuts across corporate America. Again, not good for real estate and consumer spending.
4) Retail spending! Exactly how long can the affluent keep consumer spending up? At what point does the failing economy on Main Street creep into the affluent and cause a change in spending habits? Will taxing the rich force spending change? Or will a soft economy force layoffs and compensation changes in the affluent, like those being announced recently on Wall Street?
5) Baby boomer demographics! It's just a matter of when the Baby Boomer weighs on this economy. The investment and spending changes expected as this group hits retirement is a net negative economically and for real estate.
Gary Schilling is dead right. It doesn't take much of a shock to push into negative territory because there's been not real change on the Main Street economy. I also think he's on point that it doesn't matter what Bernanke does!
I think Gary Schilling is talking Critical Mass! He thinks the upside down crowd could grow to 40% if values fall another 20%. That gels with my math. And a 40% threshold could easily be a large enough level to create a water fall event. It's just too big a portion of the population to not psychologically damage attitudes towards real estate on mass scale. Nothing like we've seen so far!
Schilling calls for a recession in 2012! Which is highly likely. I think it will be another deflationary leg of the current deflationary cycle.
Hope all is well.
J.D. Rosendahl, Rosey