We recently attended the NAI Global Conference in NYC, and wanted to provide a few insights we took away from the keynote speaker: Dr. Linneman, Chief Economist of NAI Global, Principal of Linneman Associates, and Real Estate professor at our alma mater, the Wharton School. The following is a close paraphrasing of his thoughts.
A typical recession is usually centered on the housing and auto sectors, and their financiers. GDP goes to 0% and 1.5-2 million jobs are lost. This occurs because that’s the amount of people that were hired in anticipation of growth that never materialized. However, this was no ordinary recession.
In this past one, the Fed made the greatest monetary policy mistake since the Great Depression: from 2002-2005 it kept the short term interest rate too low (making it negative net of inflation). This incentivized people to:
- Borrow short, because of the negative interest rate
- Invest long and risky (read: homes, factories, buildings, etc.), and create more long and risky assets to feed this demand
This game ended as soon as interest rates increased with the Fed taking rates to 3.25% net of inflation. Now, the opposite kicked in:
- The demand for long and risky assets fell
- Asset prices went down double fold, first because of the now higher supply of long and risky assets, and second because of the artificially high short term rates
In addition, we saw the greatest regulatory failure since perhaps Pearl Harbor. We paid billions of dollars to make sure the FDIC can ensure that banks are “safe and sound”, as per its 1933 charter, and we failed in our oversight of the banks.
The combination of artificially low-to-high rates and our regulatory failure led to a panic. By the time financial gurus and Fed presidents all came out to say “the world’s coming to an end this weekend unless we save you”, the entire system panicked. This translated into one of two actions: running or freezing (i.e. either laying off workers or halting any new hires and replacements).
Thereafter, we lost 8.5 million jobs (7 million of which were due to this panic) during which time we added 1.5 million jobs’ worth of space (lagging supply). We are therefore 10 million jobs short of the same rent and occupancy dynamics we had in 2008. Note that 3 million people are added to the population each year, of which 1.8 million or so need to work, equivalent to our approximate annual job creation during normal times. At this rate, it will therefore take us 5.5 years until we get back to the same rent and occupancy dynamics of 2008.
If, however, we were to add 3.5 million jobs/year, it will take us until mid to late 2013 to reach that threshold. This is very possible, despite the predictable group of people who can’t see how we will do so (these naysayers appear at the tail end of every recession). Every metric hit bottom last year except unemployment, which relies on profits to decrease. Further, we are in the fifth quarter of consecutive profit growth (typically, hiring begins 5-6 quarters in). Job growth should therefore pick up in July and will take place in the hardest hit sectors (housing and auto) and the strongest sectors (healthcare, medical/pharma and education). Noteworthy is that 65% of jobs lost were in sectors that froze, not those that ran (i.e. those that still have natural demand and growth such as the medical space). Further, healthcare represents 19% of our economy and has been at a complete standstill since mid-2008 due to the uncertainty that came along with the healthcare reform package. Now that we have clarity, regardless of direction, growth, innovation and progress in the space can ensue, unlocking the power of that 19% of our economy.
The bottom line is that we will get a very strong recovery to mediocrity. We will robustly propel ourselves forward for 3 years only to reach the dynamics of five years ago, yet with a whole lot more people (translating into a 7% unemployment rate) … having basically flat-lined for five years.
{ 3 comments… read them below or add one }
A very good summary of the sad state of affairs in the macroeconomy. If economists were actually licensed, we would face massive malpractice lawsuits.
I agree that Greenspan kept short-term interest rates too low for too long. In this paper, however, he defends the Fed’s monetary policy during this time. He notes that the global savings glut drove down longer-term interest rates, such as mortgage rates. In turn, lending standards, in particular for residential real estate, declined. Through securitization and leverage, poor quality loans contaminated investment portfolios. Once housing prices peaked and, worse, declined, the process unraveled. Fr economists, this process should not be a great surprise. Hyman Minsky developed a simple analytic framework, the conjectures of which he called the “Financial Instability Hypothesis.”
In my opinion, Greenspan bears some of the blame for everything but the global savings glut.
(Pseudo) John Hicks, PhD
NICE reference to Minsky … though this is probably not too academic on my part, I actually think he describes behavioral economics, just in terms of symptoms (i.e. higher debt) vs. causes (human behavior and its predictable cycles). I strongly believe that there’s a reason that history keeps repeating itself, either in terms of economics, booms/busts, wars, etc. … because our human nature is what it is – it’s the one constant throughout history.
The Greenspan/Bernanke global savings glut hypothesis (GSGH) notes that a rise in savings rates outside of the US was the leading cause for the bubbles in real estate and asset prices. In making this claim, they, of course, let themselves and the Fed off the hook. Here is a summary of an interesting paper that refutes the GSGH. The authors say the direction of causality is wrong. They say that the bubble in US real estate and asset prices made people feel weathier, which drove a consumption binge, resulting in the massive current account deficits during the period 1995-2005.