The Slowing Economy & the Fed’s Dilemma

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
August 31, 2010

IN THIS ISSUE:

1. The Economic Slowdown Continues

2. Confidence & Employment Remain in Retreat

3. Bernanke Announces Fed’s Latest Plan

4. Is Obama Planning a “September Surprise”?

Introduction

We will touch several bases this week, including the latest mostly disappointing economic reports, which confirm that the recovery is losing steam. We will also review Fed Chairman Ben Bernanke’s latest speech and his plan to deal with the slumping economy.

And finally, I will briefly touch on the political front. The Democrats are plunging in the polls, and a Republican takeover of the House of Representatives looks like a given. The Senate could now be in play as well. All this raises the question as to whether President Obama will pull out some kind of “September Surprise” as a last-ditch effort to change the mood of the voting public.

Stranger things have happened, but I don’t want my readers to be surprised if Obama uncorks something unexpected over the next month. You will find that discussion at the end of this E-Letter.

But before we get into the topics above, we need to revisit my E-Letter of two weeks ago regarding federal vs. private sector compensation.

Federal Worker Versus Private Sector Compensation

Most of you will recall my E-Letter of two weeks ago when I wrote about how the average federal worker makes double that of the average worker in the private sector. Remember, in 2009 the average federal (non-military) worker made over $123,000 versus just over $61,000 for the average private sector worker. Both figures include benefits such as health insurance.

Not surprising, we had a very large response to that E-Letter. Many readers were shocked that federal workers make double their counterparts in the private sector on average. Surprisingly, a number of readers were so shocked that they claimed I simply made up the salary figures and that they were false. Clearly, these folks are “selective readers” who did not note my sources.

So let me be clear: All of the salary numbers and statistics I quoted came from the Commerce Department’s U.S. Bureau of Economic Analysis annual report that was released earlier this month. The compensation numbers all came straight from the government. Numerous media outlets reported on the federal compensation levels versus those in the private sector. Among them was USA Today – you can read the story at the following link:

http://www.usatoday.com/money/economy/income/2010-08-10-1Afedpay10_ST_N.htm

Some comments we received came from current and retired federal employees who said that they had never earned anywhere near the $123,000 number quoted in the article. That’s probably very true for several reasons. First, the numbers in the USA Today story are averages. That being the case, higher-end salaries tend to skew the average calculation to the upside.

Another possible reason for the feeling that these numbers are too high is that benefits are included along with the salary. While all federal employees know how much they are paid in salary, many do not know the true value of all of the retirement and health insurance benefits they receive. These benefits amounted to over $41,000 of the $123,000 average compensation.

So, no matter how you slice it, federal government employees receive a very comprehensive benefits package that is far beyond the capability of many private-industry employers to provide.

Another comment we received was that it was unfair to compare government jobs to private enterprise because: 1) government jobs often require more education and certifications; and 2) the federal government outsources a lot of lower-paid jobs. Both of these comments are generally true, but they do not explain all of the pay discrepancies between private and federal government employees.

Actually, USA Todaydid another analysis of federal job data back in March of this year that did do an apples-to-apples comparison of specific government and private sector jobs. This study found that federal workers earned higher average salaries than their private-industry counterparts in apprx. eight out of 10 specific job classifications.

The analysis, based on 2008 data published by the Bureau of Labor Statistics (BLS), found that: “Accountants, nurses, chemists, surveyors, cooks, clerks and janitors are among the wide range of jobs that get paid more on average in the federal government than in the private sector.” You can read more about USA Today’s analysis at the following link:

http://www.usatoday.com/news/nation/2010-03-04-federal-pay_N.htm

The fact is that there are some occupations where private industry pays better than the government for the same job. However, for most occupations included in USA Today’s analysis, just the opposite is true.

The bottom line is, I don’t make these things up, ever. If you choose not to believe the official numbers, that is your decision. Keep in mind that this compensation report – public versus private – is published every year by the government. And the compensation advantage for federal workers widens every year.

If you would like yet another take on federal worker compensation versus that of the private sector, read the following Forbes column posted yesterday by John Tamny. He argues that because federal workers are paid so much more than their private industry counterparts, the government is sapping potential innovation from the private economy. It’s an interesting read:

http://www.forbes.com/2010/08/27/government-jobs-wages-innovation-opinions-columnists-john-tamny.html

The Economic Slowdown Continues

Last Friday, the Commerce Department revised downward its latest estimate of 2Q GDP growth to an annual rate of only 1.6%. The previous estimate was 2.4%, and that was considerably lower than the pre-report consensus. And now that number has been further reduced to 1.6%.

The latest GDP number once again came as a surprise to many, but I warned you about this forthcoming revision in my August 17 E-Letter. As I discussed two weeks ago, the downward revision in 2Q GDP was required because more recent data showed that US imports were much higher than expected in June. Imports have a negative impact on GDP figures.

Most of the economic reports over the last two weeks have been negative, including a couple which were the worst we’ve ever seen. On August 24, the National Association of Realtors announced that sales of existing homes plunged 27.2% in July, the largest monthly decline since records have been kept.

Existing home sales totaled only 3.83 million units (seasonally adjusted) in July, down from 5.26 million the month before. The inventory of unsold homes rose 2.5% to 3.98 million units, representing a 12.5-month supply, the highest level in over a decade.

The government also reported last week that new home sales plunged 12.4% in July to a 276,000-unit annual rate – the lowest level since the Commerce Department started keeping such records in 1963. The government also revised down its June new home sales report from an increase of 23.6% to only 12.1% as compared to May.

The inventory of unsold new homes rose to a 9.1-month supply in July, up from 7.6 in June. In a normal housing market, there is roughly a 3-5-month supply of new homes for sale. New home sales fell in every region in the country in July and have plummeted nationally by apprx. 33% since the end of April.

Many home buyers took advantage of a temporary tax credit earlier this year to save up to $8,000, but they had to sign contracts before the end of April to qualify. Many of these contracts closed in May and June, thereby causing a temporary jump in the home sales numbers.

However, many of us cautioned that the tax credits would merely accelerate home purchases a few months, rather than create net new demand for homes. With the plunge in homesales in July, it is clear that the tax credits simply accelerated buyers’ plans without creating a great deal of new demand.

Meanwhile, the home loan foreclosure rate continues to climb. Lenders repossessed 92,858 properties last month, up 9% from June and an increase of 6% from July 2009, according to foreclosure listing firm RealtyTrac, Inc. Banks have stepped up repossessions this year to clear out the backlog of bad loans. July marks the eighth month in a row that the pace of homes lost to foreclosure has increased on an annual basis.

The Mortgage Bankers Association reported last week that 1 in 10 US households with a home mortgage are now at risk of default. The number of properties receiving an initial default notice – the first step in the foreclosure process – rose 1% last month from June, but was actually down from July of last year, according to RealtyTrac.

Does this suggest we may be seeing the worst of the housing crisis? It’s hard to say. Many homeowners around the country who have fallen behind on their payments are being allowed to stay in their homes longer. That’s partly because some lenders are reluctant to add to the glut of foreclosed homes on the market.

But at some point, these homeowners have to get current on their payments or these properties will face foreclosure as well. With unemployment remaining very high, the prospect of these homeowners catching up on their payments anytime soon looks rather doubtful.

So it remains to be seen if we have seen the worst of the housing crisis. There is no shortage of forecasters that expect home prices to fall another 10-15-20% or more before we hit bottom. With the economy now in slowdown mode, it’s hard to rule that out.

Confidence & Employment Remain in Retreat

The government’s Consumer Confidence Index fell off a cliff in June after rising for three consecutive months. The Index plunged from 62.7 in May to 52.9 in June, down 9.8 points in one month, which was far more than the pre-report consensus. In July, the Index fell another 3.9% to 50.4. While not unprecedented, that was the largest two-month slide in confidence in years.

The Conference Board’s official statement with the release of the July Consumer Confidence Index read as follows:

“Consumer confidence faded further in July as consumers continue to grow increasingly more pessimistic about the short-term outlook. Concerns about business conditions and the labor market are casting a dark cloud over consumers that is not likely to lift until the job market improves. Given consumers’ heightened level of anxiety, along with their pessimistic income outlook and lackluster job growth, retailers are very likely to face a challenging back-to-school season.”

That’s about as pessimistic as government reports get. Fortunately, the Consumer Confidence Index for August came out this morning and was up slightly to 53.5 which was above the pre-report consensus.

The independent Reuters/University of Michigan Consumer Sentiment Index has also experienced a huge decline over the last few months. This index plunged from 76.0 in June to 68.9 in July, much worse than expected. This key index fell again in August to 68.9 which was also worse than expected.

With consumer spending accounting for apprx. 70% of GDP, these confidence numbers give little hope of a rebound anytime soon.

Fortunately, not all the economic news has been bad over the last few weeks, but what little good news we did see was not all that heartening. The Index of Leading Economic Indicators (LEI) rose 0.1% in July. This index has been essentially flat over the last four months after rising nicely in the first few months of this year.

Yesterday, the government reported that personal income rose 0.2% in July, and personal consumption expenditures rose 0.4% last month. Both numbers were in-line with pre-report expectations.

Durable goods orders (big ticket items) rose 0.3% in July after falling 0.1% in June, but that was only because of a 76% jump in demand for commercial aircraft. Minus transportation, July durable goods orders fell 3.8% - very disappointing.

On the unemployment front, we are again back to disappointing news. Weekly “initial claims” for unemployment benefits remain very high. While Obama administration officials predicted earlier this year that we had turned the corner on unemployment, the data over the last month has been very disappointing.

Over the last four weeks, the number of persons filing for unemployment has been: 473,000 last week, 504,000 the previous week and 484,000 and 482,000 respectively in the two prior weeks. That’s a four-week average of 487,000. At this rate, the official unemployment rate could be back up to 10% or more fairly soon.

And as always, keep in mind that the government’s official unemployment rate does not include those that have given up on looking for work. If we include those out of work Americans, the real unemployment rate is north of 15%. And just for the record, according to the Labor Department, 2.5 million Americans have lost their jobs since President Obama signed into law his $862 billion stimulus package last year.

Bernanke Announces Fed’s Latest Plan

Fed Chairman Ben Bernanke gave a much awaited speech at the annual Economic Symposium in Jackson Hole, Wyoming last Friday. Having admitted recently that the economy is indeed slowing to below the Fed’s earlier forecasts, there was a great deal of interest in this speech and what steps the Fed was prepared to take in an effort to stimulate the faltering economic recovery.

Bernanke admitted in his speech that the US economy has decelerated in recent months, that unemployment remains too high, and that bank credit remains “tight.” Bernanke voiced his concerns regarding the unprecedented budget deficits we’re running, saying that: “Managing fiscal deficits and debt is a daunting challenge…” He added that the economy is still very vulnerable to shocks. (See my August 24 E-Letter for more information on possible shocks.)

As for what the Fed would do to help boost the economy, Bernanke said the Fed is prepared to make additional large-scale purchases of securities, most likely US treasuries, if the economy continues to deteriorate. You may recall that the Fed – in an unprecedented move – purchased $1.5 to $2 trillion of mostly mortgage-backed securities from big banks during the height of the credit crisis. Now, apparently, the Fed is prepared to buy even more.

The markets have worried for much of the last year that the Fed would have to unload these massive securities positions at some point, as well as raise interest rates. But based on Bernanke’s speech last Friday, the Fed has signed-off for more large purchases (ie – more “quantitative easing”) if need be in the months ahead, and keeping interest rates extremely low.

Bernanke noted several options the Fed may use to lower interest rates even further in the months ahead. He suggested that lower interest rates could trigger more spending by Americans, even though it would make dollar-denominated assets less attractive to investors. Frankly, I think Bernanke is engaging in wishful thinking if he believes incrementally lower rates will spur significantly higher consumer spending.

There was one other option Bernanke put out there that few in the media paid attention to, but one that might actually work. Bernanke acknowledged that the greatest problem for the recovery is the lack of willingness of the banks to lend (I have made this very point all year). Banks have hundreds of billions of deposits sitting at the Fed earning 25 basis points in risk-free interest, which the Fed calls the IOER rate (“interest on excess reserves” rate). Bernanke said:

“The IOER rate, currently set at 25 basis points, could be reduced to, say, 10 basis points or even to zero. On the margin, a reduction in the IOER rate would provide banks with an incentive to increase their lending to nonfinancial borrowers or to participants in short-term money markets, reducing short-term interest rates further and possibly leading to some expansion in money and credit aggregates.” [Emphasis added.]

The fact that Bernanke would threaten to lower – or even eliminate – the 25 basis points in interest it pays to banks that hold reserves at the Fed clearly means that they are extremely worried about deflation. Obviously, my E-Letter last week – “Inflation, Deflation or Stagflation?” – was very timely.

Bernanke’s threat to significantly cut or eliminate the interest paid on commercial bank reserves that are parked at the Fed was a very carefully crafted warning that basically says: Start lending, or else!

While you can bet that the big banks picked up on this shot across the bow, it will only be effective if the Fed is prepared to act on it. We’ll see. The point to be taken here is that the Fed Chairman would never make such a threat unless he is clearly worried about deflation. And he will do everything in his power to make sure that outright deflation does not occur.

As I argued last week, I think we are headed into hopefully a mild bout of deflation that could last a year or longer – assuming it is only a mild bout – to be followed by an unknown period of stagflation (slow economic growth with rising interest rates and inflation).

Is Obama Planning a “September Surprise”?

With the mid-term elections just two months away and their polls dropping like rocks, the Democrats are getting desperate – as well they should be. Democrat pollsters, for the most part, have given up hope of holding their majority in the House of Representatives. Republicans are now on-track to gain 40-50 House seats easily, and 60-70 seats is not out of the question. It is now conceivable that the GOP could take the Senate back as well.

Given these dire circumstances, there is growing talk that President Obama may be planning a “September Surprise,” something radical in an effort to sway the electorate before November 2. Last Thursday, for example, former Clinton adviser and Democratic operative Bob Shrum posted an article in which he called on Obama to cut taxes significantly. Say what??

Specifically, Shrum advised the president to make the Bush tax cuts permanent for all but the top 2%; then he recommended that Obama give a new tax cut to those in the middle class; and he recommended permanently capping the tax rate on capital gains and dividends at 15%. Wow – that’s really something coming from one of the most influential liberal Democrats!

Shrum added, “This wouldn’t be an ideologically pure exercise in economic justice. But it’s a pragmatic [last ditch] measure that could boost markets, sending a powerful, positive signal to voters.” You can read the full article in the links at the bottom of this E-Letter.

In another vein, there are rumors that Obama might order Fannie Mae and Freddie Mac to unilaterally reduce mortgage payments for the millions of homeowners who are under water or behind on their payments. This could mean tens of billions of taxpayer dollars going to those who can’t afford their mortgages. Again, this is just a rumor, but you never know.

And finally, there are those in the Democratic party who are calling on President Obama to announce a huge new Stimulus II. They know the president doesn’t have the votes to pass another new stimulus bill, but they believe his support of it would sway many voters in November. I, on the other hand, think this would be political suicide given the public’s concerns about huge deficits.

I have no idea whether President Obama will announce a September Surprise, but he certainly knows that his party is going to get lambasted on November 2. So, don’t be surprised if he makes some bold moves in the next few weeks…. Remember, you heard it here first.

Best regards,

Gary D. Halbert

SPECIAL ARTICLES:

Bob Shrum - What Obama should do now
http://theweek.com/bullpen/column/206496/what-obama-should-do-now

Health Care Reform Has Endangered the Democrats
http://www.realclearpolitics.com/horseraceblog/2010/08/health_care_reform_has_endange_1.html