“If past performance is a reasonable guide to accuracy of future
forecasts, considerable uncertainty surrounds all macroeconomic projections.”
– Federal Reserve – 11/2007
This marks the fifth year that I have written an economic forecast for the
Wisconsin REALTORS® Association. As the quote from the Federal Reserve suggests,
the dynamic nature of our new, global economy is a cause for much humility among
economists. We continue to see economic challenges and changes – many appearing
without much warning – that affect the U.S. and Wisconsin economies.
Despite those changes and challenges, the data indicate that we are now in
the 75th month of economic expansion since the brief recession of 2001. This
expansion has continued well beyond the post-war average of 51 months of
recovery and is remarkable in many respects.
The Subprime Economy
Economic forecasts for the last half of 2007 and for 2008 are dominated by
the current crisis in the subprime mortgage market. High oil prices and tepid
auto and retail sales are taking a back seat to the credit crunch caused by the
financial engineering of subprime securities. The essence of this crisis is the
uncertainty of the value of securities that were issued on pools of subprime
mortgages. This problem has spread across the financial sector and has had a
global impact on the availability of credit.
To date, the subprime mortgage problem has manifested itself in rising
mortgage default rates, massive write downs for Wall Street investment bankers,
and the failure of at least two large hedge funds that used extensive leverage
to boost returns on subprime mortgage investments. Daily revelations of
additional losses related to subprime securities has increased uncertainty on
Wall Street and global financial markets. The subprime mortgage crisis has
worked its way throughout the global financial system and has raised credit
availability problems for home lenders and business lenders and now threatens
the municipal bond market.
Recent actions by the Federal Reserve Bank and the European Central Bank to
inject liquidity into the credit markets are a sign of the pervasive effects of
the subprime problem.
The Wisconsin Economy
How will this subprime economy play out in Wisconsin? As I have written in
most of my previous forecasts, the Wisconsin economy is diversified and
continues to grow at a steady pace. This economic balance keeps us from booming
in good times and busting in bad times.
For 2008, the economic forecast for Wisconsin, as offered by Global Insight’s
report to the Wisconsin Department of Revenue, suggests that Wisconsin will
follow the U.S. forecast. Wisconsin personal income growth, the basis for
consumer spending, is projected to be 4.3 percent compared to the projected U.S.
growth rate of 5.2 percent. Wisconsin personal income growth continues to be
influenced by slow growth in the Milwaukee and Racine metro areas. Low growth
rates in these regions offset higher growth rates in the Madison, Appleton,
Green Bay and La Crosse metro areas.
A number of economic trends in the Wisconsin economy could boost economic
growth prospects for 2008.
- Wisconsin will not be hit by the subprime crisis as hard as most other
states. Mortgage foreclosures in Wisconsin are half the national average.
- Wisconsin consumers have above national average credit scores and lower
debt levels.
- Booming export sales are employing manufacturing workers in Wisconsin.
Exports in 2006 were over $17 billion dollars, a 50 percent increase over a
three-year period.
- Wisconsin business, particularly the technology business sector, is
expanding and creating wealth. A buyout and initial public offering of just
two companies, Tomo Therapy and Nimble Gen, produced nearly a half a billion
dollars in wealth creation for investors. Angel investing in the state
continues to rise as the number of formal angel groups in the state approaches
20.
- Regional economic development groups like New North, Thrive, M-7, Centergy,
and Grow North are beginning to have a positive impact on economic development
and technology transfer.
The U.S. Economy in 2008
The current set of economic problems has led to very cautious predictions for
2008. About 20 of economists now think we could have a recession in 2008. Alan
Greenspan puts the chance of recession at 50 percent. The Federal Reserve in its
first ever forecast for the U.S. economy pegs 2008 growth in Gross Domestic
Product (GDP) at 1.8 percent to 2.5 percent. The White house lowered its
forecast of GDP growth in 08 to 2.7 percent. And Global Insights sees growth in
GDP of about 2.8 percent.
These forecasts are typical of the thinking in the economic community as of
December 2007. But these forecasts were hardly out the door when we saw
unexpectedly high Black Friday and Cyber Monday retail sales beating forecasts
by about 10 percent. Thereafter came a robust report from the Business
Roundtable. That survey of companies with aggregate sales of $4.3 trillion
showed that over 75 percent of the firms expected no change or positive growth
in sales, hiring, and capital investment. Additional data late in 2007 showed
that the U.S. economy had its best quarter in four years (4.9 percent economic
growth in the third quarter of 2007), productivity surged, and corporate
insiders bought more shares in the third quarter of 2007 than any other time in
the last four years.
Despite very serious problems in the housing sector, the U.S. economy
continues to be very resilient. It is important to keep in mind the sheer size
of the U.S. economy. Many discount the U.S. economy in favor of emerging market
economies. Yes it is true that China and India are growing their economies at a
double digit rates and are creating global market opportunities. And the U.S.
growth rate has been around 3 percent over the last three years. But keep in
mind that if the U.S. economy grows 3 percent on a base of nearly $14 trillion,
that produces nearly a half a trillion dollars in economic growth. By contrast,
if China grows at 10 percent on a base economy of less than $4 trillion, that
produces less than a half a trillion in economic growth.
Why the U.S. Economy May Beat the Economic Forecasts
The U.S. economy has less economic risk (risk of recession) than at any time
in its history. In the last 16 years we have had one very short, very mild
recession. This large, nearly $14 trillion dollar economic engine is in my view
less risky today because:
- As we have lost low value, cyclical manufacturing jobs and product, we
have also reduced the cyclical risk that goes along with manufacturing.
- We spend more on health care (now about $1 of every $6 of economic
activity in the U.S.), and most of that sector is not subject to short term
recessionary risk.
- And as the number of retirees increases, the portion of national income
drawn from transfer sources funded by assets or taxes increases. Put simply,
we derive more of the national income from Social Security and pensions and
that income too is far less subject to downturns in the national or global
economy.
But the real reason I believe the overall economy will do well in 2008 is all
about politics. 2008 is a presidential election year. The table below shows
growth in the GDP in presidential election years and the year before election
year since 1972.
The good news is that in a year of presidential politics, it is highly
unlikely that the subprime mortgage crisis will be ignored by either the White
House or the Congress. Both will act to fashion some sort of assistance or
bailout. That said, the bad news is that no matter what the politicians do, it
will take some time to normalize mortgage and credit markets and additional time
to prime the pump to boost home building and sales.
Why Housing and Home Sales Won’t Perform as Well as the Economy:
The overall economy is in our view likely to grow 2-3 percent in 2008.
Unfortunately, housing will be a drag, not a contributor to economic growth. How
long this will persist is the subject of much speculation. In Wisconsin and the
national economy, housing starts, permits, and sales continue to decline on a
year over year basis. The good news is that the rate of decline seems to be
slowing.
The longer term problem that needs to be resolved is the normalization of
mortgage credit markets. The subprime issue involves about $2 trillion in
collateralized subprime securities. The valuation of those securities is one
issue that will take some time to work out. The recent appearance of investment
and hedge funds who will speculate in subprime securities, many of which sell
for 30 cents on the dollar, suggests we are beginning to work our way out of
this mess.
A larger issue is to restore credit capacity to the housing sector. The
Federal Reserve is proposing rules to regulate mortgage underwriting and to
raise standards to avoid future defaults. The White House and Congress are also
proposing measures to help. Keep in mind that 2008 is an election year.
All of these steps will help. But housing tends to run in long cycles. We had
an uninterrupted housing boom of about 15 years. Because of the number of credit
issues and the longer lead times to ramping up economic activity in housing, we
could see this period of consolidation last for several years.
Unfortunately for Wisconsin, the national subprime mortgage effects wash over
us as well. We generally take care of our financial business but can’t avoid the
spillover effects of the national housing bubble. On the other hand, even in
this subprime crisis, houses will continue to be built (the current rate
suggests 1.1 million new starts in the U.S. next year) and homes will be bought
and sold at a projected rate of 6.3 million, similar to rates in the early part
of this decade.
Dr. David J. Ward is the founder of NorthStar Economics, Inc., a private
economic consulting firm in Madison, Wisconsin. Dr. Ward earned a BBA, MBA and
Ph.D. in finance from the University of Wisconsin – Madison, and completed a
31-year career in the University of Wisconsin System in July of 2000.
Dr. Ward has extensive experience in strategic economic planning, and his
work on “Wisconsin and the New Economy” has been widely recognized throughout
the state and the Midwest. He was instrumental in planning and presenting at the
statewide Wisconsin Economic Summits I, II, III and IV that have led to New
Economy strategies and regional economic planning efforts in Northeastern,
Central, and Northern Wisconsin.
Published: 1/15/2008
