good news! ;-)
Source Jim Devine
Date 09/01/08/11:57

2009 Will Be Very, Very Bleak
Nouriel Roubini

IT IS clear that 2008 was not a very good year, and it is official
that the current recession started in December 2007. So how far are we
into this recession that has already lasted longer than the previous
two (the 1990 and 2001 recessions lasted eight months each)? I believe
the U.S. economy is only half way through a recession that will be the
longest and most severe in the post-war period. U.S. gross domestic
product will continue to contract throughout 2009 for a cumulative
output loss of 5% and a recession that will last close to two years.

Let us look at the picture in detail:

Personal Consumption

The resilient U.S. consumer started to give up the ghost in the third
quarter of 2008, when for the first time in almost two decades,
personal consumption contracted. With personal consumption making up
over two-thirds of aggregate demand, the outlook for the U.S. consumer
is at the center of the dynamics that will play out in the real
economy in 2009.

In my view, personal consumption will continue to contract quite
sharply throughout 2009 as a result of negative wealth effects from
housing and equity market losses, the disappearance of home equity
withdrawal from the second half of 2008, mounting job losses, tighter
credit conditions and high debt servicing ratios (the debt to income
ratio went from 70% in the 90s, to 100% in 2000, to 140% now). This
retrenchment of the U.S. consumer will result in a painful rebalancing
in the economy that will eventually restore the savings rate of a
decade ago.

The wealth losses for households related to the fall in home prices
are roughly $4 trillion so far, and are clearly bound to increase
further as home prices continue to fall -- eventually reaching the
$6-8 trillion range (compatible with a 30-40% fall in home prices peak
to trough). With a negative wealth effect of 6 cents on the dollar,
the reduction in personal consumption could amount to a whopping $500
billion. And negative wealth effect from fall in equity prices -- on
the wake of a bleak 2009 for corporate profits -- will also contribute
to the contraction in personal consumption by an estimated $100
billion (compatible with a 25% contraction in the stock markets).

Housing Sector

The fourth year of housing recession is well on course.

Total housing starts have plunged from the 2.3 million seasonally
adjusted annual rate peak of January 2006 all the way to the 625,000
SAAR of November 2008 (the last data point available), an all-time low
for the time-series that started in January 1959. Single-family starts
built for sale are down 75% from their Q4 2005 peak.

On the demand side, new single-family home sales are down 65% from
their July 2005 peak. Both demand and supply of homes are therefore
still falling very sharply, which does not bode well for inventories.
Inventories are the mortal enemy of prices for any goods-producing
sector, including housing.

Starts need to fall substantially below sales so that the excess
supply in the housing market is reabsorbed. Inventories persist at
record highs and the gap between one-family starts (for sale) and
one-family sales is at levels that cannot promote a fast work-off of
inventories. To put these numbers in perspective, compare this with a
measure of vacant homes for-sale-only. Vacant homes for-sale-only were
at 2.2 million in Q3 2008, an all-time high. In the decade between
1985 and 1995, it oscillated around 1 million units on average and 1.3
million units between 2001 and 2005. This implies that we have to deal
with an excess supply that ranges between 0.9 and 1.2 million units,
of which roughly 85% are single-family structures.

The sharp and unprecedented fall of starts might not have reached a
bottom yet. In this economy-wide recession, weakness on the demand
side is bound to persist, and we believe that supply will have to fall
further, given also the great wave of foreclosures that is adding to
the excess of supply in the market. I see starts falling another 20%
from current levels and believe that home prices will not bottom out
until the middle of 2010.

Labor Markets

With the continued credit crunch and significant cut-down in consumer
and business spending, the monthly job losses will continue in the
400,000 to 500,000 and 300,000 to 400,000 range during the first two
quarters of 2009 respectively, bringing the unemployment rate to 8% by
mid-2009. The severe contraction in private demand until early 2010
will keep layoffs high and the unemployment rate elevated over 8%.

[I'd add that the human impact of higher unemployment is larger than
it was 20 or 30 years ago. People are more dependent on their jobs for
medical insurance, have more debt, etc. So an 8% unemployment rate
might have the impact of a 11% unemployment rate back in 1982. -- JD]

Economy-wide job cuts are expected, with big corporations and small
enterprises, residential and commercial construction, financial
services and manufacturing continuing to shed jobs at a strong pace.
Moreover, with structural shifts in the economy since the last
recession, job losses this time will be more severe in the service
sector, including retail, business and professional services and
leisure and hospitality. Unless the fiscal stimulus addresses the
deficit problem for state and local government, job losses at the
government level will also gain pace. In turn, income and job losses
will further push up default and delinquency rates on mortgages,
consumer loans and credit cards. Moreover, the loss of high-paying
corporate and financial sector jobs will be a big negative for tax
revenues over the next two years.

Layoffs are bound to continue thereafter as cost-cutting gains pace
with the beginning of the (sluggish) recovery period in early 2010.
Even as consumer demand might show some signs of recovery, firms, as
in the past, will begin by hiring only part-time and temporary workers
initially. The unemployment rate might peak at close to 9% in Q1 2010,
almost two years after the recession began. However, the hiring freeze
across industries that began in late 2007 will continue at least until
2010, causing discouraged workers to leave the work force and
containing the extent of the spike in the unemployment rate. Further,
the decline in labor utilization will add to the deflationary pressure
in the economy. An aging labor force, lower capital spending and
potential growth over the next few years might also result in lower
productivity growth and an increase in the natural [sic] rate of

[On the other hand, the NAIRU or inflation barrier (more scientific
terms for the "natural" rate) has been steadily falling because of the
destruction of labor unions, etc. Worker desperation helps avoid

Capital Expenditure

Firms have been drawing down inventories beginning in Q4 2008. As the
slump in domestic and foreign demand and difficulty in accessing
short-term credit persist over the next four quarters, business
investment is bound to contract in double-digits throughout 2009.
Industrial production, spending on equipment and durable goods will
also remain in the red through 2009. Moreover, with a sluggish
recovery in private demand even during 2010, firms will start building
inventories and contemplate capital expenditure plans only at a slower


Exports contraction that began in late 2008 will gain pace in 2009 as
more and more emerging economies slip into slowdown following the G-7
countries. On the other hand, easing oil prices and secular downward
trends in consumer spending and business investment will help imports
to shrink. In fact, this might cause the trade deficit to contract in
1H 2009 since the contraction in imports might well exceed the decline
in exports, thus containing any negative contribution of trade to GDP

Dollar Outlook

The fate of the dollar in 2009 rests on the global growth outlook.
After profit-taking on long dollar positions ends, and trading volumes
pick up as investors return from their holidays, the dollar may
temporarily recover its relative safe-haven status in H1 2009. [H1??]
Since markets have yet to fully appreciate the impact of the commodity
slump and financial crisis on the rest of the world, risk appetite may
collapse again on signs of a deeper- or longer than expected recession
outside the U.S. Further de-leveraging of dollar-denominated
liabilities could provide an additional boost to the dollar as a
funding currency.

The bond-yield outlook could be a further source of strength: While
the Fed is already at a zero interest rate policy, other central banks
will cut rates further to stimulate growth, putting downward pressure
on currencies like the euro.

Alternating with these upside risks to the dollar may be downside
risks from 1) a supply crunch in commodities that lifts commodity
prices and producers' economies, and 2) the inability of the market to
absorb increased Treasury supply at low yields.



Annual U.S. inflation, as measured by official producer and consumer
price indexes, is likely to slow in 2009 and even fall into technical
deflation despite increases in the monetary base and fiscal measures
to boost spending power. Slumping commodity prices may drag down the
average annual headline CPI inflation rate to around -2% -- a
technical deflation, which may morph into genuine deflation if falling
prices generate expectations that they will continue to fall.

Meanwhile, the growing slack in product and labor markets will keep
core consumer inflation subdued at an average year-over-year rate of
1% to 2%. Steep discounts to get rid of unsold retail inventory,
rising job losses and lower wage growth will reinforce the trend of
stagnant or falling prices. Loose labor markets and weak demand for
commodities and goods/services will keep producer prices at bay. Risks
to the outlook include 1) a commodity supply crunch or geopolitical
shock that leads to a sustained rise in commodity prices and 2) an
earlier than expected global economic recovery.

Credit Losses Still Ahead

Back in February 2008, I warned that the credit losses of this
financial crisis would amount to at least $1 trillion and most likely
closer to $2 trillion. As of mid-November 2008, the threshold of $1
trillion in global financial write-downs was finally reached. Given
that national house prices are expected to drop another 20%, we expect
credit losses of $1.6 trillion.

The cycle has also turned in the commercial real estate arena with the
traditional lag of around two years. Current serious delinquency plus
default rates of 5.9% of CRE loans (net recovery, via Fed data) are
projected to increase to up to 17% by Fitch, assuming a 25% fall in
prices ($142 billion out of $2.4 trillion.) In the consumer loan area,
we estimate the credit card charge-off rate could increase to 13% in
the worst case scenario. Adding a typical 5% delinquency rate during
recessions, the total loan losses on unsecuritized consumer loans are
projected to increase to $252 billion out of $1.4 trillion.

Based on my calculations, I expect total loan losses to reach about
$1.6 trillion out of $12.4 trillion of unsecuritized loans alone,
implying an aggregate default rate of over 13%. The International
Monetary Fund assumes that the U.S. banking system carries about 60%
to 70% of unsecuritized loan losses (and about 30% of mark-to-market
losses on securitizations). Even assuming that future loan losses are
fully discounted at current market prices, deploying the remaining
TARP funds towards recapitalizing the banking system would still be

The Disconnect Between Bond and Equity Markets

U.S. government bonds were on a tear in 2008, while equities plummeted
in a nasty bear market. Bond yields at the long end hit all-time
record lows, while the short end even dipped into negative territory.
Only Treasury Inflation-Protected Securities suffered as deflation
risks rose. Stocks, on the other hand, had their worst year since the
Great Depressions: Dow Jones Industrial Average lost 34%, and S&P 500
was -38.5%. At its 2008 low on Nov. 20, the S&P 500 was down 49% for
the year and 52% from its October 2007 peak. Stocks rallied in
December, though, resulting in an apparent disagreement between the
stock and bond markets over the outlook for the U.S. economy. Bond
markets seemed to be discounting a recession in 2009, while stock
markets have been gaining since late November. This disconnect may
vanish in 2009, though, if the stock market rally was really just a
bear market rally due to portfolio rebalancing and thin year-end trade

However, there have been intimations that the bond market is in a
bubble about to burst in 2009. Indeed, with ultra-low bond yields,
investors may be tempted to switch into higher-yielding equities --
which are now considered by many to be undervalued. Valuation,
however, is not the be-all and end-all of asset performance. The
credit freeze needs to end before equities can see the end of the bear
market. However, considering the likely economic stagnation ahead,
bonds should be a better bet than equities for some time. I see
meaningful downside risks to stock prices as bad macro news -- worse
than expected -- continues to dominate in 2009. Using the S&P 500 as
the benchmark, earnings per share will stay in the $50 to $60 range --
and earnings will fall further. If -- and it is not unusual during
recessions -- the price-to-earnings ratio falls in the 12 to 14 range,
we could see another 25% slide in stock prices.

Fiscal and Monetary Policy

1. Fiscal Policy

A lot of hope is being placed on the expected fiscal stimulus package
of around $750 billion spread over 2009-10, including 40% of the
stimulus in tax cuts for households and firms. Around half of the
stimulus is expected to kick in starting Q2 2009 and through 2010. But
this will fall short of the pullback in private demand of close to $1
trillion during this period.

Infrastructure spending, in spite of being highly effective, might not
be timely, stimulating the economy only in late-2009 and 2010 when it
has well passed the severe recession phase only to exacerbate the
ballooning fiscal deficit. Nonetheless, around $100 billion of
infrastructure investment might be able to kick in during 2009.
Moreover, job creation in infrastructure might be overestimated, given
limitations in moving laid-off workers from other sectors to the
infrastructure projects. As such, any job creation via government
spending and tax incentives for firms will significantly fall short of
the ongoing layoffs.

Given the drawback of the "spending" component of the stimulus, the
government may be enticed to implement more tax cuts. While tax
incentives for households like payroll and child tax credit might be
well-targeted at the group with high propensity to spend, tax cuts in
general will be less effective in stimulating demand, given a secular
rise in the savings rate expected over the next few years. Likewise,
tax breaks for firms hiring new workers or investing in new equipment
will be rather ineffective, since businesses see little viability in
doing so during a slump in domestic and export demand. At the most, a
tax stimulus, in spite of being timely and well-targeted, will cause
only a temporary rebound in the economy for a month or a quarter,
merely shifting the spending-decision period just like tax rebates did
in second-quarter 2008.

Expansion of unemployment benefits, food stamps and other incentives
will have a high bang-for-buck effect in 2009 and will only assuage
the impact of the recession. The stimulus will also include up to $100
billion for state and local governments to meet their severe budget
shortfalls, including grants, Medicaid and unemployment insurance
funds, preventing cutbacks in public services, and investment and jobs
in several recession-hit states. But again, fiscal aid for states
often suffers from time lags.

Fiscal stimulus, TARP spending,
government-sponsored-enterprise-related expenditures, along with
further slowdown in corporate and individual income tax revenues, will
push the fiscal deficit to around $1.3 trillion in fiscal year 2009.

2. Monetary Policy

The Fed has enacted a wide and unprecedented range of measures to
mitigate the credit crisis and stimulate the economy. It has already
cut its target range for the Fed funds rate down to 0% to 0.25% but,
more importantly, it has created currency swap lines and an alphabet
soup of programs to provide liquidity to the financial system and
clean out toxic financial assets. The Fed experimented with different
forms of financing itself in order to enable a sharp expansion of its
balance sheet to accommodate these liquidity facilities. In addition
to rate cuts and quantitative easing, the Fed has directly aided
failing financial institutions. Now, the Fed is considering issuing
its own debt and/or purchasing long-dated Treasuries and Agency debt.

Will the monetary easing work? So far, the increase in money supply
has not been accompanied by an increase in the velocity of money. In
other words, credit growth remains stagnant as banks are reluctant to
lend back out the money provided by the Fed and, at the same time,
borrower demand has fallen.

Nouriel Roubini, a professor at the Stern Business School at New York
University and chairman of Roubini Global Economics, is a weekly
columnist for A number of analysts at Roubini Global
Economics assisted in the writing of this week's column.

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