It's going to be a bumpy 2008

The Farm Bureau sent me the December issue of their Market Update, a monthly economic analysis of both the general economy and farm commodities. As for the overall outlook, I found it particularly sobering (negative growth ahead!) and yet well supported by facts. It confirms the general dread that we all experience when we see the stock market plunge for days in a row. Of course, we know economic predictions are often wrong........

From Bob Young, chief economist of AFBF

About the only thing that seems to be certain with respect to the future course of the general economy is the notion of at least a coming slowdown relative to the performance we observed in the first three quarters of 2007. Some have continued to raise the specter of things getting so bad that we may actually tip into negative growth territory. (There’s an economist term for you – negative growth) Third quarter numbers for overall growth in the general economy came in stronger than a lot of people anticipated. At an annualized rate of
4.9%, it caught a lot of people by some surprise.The figures were strong enough to move the
Federal Reserve to state at the October 31 meeting, “The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth.” One of those risks is the current rapid rise in mortgage delinquencies and the potential number of loan delinquencies. Numerous borrowers will see their loans reset over the next 9-18 months, moving even more home mortgages into delinquency and potentially even foreclosure. Foreclosed homes typically sell at a 25-30% discount compared to other homes in the market, dragging down housing prices for even the good borrowers. If you believe the financial press reports,thinking has changed considerably since the last meeting of the Federal Open Market Committee. Continued problems in the financial markets deriving from the sub-prime lending mess are being discussed daily with some discussion now moving over to how the issue is coming through on car loans and how it will affect some state and local governments that used the derivates as investment tools to park money. The results of efforts to get a handle on this issue are having mixed reception. A privately financed effort created to try to serve as a conduit of funds to buy some of these loans instruments was originally envisioned to start with a solicitation of $100 billion. It now appears that fund will only be about half that size. Lending institutions that are not able to move products into this fund or some other funding source will likely be forced to bring these loan amounts back onto their books. This will reduce their reserves and limit the supply of funds they have available to lend to other qualified borrowers. It is this potential limit in credit availability and flow of funds that is causing significant concern. This credit problem at the consumer level is already showing up as a sharp decline in net borrowing by the household sector. First quarter 2006 showed $1.2 Trillion in net borrowing on an annualized basis. Third quarter 2007 had the same number down to $691 billion. A significant chunk of these funds represent a decline in ‘mortgage equity extraction’ – read that as home equity loans that allowed consumers to extract part of their home equity for short term spending. Mortgage equity extraction has fallen 50% from its peak. This was a fine strategy when housing prices were rising and by some measures provided the funds for upwards of 5% of consumer spending. Remove those monies and consumer spending starts to feel pressure. Higher gasoline prices are taking an additional $30 billion per month out of consumers pocket books compared even to August levels of this year. Moody’s Economy calculates a cash-flow measure of income for households that includes salaries and wages as well as equity extraction and other consumer credit. It is at its lowest level in over a decade. Add all this together and you have strong expectations of a slowdown in consumer spending in the coming months, possibly even out to the middle of next year. Consumer spending typically makes up roughly two-thirds of the general economy. Exports have been very strong with the weak dollar and better economic activity in other countries. Many business balance sheets are still in strong shape with a significant amount of cash on hand to deal with slow-downs and possibly even to make investments. Job growth has certainly weakened, but is staying in the 1% range. Bottom line is an economy that is very fragile. Many have talked about the probability of a recession now approaching the 50% mark. This is certainly possible, but my expectation is that we stay slightly on the positive side for the next few months before things start to settle out and the economy moves back toward recovery. Hang on for what could be a rough ride in 2008.