He may not be the Fed Chief anymore, but folks still listen to him. On February 26th, Alan Greenspan warned that the U.S. Economy could slip into recession by the end of this year.
During a satellite link to a business conference in Hong Kong, Greenspan suggested that there are signs that the current economic expansion, which began in 2001, is coming to an end. As an example, he noted that profit margins in the U.S. have begun to stabilize, "which is an early sign we are in the later stages of a cycle."
Mr. Greenspan also conceded that most forecasters are not making such a prediction, but rather pointing to a slowdown in 2008. Surprisingly, he also admitted that he has not seen any economic spillover effects from the slowdown in the housing market.
I found his statements to be of particular interest because I have hinted in my own columns here in Realty Times my belief that a recession is more of a threat than the economic gurus believe.
Back in January of 2006, I reported in a column that the yield curve flipped, meaning short term rates became higher than long term rates. Historically, an inverted yield curve has been followed by a recession. Without making a solid prediction, I did suggest that if the economy slows in 2006, lower interest rates were likely.
Well, it seems I was wrong, but perhaps only temporarily. The economy continued to grow at a brisk pace in 2006. Long term interest rates have risen only slightly -- about a quarter percent.
I wrote another column in August to report that the Federal Reserve finally paused its interest rate hike campaign, after 17 consecutive increases. While "core" inflation, which excludes volatile food and energy prices, remained at a fairly tame 2.50 percent in 2005 and 2006, overall inflation had been closer to four percent. I suggested that the American consumer doesn't care where inflation comes from. Higher prices mean higher prices, whether they come from post-Katrina energy costs or a commodity that would be included in the "core" number.
My position hasn't changed and Mr. Greenspan's comments only strengthen my beliefs. Consider the following example from my field: mortgages and housing.
Back in 2003 my small mortgage company, consisting of 10 employees, originated more than 1,200 loans. The majority of these applications were homeowners refinancing their existing mortgages to take advantage of sharply lower rates. With the exception of folks taking out shorter term loans, such as a 15 year loan, most refinancers dropped their monthly payment by taking a lower rate or took out a larger loan, resulting in "cash out." Either way, these refinancers winded up with more liquidity.
Multiply these numbers with the thousands of other mortgage companies who shared the same refinance volume in 2003 -- Liquidity poured into the economy. Americans are not known for being big savers, so this money went into the economy.
Let's fast forward to 2006. My company's refinance volume was a fraction of what it was in 2003. And many of the refinances were not to lower the interest rate or obtain cash. Rather, many folks with adjustable rate mortgages were moving into fixed rate products, often abandoning the current "teaser" rate for a higher fixed rate.
Moreover, the unprecedented housing market finally turned in 2006. During most of this decade homeowners were watching their wealth increase by leaps and bounds just by looking at the rapid rise in home values.
Not anymore. The 4th quarter of 2006 saw U.S. home prices fall by almost one percent. Taking 2006 as a whole, home prices were up by less than .5 percent. Considering the fact that it costs up to six percent or more to sell a home, I'd say values have dropped.
Regarding the housing niche of the American economy, it seems to me there are two major issues that will indeed curtail consumer spending. First, the liquidity that poured into the economy as a result of the refinance boom no longer exists. Second, homeowners are feeling less wealthy because their homes are no longer skyrocketing in value. Even for folks who don't plan on selling anytime soon, the psychological effect when one's biggest asset no longer appreciating, or even losing some value, is likely to curb spending.
I think Mr. Greenspan may be right. Stay tuned.
