Banking & Finance and Economy

ECONOMIC ANALYSIS: Signs of economic trouble are beginning to surface

May 7, 2007

There is a character in an old Hunter S. Thompson novel who shows up in every scene sweating profusely. Halfway through the book, he finally explains it-sweating is normal. It's when he stops sweating that the alarm bells should sound.

It's a little like that with bankers. Except it's not literally sweat, but worry. Bankers are always worried-about loan quality, interestrate spreads, renewed inflation, you name it. After all, the banking business is really business in general. How we collectively and individually succeed in all the things we do to make money ultimately feeds into the banking system and shows up on banks' bottom lines. And risk-and worry-is a fundamental part of the business.

That's why the stories of easy money in the home lending markets for the last several years, with handshake loans and little or no verification of borrowing capacity, are so unsettling. The idea that bankers-or, more accurately, mortgage brokers and the mortgage debt industry-would be sufficiently blinded by a few years of booming housing prices to set their worries aside has given us all something to worry about. That something is how, or if, the economy will safely handle the negative shock as the credit cycle reverses and money becomes tighter.

That's happening right now, and the nation's chief banker, Federal Reserve Chairman Ben Bernanke, has to be plenty worried. The U.S. economy recorded its second consecutive quarter of sluggish growth to begin the new year, and the fingerprints of the housing contraction are all over the data. And those among us who have gotten used to seeing recessions occur every 10 years may be in for an unpleasant surprise.

You certainly can't blame consumers for the disappointing 1.3-percent gain in economic output-as measured by gross domestic product-in the national economy over the first three months of the year. Individuals and households, fueled by steady job and income growth, boosted their spending at an annualized rate of 3.8 percent in the first quarter of 2007, with spending on durable goods particularly strong. And while the gaze of headlinegrabbing consumer confidence surveys seems to be locked into the upward creep of energy prices, the best measure of the sentiment of consumers-how they spend their money-remains quite bullish.

But the spending of businesses reveals a quite different mind-set. Spending growth in housing hasn't just stopped; it has reversed itself quite dramatically. For the last three quarters, residential investment has declined at a nearly 20-percent annualized rate. That's the worst sector in the economy by far. Even though investment spending elsewhere has managed to tread water or even grow slightly over the same period, that's a far cry from the booming business spending growth of just a year ago.

The bottom line is that a smaller, but important, segment of the economy that was leading the charge 12 months ago is now braking, not boosting growth.

And now that the Fed has the new worry of shaky sea legs for the overall economy to concern itself with, news on inflation comes that might tie its hands. In the same gloomy first quarter GDP report, we learned that the price deflator for consumer expenditures-perhaps the most comprehensive price index available-pushed up to a 3.4-percent growth rate in the first three months of the year. That means the inflation rate, by this measure, has equaled or exceeded the central bank's 2-percent growth threshold nine of the last 10 quarters.

Now if all this news gets you down, take some solace in this: There is always something to worry about when it comes to the economy, particularly for policymakers who are charged with managing its growth. Outside of housing, prospects for growth in the short term remain good, and few forecasters are openly using the "R" word just yet. But the experience of the last few years should tell us a little more worrying about things just might be a healthy change.



Barkey is a research economist at Ball State University. His column appears weekly. He can be reached by e-mail at pbarkey@ibj.com.
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