Current economic conditions

and

A retrospective (?) on the economic crisis

Jeff Fuhrer

Exec. VP and Director of Research

Federal Reserve Bank of Boston

October 1 2009

Plan for the talk

Part I: Review economic conditions and their

implications for the outlook

Part II: Look back on the financial crisis (to date)

– Innovative Fed actions and market responses

– Is deflation a concern?

– Is inflation a concern? (Balance sheet issues)

Part I

Economic conditions and outlook

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200

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2000:Jan 2002:Jan 2004:Jan 2006:Jan 2008:Jan

3-mo. avg. chg., total employment

3-mo. avg. change, private employment

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Global Insight

Employment is declining less and less rapidly

We are emerging from a very severe recession

Housing market progress: It’s really happening

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1900

2000:Jan 2001:Jul 2003:Jan 2004:Jul 2006:Jan 2007:Jul 2009:Jan

Th

ou

san

ds

Th

ou

san

ds

Stock of 1-family houses for sale (right scale)

Single-family housing permits (left scale)

Source: Census Bureau

Improvements

in outstanding

inventory

Small

improvement

in

construction

With reductions in inventories and some improvement in sales, I/S is clearly improving

Source: Census Bureau

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1100

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1500

0

2

4

6

8

10

12

14

2000:Jan 2001:Jul 2003:Jan 2004:Jul 2006:Jan 2007:Jul 2009:Jan

Months supply of homes for sale (left scale)

New single-family homes sold (right scale)

…and house prices have

flattened in many locations

Some hopeful signs in recent investment data

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45000

50000

55000

60000

65000

70000

2008:Jan 2008:May 2008:Sep 2009:Jan 2009:May

Shipments

Orders

…improving orders

for capital goods

suggest an

improvement

in capital spending

next year

Source: New sales, permits, shipments and orders: Bureau of the Census; Existing sales: Nat’l Assoc. of Realtors

Commercial real estate is still a serious

concern

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1990 - Q1 1993 - Q1 1996 - Q1 1999 - Q1 2002 - Q1 2005 - Q1 2008 - Q1

Qu

art

erl

y R

etu

rn

NACREIF Total Return on CRE

Total

Office

Retail

Equity markets have responded favorably of late

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700

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1000

1100

1200

20081001 20081112 20081224 20090204 20090318 20090429 20090610 20090722 20090902

•55% above March trough

• 17% above beginning of 2009

9/29

This helps to offset the significant loss to household wealth from fallen home prices

Source: S&P 500:New York Times; House prices: S&P Case Shiller

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20000

30000

40000

50000

60000

70000

1990:Q1 1993:Q1 1996:Q1 1999:Q1 2002:Q1 2005:Q1 2008:Q1

Household Net Worth

HH net

worth down

over $12.2T

through June

A caveat: Despite the equity rally, overall

household net worth remains well down

Source: Board of Governors, Flow of Funds Accounts

…this is likely to restrain household spending in 2010

The largest concern going forward:

Unemployment is likely to remain elevated

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5.0

6.0

7.0

8.0

9.0

10.0

11.0

2003:Q1 2005:Q1 2007:Q1 2009:Q1 2011:Q1 2013:Q1

Civilian Unemployment Rate

Macro Advisors

Global Insight

Full Employment Estimate

Slow employment growth and slow wage

growth will challenge the consumer

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1

2

3

4

5

6

7

2000:Q1 2003:Q1 2006:Q1 2009:Q1

Employment Compensation index, private industries

Total compensation

Wages

Source: Bureau of Labor Statistics

High unemployment may also bear

implications for inflation

Disagreement on this: Too high or too low?

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3.5

Jan-07 Jan-09

Blue Chip Forecast SurveyCPI inflation, 2 years out

Bottom 10

Median

Top 10

Summary of conditions

The economy is recovering, likely slowly

Underlying fundamentals are still challenging

– Household net worth remains low

– Employment and wage growth remain weak

– Foreign growth remains weak

Expect a gradual recovery over the next several

years, with elevated unemployment

Inflation

– Balance sheet, deficit suggest higher inflation

– Lingering excess capacity suggests lower inflation

Part II

A look back (and forward) at the

crisis

What caused all this?

Many causes– Over-priced residential real estate

– Over-priced commercial real estate

– Over-building in residential real estate

– Heavy leverage in all of the above—borrowers in precarious positions

– A significant decline in house prices (a result of the over-building above)

– Households in trouble due to job loss, falling prices, default

– Financial firms in trouble due to losses on mortgage-related securities

– Similar problems at many foreign financial institutions

– Some missed supervisory opportunities

– Reliance on ratings agencies for new, untested products

– Contagion from mortgage-related to all other securities

– Loss of confidence among consumers and businesses—PANIC

– Loss of short-term credit at major financial institutions

– Pull back in hiring, spending, etc.

What caused this? Housing and Debt:

Over-building, Inventory overhang

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2000:Jan 2001:Jul 2003:Jan 2004:Jul 2006:Jan 2007:Jul 2009:Jan

Months supply of homes for sale (left scale)

New single-family homes sold (right scale)

What caused this?

Housing and Debt: Price rise and fall

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50

100

150

200

250

1990:Jan 1993:Jan 1996:Jan 1999:Jan 2002:Jan 2005:Jan 2008:Jan

Jan

. 2000 =

100

Composite 20

Boston

Las Vegas

As prices fell and unemployment rose,

delinquencies and foreclosures surged

Subprime ARMs showed the

most dramatic rise in

foreclosures…

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1.00

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3.50

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4.50

1998:Q1 2001:Q1 2004:Q1 2007:Q1

90 days delinquent

Foreclosure initiated

Prime, 90-days

Prime, foreclosure

Losses at financial institutions soared,

especially for mortgage-related securities

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1991:Q1 1994:Q1 1997:Q1 2000:Q1 2003:Q1 2006:Q1 2009:Q1

Commercial Banks

Delinquency rate (left)

Charge-offs, $millions (right)The losses are ongoing, and

imply significant risk going

forward

Some mortgage lenders disappeared

Financial markets freaked out

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4.0Spread, 3-mo. $ Libor over 3-mo. OIS

"Spread, 1-mo. $ Libor over 1-mo. OIS"

Normally secure short-

term lending dried upBut note the

recent

improvement

Widespread loss of confidence;

Real activity plummeted

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2007:Jan 2008:Jan 2009:Jan

Michigan sentiment index

Conference Board sentiment index

Confidence measures

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2002:Q1 2004:Q1 2006:Q1 2008:Q1

Unemployment Rate

4-qtr. % chg. In real GDP (right)

Real activity measures

Policy Responses

The Fed

– Lowered the funds rate to zero—can’t get any lower!

– Pursued liquidity policies (short-term lending)

– Rescued individual firms (good or bad?)

– Tried some substitutes for conventional policy

(purchased MBS)

The Treasury

– Pumped capital into the banking system

– Insured deposits, secured lending

– Provided fiscal stimulus package

– Bailed out auto companies

Fed Responses, itemized

Term Auction Facility (TAF)

– Lend to banks, but remove stigma of discount window

borrowing

Commercial paper (CPFF)/MMMF (AMLF) facilities

– Help commercial-paper and ABCP-based MMMF’s to meet

redemptions, continue funding (over $300B)

ABS facilities (TALF)

– Facilitate new-issue AAA ABS purchases, up to $200B

– ―Legacy securities‖ (with PPIP program)—CMBS, RMBS

MBS, Treasury purchases (LSAP: up to $1.25T, $300B)

– 30-year conforming rates down 1-1.25 ppts., refis up

FRMLFFA (Facility for Restricting Multi-Letter Fed Facility Acronyms)

Provide

short-

term

liquidity

Provide

longer-

term

credit,

macro

stimulus

Maintain

sanity

Summary

The economy is in better shape than it was

The recovery is likely to be characterized by

– High unemployment for an extended period

– Risk of falling inflation—but some disagree

The crisis: A post-mortem

– Many causes

– Hard to predict many of the consequences

– Some appropriate policy responses

– Some are debatable