The Perfect Storm
Economist expects recession to recede late 2009

By Frank Ruggiero

Economic forecast: Cloudy through the year, with a chance of sunshine toward the end.

Economist Harry Davis addressed a near capacity crowd at the Boone Area Chamber of Commerce’s Wake Up Watauga breakfast Friday, offering his thoughts on the recession, its triggers and its future.

Davis is the chief economist of the N.C. Bankers Association, past chairman of the chamber’s board of directors and professor of finance at Appalachian State University’s Walker College of Business.

He posed the question, “What is a recession?” and answered that the official economic state is determined by the National Bureau of Economic Research, which determined this recession started in December 2007. “They look in the rearview mirror to make all their decisions,” Davis said.

The nation’s last two recessions, in 2001 and 1991, both lasted eight months, Davis said, noting that in 2001, consumer spending never even slowed.

The post-World War II average recession lasts 10.5 months, he continued, and the nation has been in its present recession for 13 months. “The 1981 recession lasted 16 months, and this one’s going to last longer than that,” he said.

Recessions, Davis explained, are part of an economic cycle, meaning they cannot be prevented or stopped. “It’s not possible,” he said. “We need to be patient and realize we’re in part of the economic cycle we have to have. It’s not avoidable.”

Consumers are reacting differently than in 2001, however. Davis said that in the third quarter of last year, consumer spending fell for the first time since 1991, the most significant drop in the statistic’s 37-year history.

The United States has also suffered a drop in employment, with the national unemployment rate at 7.2 percent in December, a dramatic increase from 4.9 percent in January 2008.

Davis discussed the housing market, explaining how subprime lending created homeowners who could not afford to own a home, driving that number to an unsustainable level. Home prices grew faster than incomes through 2006, Davis said, and, “We can’t do that for very long before housing has to stop, and that’s exactly what happened.”

About one in 10 homes in the United States is either delinquent or in foreclosure, Davis said. “To fix housing, I think we should go at it from the employment side,” Davis said, suggesting cutting the payroll tax, extending benefits and driving the mortgage rates down.

Davis took a turn to Wall Street, asking attendees if they could remember when Wall Street would help sell securities, rather than own them. He said firms started borrowing massive amounts of money to buy securities, many of which turned out to be subprime. At the end of 2007, Lehman Brothers had more than $700 billion in assets and $23 billion in capital, resulting in a leverage ratio of 30:1. “If they hit a bump in the road, they’re bankrupt, and that’s exactly what happened to them,” Davis said.

Davis said while Fannie Mae and Freddie Mac were supposed to help underwrite mortgages, Congress and HUD suggested they buy. As a result, 40 percent of mortgages they bought last year were subprime, with a leverage ratio of $100 in assets to every dollar in capital.

“Where were the rating agencies?” he asked. “Ninety-five percent of the revenue the rating agencies earn comes from the companies whose securities they rate.”

Davis said banks have taken a lot of criticism for lending this money, with bank profitability at its lowest rate since 1990, as of the third quarter. Loan loss provisions are on the rise, he said, and problem loans have increased.

“Now banks aren’t exactly sure what capital requirement is anymore,” he said. “Banks have got money to lend. The trick is how to lend money when there’s no one standing in your lobby wanting to borrow.”

Davis then addressed energy independence, saying that in the present budget, there are all sorts of subsidies for solar and wind energies, which he said could not possibly work when the price of oil is $40 a barrel.

“If you’re in favor of alternative energy sources, raise the gas tax,” he said. “It’s the only thing that got people’s attention … when the price when to four bucks a gallon.”

Davis addressed the economic stimulus package currently under development, and said supporters must believe two things – the government can make use of underutilized assets and that there is a multiplier effect, meaning, “If the government borrows a billion dollars, it must generate a billion dollars of economic output.”

He said certain parts of the stimulus package do not make sense, such as funding to the National Endowment for the Arts and funds to install solar panels on government buildings in Seattle, Wash.

“What we’re doing is raising the level of spending to a new level,” he said. “It’s not a stimulus package; it’s just a government spending program.”

Davis expects the recession to recede in the fourth quarter of 2009, when the economy should start picking up.

He opened the floor to questions, with Wachovia market president Jason Triplett asking Davis feeling on a stimulus package geared toward creating jobs.

Davis said in the current bill, there is money for unemployment benefits, and he’d like to see that part strengthened. “We ought to help people who lost their jobs – that’s what we ought to be doing,” he said.

Realtor Todd Rice noted that the economy is in deflation now, meaning inflation is inevitable. He asked Davis when he thought that would happen, and Davis said he is concerned about inflation toward the end of 2009 and all of 2010, as massive levels of debt are raised.

The chamber’s next Wake Up Watauga will be hosted at the Watauga Medical Center, with speaker Richard Sparks, CEO of Appalachian Regional Healthcare System, discussing health care in the High Country. The event is tentatively scheduled for Feb. 27.

For more information on the Boone Area Chamber of Commerce, call (828) 264-2225 or visit www.boonechamber.com on the Web.