Is the recession almost over?

Is the recession almost over?




That seems to be the new line coming from the mainstream media. It also seems reasonable given the fact that this recession has already dragged on long enough for it to be "time" for a recovery based on statistical averages of past recessions.

The end of the recession is in sight, according to a new survey of leading economists...

The panel of 45 economists said it expects economic growth will rebound in the second half of 2009. However, the group still expects to see a decline in second-quarter economic activity.



And we hear the administration talking about "green shoots" in the economy. And consumer confidence as well as job expectations surged significantly in April. All of this would seem to support the hope that the recession is easing.

And perhaps that's the case.

But we also have the fact that, just a few days ago, the Federal Reserve updated its economic outlook to be more gloomy, not more rosy. And we have the fact that the price of homes seems to be falling faster, down almost 20% year-over-year in the first quarter of this year. Falling home prices seem to continue to be fueled by increased foreclosures; as long as we have foreclosures flooding the market prices will continue to fall. And with another large round of ARMs set to reset over the next two years , and with mortgage rates apparently starting to go up, it would seem likely that we're going to be seeing another wave of foreclosures starting later this year.

So the question is: Can we have an economic recovery while foreclosures continue to increase and home prices continue to fall?

Considering falling home prices and increasing foreclosures have been the largest contributing factors to this recession, the possibility of a recovery with those factors not resolved doesn't seem entirely probable.

In addition to increasing foreclosures, it would also seem that increasing interest rates will eventually put downward pressure on the number of people buying homes--indeed, higher interest rates drove mortgage applications down 14% last week. Combined with increased foreclosures due to ARMs resetting this would tend to leave more homes on the market which would continue to push home prices down. The Federal Reserve does not seem to be able to succeed at keeping interest rates artificially low.



"US Treasury yields rose to their highest level in six months on Wednesday, raising more worries that rising mortgage rates could damp a nascent recovery in the economy"

Traders say that while short-term yields remain stable and low thanks to intervention from the US Federal Reserve, the real action is in longer-term paper. Long-term yields are expected to move higher as the market prices in evidence of “green shoots” in the economy, the increasing US debt burden, the risk of a revival in inflation and a flood of new issuance....

But traders say it is difficult for the Fed to contain the longer-term upward trend.


All this seems to indicate that the financial position of homeowners is going to continue to worsen as their home values continue to fall.

So to answer the above question about the possibility of a recovery, we need to know the answer to this underlying question: Will Americans begin spending again even though their net worth--essentially their savings for retirement--continues to fall? That's the magic question. If the answer is "yes" then we could see a recovery. If the answer is "no" then it seems like a recovery is still wishful thinking.

Unfortunately there's no way to know the answer to this question.

The market seems to be betting on "yes" being the answer. And perhaps the market's right--perhaps people have essentially written off their losses and have just gotten used to the idea that they've lost the equity in their house. They've taken their lumps and are just going to move on.

But that only makes sense to me if the losses are in the past. But with the possibility of rising interest rates reducing future demand for houses as resetting ARMs most likely drive increasing foreclosures, it seems that we are still looking at further losses for home values. So the question becomes whether or not people are willing to start spending again while they continue to lose money in their house.

My opinion is it seems unlikely and would only make sense if people don't know they're still losing money in the value of their house. That's not impossible. It might have even been likely a few years ago when people weren't keeping a close eye on what their house was worth. But given the losses of the last couple of years it seems that most people are keeping track of what their house is worth so continued losses in home values will not go unnoticed.

As much as I'd like to be optimistic, and although a rise in consumer confidence in April is a very powerful reason to be optimistic, I think realistically we're not out of the woods yet. The current market optimism is coinciding precisely with a lull in ARM resets according to the chart above. But that's a "reset lull" that is almost over and which won't be repeated until November 2011.

The underlying economic factors that have been driving this recession have not yet improved and the threat of more ARM resets coinciding with higher interest rates due to increased government deficit spending is not a good combination. And it doesn't give us a good fundamental reason to have confidence that a recovery is around the corner.