How Green are the Economy’s Green Shoots?

This past Thursday, the government announced that our Gross Domestic Product – a broad measure of the economy that sums up all the goods and services produced in the U.S. – increased at a rate of 3.5% during the third quarter of 2009. The Dow Jones Industrial Average has been hovering around 10,000 and housing market indexes have been positive for months. These statistics might lead you to think that our economy was starting to briskly emerge from the recession, however,  let’s take a closer look at each of these green shoots.

During the third quarter of 2009, GDP did, indeed, expand after shrinking for four consecutive quarters, indicating an apparent end to the worst recession since World War II. The expansion was 3.5%, however, a majority of the increase was related to vehicle purchases and residential construction, both stimulated by government support. 2.2% of the increase was due to these two sectors and an additional 0.6% was attributed to government spending.

Additionally, inventories had been stripped to the bone and are now being rebuilt. In the third quarter, companies dumped inventory, though less aggressively than during the previous three months. By the math of GDP accounting, merely slowing down inventory liquidation will boost growth.

The most surprising result was the pace of consumer spending growth, although a significant portion of this appears to have been borrowed from the future. Consumers provided nearly two-thirds of the GDP growth with auto sales and parts alone adding 1% to the total. The cash-for-clunkers program stimulated significant increases in July and August sales but activity crashed in September after the program expired as demand was accelerated from future months.

The first time homebuyer’s credit has prompted residential investment to increase handsomely. Private residential investment, of which home building is a large component, surged 23.4%, the first increase in 14 quarters. This accounted for half a percentage point of GDP growth. We will look at this credit in more depth when we discuss the housing market.

Much of the growth relies on government spending or incentive programs which are either expired or expiring. Therefore, it is unclear if consumers and businesses have regained the strength to propel the economy on their own. Businesses remain cautious and American households are still burdened by mountains of debt, two factors that have economists predicting growth will slow considerably in the coming months.

The Dow Jones Industrial Average has closed near 10,000 for a couple of weeks as a healthy majority of firms have exceeded earnings expectations recently. Unfortunately, these earnings are the result of companies cutting jobs and working hours and squeezing costs mercilessly.

While 73% of firms beat earnings expectations, 58% had worse than expected revenue. High unemployment has created significant slack in the economy with tremendous excess capacity. Productivity has increased at a rate of 6.4% as employers are squeezing more work out of exisitng workers.  It is very typical to see productivity increases as an economy emerges from recession as firms wait until the last possible moment to begin rehiring.

These favorable earnings are, unfortunately,  not sustainable without revenue growth as there is only so much overhead that companies can eliminate.

With regard to the positive news coming out of the housing sector, most in the media point to the S & P Case Shiller Index. This index has seen strong gains for five months running. Unfortunately, many economists discount the accuracy of the index as it only tracks 20 markets, representing only approximately 38% of all homes in the U.S.  It is thought that this index overshoots reality both on the upside and the downside.

While the housing numbers appear positive, economists warn not to make too much of them because low prices and low mortgage rates, along with the tax credit, have spurred a home buying bonanza, at least in the low end of the market. Roughly one-third of home resales are foreclosures or short sales, where the mortgage exceeds the sales price.

The $8,000 first time homebuyer credit has catalyzed much of the activity in the sector and there is good reason for this. The average home price in the U.S. is $178,400. Given FHA’s 3.5% downpayment requirement (which amounts to $6,244 for the average home) the government is, essentially, paying people to buy a home.

This program has been ripe with fraud as is often the case with government run programs, particularly those with “refundable” credits that guarantee that claimants will get cash back even if they paid no taxes. A lack of documentation requirements make this program a layup for scammers ( You really couldn’t even make this stuff up!).

The Treasury tax-oversight office said at least 19,000 filers who hadn’t purchased homes claimed $139 million in tax credits and were reimbursed. Officials have found an additional 74,000 tax credit claims, valued at $500 million, where evidence of previous homeownership could make their claims invalid. More than 500 people under the age of 18, including a 4-year-old child, also had their names on applications for the credit which has no minimum age requirement. Most of the claims involving children were made by parents who purchased homes but would not qualify for the credit because their incomes were too high.

These problems show the dangers in creating refundable tax credits that give money to filers even if they don’t owe any taxes. The Internal Revenue Service and Justice Department are investigating more than 100 suspected criminal schemes involving the credit. The IRS is conducting more than 100,000 examinations that could require filers to give back the credit and pay civil penalties.

This program was set to expire at the end of November, so naturally given its record of abuse, Congress has extended and expanded the program. Not only is the program extended into 2010 but now existing homeowners, who have owned their present home for at least 5 years, can qualify for a $6,500 credit in the event of a new purchase.

So let’s recap the housing situation: 1) the government is providing tax credits to buyers through which buyers are “paid” to purchase a house; 2) there are no documentation requirements for the reciepients of the credit; 3) the government guarantees 92% of all single family mortages through Fannie, Freddie or FHA; 4) the government purchases most of those mortgages. Does everyone on Capitol Hill have amnesia?

While the credit seems to have boosted home sales, many of those sales would have happened anyway and have merely been stolen from the future. Meanwhile, the credit continues to distort the housing market and delays the process of home prices achieving a natural bottom which would serve as the basis for a fundamentally sound recovery.

There has only been modest growth in business investment which reveals how wary companies are about taking new risks or committing to expensive projects or new job creation in the current political and economic climate. The fiscal stimulus has pounded the federal balance sheet. With a deficit of $1.4 trillion in 2009, and $9 trillion more predicted over the next decade, every investor and business in America can see a gigantic tax bill coming right at them. The House health-care bill, which was released last week, takes another major wack at the job creators who own small businesses. The uncertainty of the Washington policy outlook is, no doubt, putting a significant crimp on future investment plans.

The simple truth is that without a recovery in the job market, consumers will not be able to carry the expansion for long and real growth is just an illusion. I guess it was heartening when, last week, after the recession has been with us for 22 months, Nancy Pelosi finally said the the focus has to be on job creation. Washington’s current policy makers are growing increasingly concerned about the jobless rate and the looming mid-term elections in 2010. They should, however, remember that the best way to nurture an expansion isn’t to feed it recklessly with easy money and more stimulus in order to meet an election timetable. Let the economy’s natural animal spirits revive at their own pace.

We are certainly in a better place than we were one year ago, but we still have a long way to go and should not be misled by data that inaccurately reflects reality.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

4 Responses to “How Green are the Economy’s Green Shoots?”

  1. 1 Carl Todd November 1, 2009 at 11:34 am

    Good article. The green shoots are not shoots from edible plants but from the weeds that choked our economy in the first place – the Wall Street financial market.

    Lets look reality in the face – Productivity increases: –
    1. Fewer people working longer hours for less pay.
    2. Technological advances that enable higher rates of product production with fewer people.
    3. Service sector jobs (90% of US employment)- outsourcing that was normally done in house now can be done any where world wide via the inter-net and much is being done even closer than Asia in Latin America.
    4. Manufacturing – (10% of US employment) The export segment is mainly making highly productive new machines to make consumer goods that are being sent overseas to be used to make the consumer goods imported and sold here.

    Bank bailouts to ease small business credit and consumer loans – shades of the “trickle down economy theory” my dad used to say worked if one was a horse and the recipient a sparrow.

    Show me a sustained increase in full time employment in USA and then I’ll concede the recession is over. We have to recover over 10,100,000 jobs to bring our employment back to what it was before the “recession” – let alone more to take care of the increase in population since then.

    When the Americans has money in their pockets then prosperity will begin – anything else is just sound bites.

    On the stock market why isn’t the daily short position ever mentioned on the financial talk shows? A strong short position heralds a short term increase and when that is satisfied a down turn follows when there is not true increase in productive domestic prosperity. The gambler who calls it right wins, but does nothing to add to the economy except by the taxes he pays to cover some of our stupid foreign policy spending at trying to Westernize Eastern culture.

  2. 2 Abe Hedaya November 2, 2009 at 12:21 am

    The concept of economic morality, not just economic effectiveness or efficiency, needs to be part of the discussion. Why are first-time home buyers more deserving of these credits? More importantly, why are they being doled out at all? It’s unreasonable to push for housing to be such a large part of GDP, especially when this push is provided by the capital that should be invested in manufacturing or green technologies. The free market will determine an appropriate level of activity in the housing sector. However, it won’t lay down the mechanisms to reduce the pain of worldwide oil depletion or abrupt cutoffs in supply.

    What we need is a government that looks out for the economic future of its entire people, not just those who, whether knowingly or not, helped feed into a bubble.

    “So let’s recap the housing situation: 1) the government is providing tax credits to buyers through which buyers are “paid” to purchase a house; 2) there are no documentation requirements for the reciepients of the credit; 3) the government guarantees 92% of all single family mortages through Fannie, Freddie or FHA; 4) the government purchases most of those mortgages. Does everyone on Capitol Hill have amnesia?”

    Yet again, you’ve hit the nail on the head, Bob.

  3. 3 James November 2, 2009 at 11:12 am

    Bob, Very insightful post. I can only hope more people read information like this and realize the full extent of what is going on in our economy!

    On a side note, I did a post related to this topic from an investors point of view. It concerns the homeowner tax credit and its possible implication on 1031 tax exchanges:

  4. 4 Matt Isken November 3, 2009 at 3:09 pm

    Great article!

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