Credit managers should view their credit decisions in the larger context of the overall U.S. and global economies. Economic trends may affect how generous or tight their credit decisions are. Credit and other business professionals must rely upon economic forecasts to determine what to expect from the economy weeks or months into the future. The problem is that long-range economic forecasts are as unreliable as long-range weather forecasts. However, sometimes an economist’s long-range prognostication turns out to be right on target with the economic outcomes that later unfold. One economic forecaster that NACM relies on appears to be on the road for an accurate prediction of 2007, even though he offered his economic forecast back in December 2006.
In an article entitled, “Global Economy to Slow in 2007: Asia Emerges as Driving Force,” in the January 2007 edition of Business Credit, NACM obtained the views of several economists. A quarter of the way through 2007, it appears Dan North, Chief Economist for credit insurer Euler Hermes ACI, is the most accurate. At the time the economists were interviewed in December 2006, North predicted the smallest GDP for the U.S. at 2-2.5%. One of the factors he cited in his less optimistic view of the United States economy in 2007 was the declining condition housing market. In view of grim information on the U.S. housing market coming to light in mid-March 2007, North’s views three months earlier appear prescient. In the Business Credit article North said, “If you look at any measure of the housing market, the numbers are grim.” North pointed out that year-on-year housing starts were down 22 percent, new and existing home sales were down, and in September 2006 there was a drop in the median price of homes. North said that has happened only five months in the last 35 years. Even back in December, North didn’t view the housing market as bottoming out yet nor was he expecting a recovery any time soon.
The recent news on the U.S. housing market centers on the collapse in the sup-prime mortgage market. Subprime mortgages are those that are written for consumers who have less than solid credit. In fact, media reports show that some mortgage companies didn’t even verify the information on the mortgage applications, such as whether or not the applicant’s employment status was accurate. A March 12 article by Bob Ivy on Bloomberg.com provided a good analysis of the crisis facing the subprime mortgage sector that will likely have reverberations throughout the housing market and the general economy. The article stated: “As many as 1.5 million more Americans may lose their homes, another 100,000 people in housing-related industries could be fired and an estimated 100 additional subprime mortgage companies that lend money to people with bad or limited credit may go under, according to realtors, economists, analysts and a Federal Reserve governor. Financial stocks also could extend their declines over mortgage default worries.”
As for the near term prospects of the U.S. housing market the Bob Ivy, Bloomberg.com article stated: “The spring buying season, when more than half of all U.S. home sales are made, has been so disappointing that the National Association of Home Builders in Washington now expects purchases to fall for the sixth consecutive quarter after it predicted a gain just last month.” Of the subprime mortgage dilemma North said, “When times are good, you start extending credit to people to whom you wouldn’t normally extend credit.” North also pointed out year-to-year housing prices fell in the last six months, with four of six months being the largest declines ever. “This is unprecedented.” He said from the peak of the value of the housing market that value has dropped a total equivalent to 15% of GDP. Another negative impact on the economy that can be caused by declining house prices is that less home equity borrowing will take place, which could result in less consumer spending. “If the consumer can’t spend any more, then that will slow down the economy,” North said. He noted that 2/3 of the economy is driven by consumer spending.
Another factor of weak growth in the U.S. economy cited by North back in December was the inverted yield curve. Essentially, the yield curve charts interest rates over time and North said that the inversion of the curve indicates that interest rates on shorter term notes are yielding more than for longer notes. While not predicting a recession, North noted that in the last 35 years every time the curve is inverted a recession followed. The trend of the yield curve has gotten worse since North spoke to NACM in December. “The yield curve has gotten more inverted since then,” North said. “You can’t have that without having a dramatic impact on the economy.” Another factor cited by North back in December was the previous interest rate increases by the Federal Reserve. Even though the last several meetings of the Fed resulted in the rate remaining unchanged, North pointed out there is a 3-5 quarter lag on the effects of these rate changes in the economy so the Federal Reserve interest-raising decisions that ended several months ago may still be having a drag on the U.S. economy.
In early March 2007, former Fed Chairman Allen Greenspan addressed a group in public and referred to the possibility of a recession. This statement sent the world stock markets in a significant decline. Greenspan cited possible declining corporate profits as the main reason for the recession possibility. “I was a little surprised when Greenspan came out and used the ‘R’ word,” North said. North does not predict a recession in the U.S. economy in the near future, which he defined as two successive quarters of negative GDP growth. He did, however, revise downward his December prediction of the 2007 U.S. GDP growth rate from 2-2.5% to a lower rate of 1-1.5%. On the global economy North said, “I don’t see an ominous forecast for the world as a whole.”
Source: Tom Diana, NACM Staff Writer