NASHVILLE, Tenn. — Yes, Virginia, there is a recession, said Moody's Economy.com's Director of Macroeconomics Gus Faucher in an exclusive interview with Credit Union Times prior to his presentation at ACUMA's Annual Spring Conference here. The good news is that it will be short and mild, with gross domestic product picking up again in the latter part of the year.

Filling in for an ailing Mark Zandi, founder of Moody's Economy.com, the economics Web site, who correctly identified the housing bubble before it became evident to other economy watchers, Faucher acknowledged that “things just couldn't go on the way they were going.”

It takes a while for the government to admit to a recession because the indicators take time to be analyzed, but some areas of the country have been in recession for months, he said. Those areas are the same hot spots where home prices escalated the fastest–California, Nevada and Florida, for example. The upper Midwest is in recession largely due to the job losses associated with the auto manufacturing sector. “The labor market started to lose jobs in early 2008 and families have been under financial stress since the end of 2005, but delinquencies on credit card and auto loans became dramatic in 2006. Now, home prices are down 10% from their peak and people are pulling back on spending owing to the big jump in gas prices and food.”

A number of factors helped to contribute to the housing downturn, Faucher explained, which has accelerated in the last six months and further exacerbated the credit crunch. “The safety net's been broken, and what caused that to happen are several things, including cheap credit, some of which the Federal Reserve was responsible for, a broken regulatory system, where banks can select their own regulator–which have an incentive to go easy on them–a conflict at the Fed itself and its dual role as a regulator and monitor of consumer protection, and finally, some outright dishonesty among both those writing loans and those taking loans,” said Faucher.

But the picture for credit unions is better than for other financials, he said, simply because “credit unions avoided the worst of the excesses and their capital is in good shape. So if someone can't get a loan from a mortgage broker because of tightened lending standards, they should try a credit union. My feeling is that because credit unions are sitting on money now, they will play an important role in mortgage lending in the near future. And that's particularly true because it remains a low-rate environment.”

Banks are wary these days because many still aren't sure just how much bad debt remains in their portfolios. “Already they've written down $200 billion in disclosed losses and that may be just the half of it, so it'll take time for that to work itself through the system,” Faucher said.

Congress will likely take bolder action than even the already announced mortgage rescue plans, Faucher predicted. “I think we'll see something along the lines of the government acting as a backstop.” But Faucher urged caution on compromising access to credit, especially in the subprime area. “Some of the proposals coming out of the community interest groups that want to push for predatory lending laws could have that effect, so it will take some thinking through not to create unintended consequences.”

Nine Million Homes Underwater

Faucher said that the number of homes underwater (those whose mortgages are higher than their present value) is nine million, and that number will likely rise to 12 million in 2009. But seeing the bottom in the housing market will have to wait until banks get a better handle on just how vulnerable they are to more losses. “One-third of the assets of large banks are tied to residential real estate, so they are cutting back because they're not sure what will happen to their capital,” Faucher said. “They have no idea what those holdings are really worth, so the Fed's action is designed to remove that uncertainty by buying it up. In exchange, they get Treasuries, on which they can lend. The Fed is also doing what it can to inject liquidity into the system in hopes of freeing up credit.”

The stimulus package passed by Congress will also help by adding as much as 1.5% to GDP, and Faucher said that the economy will grow by 3.5% by yearend. Inflation doesn't seem to be a big worry at this point. “The Fed measures core inflation, which doesn't include food and energy, which are volatile,” he said. “While they both are having an impact right now, core inflation is just north of 2%.”

Wage growth will be restrained as businesses, other than financial services, have performed fairly well, posting profits and keeping costs down, to position themselves for a rebound. That means there won't be many layoffs, which is a good sign, said Faucher.

Election Model

“We have a model for the presidential election that shows a clear victory for the Democratic Party even though we don't know who the candidate will be. It'll be a bad year for John McCain,” said Faucher. The Moody's Economy.com model is based on prior election voting patterns, Faucher said, with a number of factors added. “When the economy is bad, the party in power suffers for it. People also react negatively to inflation and job losses and there is an element of party fatigue. George Bush has been in the White House for eight years and people typically vote for a change. We're predicting that Democrats will win 29 states plus the District of Columbia and have a total of 350 electoral votes.”

But whoever wins the race will have to deal with a $400 billion deficit, and that won't be so easy to manage, given the war in Iraq, expiring tax cuts and inflation.

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