THE ECONOMIC OUTLOOK:

HALF-SPEED AHEADDavid Wyss

Brown UniversityDecember 13, 2011

2.

The Pace Of The Recovery Has Slowed

• A recovery has begun, but is likely to remain weak.

• Housing now appears to be stabilizing, although prices are still falling.

• Overseas partners are recovering, helping exports, but developed

economies remain slow. The financial problems in Europe and the

earthquake and subsequent nuclear problems in Japan add to risks

from overseas.

• But the dollar weakness will help

• The fiscal stimulus helped boost the economy, but is being reversed. A

government default would increase risk

• Private nonresidential construction is still weak

• Consumers aren’t bouncing back as quickly as usual.

• Another dip into recession is possible if the financial markets lock up

again or oil prices jump farther on Middle East turmoil.

3.

The Housing Bubble

• Housing was too affordable, thanks to low mortgage rates

• Ratio of home price to income hit a record high in 2007.

• We built too many houses at too high prices

• Starts and sales dropped sharply

• Defaults have soared, cutting back on willingness to lend

• Prices fell 32% from their peak, with the price/income ratio below its

historical average

• Starts and sales are recovering

• But prices are likely to drop back through spring.

4.

Home Prices Were Too High

(Ratio of average home price to average household disposable income)

Source: Bureau of Economic Analysis and Census Bureau

2

2.5

3

3.5

4

4.5

1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015

Existing New Quality-adjusted

5.

Bubbles Were Almost Everywhere

-100 -50 0 50 100 150 200 250

Hong KongNewZealand

ChinaAustralia

JapanSpain

FranceSweden

ItalyIrelandBritain

NetherlandsSwitzerland

GermanyCanada

US

(Percent increase in home prices, 1997-2005)

Source: Mortgage Bankers’ Association and Standard & Poor’s

6.

Those Who Bubbled Highest Burst Loudest

(Percent increase in S&P/Case-Shiller home price index, July 2011)

Source: Standard & Poor’s

-100 -50 0 50 100 150 200

ClevelandDallasDetroitAtlanta

CharlotteDenver

ChicagoMinneapolis

BostonPortland

SeattleNew York

San FranciscoPhoenix

Las VegasTampa

San DiegoWashingtonLos Angeles

Miami

peak-present 2000-peak

7.

Foreclosures Are Concentrated

Source: RealtyTrac

(Percentage of homes in foreclosure, 2009)

2% to 3% 1% to 2%

Over 3%

Under 1%

8.

(Percent)

The Fed Didn’t Stop At Nothing

Source: Federal Reserve

0

2

4

6

8

10

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Federal Funds Rate 10-Yr Bond Yield Mortgage rate

9.

Synchronized Sinking

• Industrial countries went into recession in 2008, and into a plunge in the

fourth quarter of 2008

• Real GDP fell in the U.S., Japan, and Europe

• Developing countries looked like they might escape

• Until commodity prices plunged in Q4 2008

• World GDP is recovering, up 4.2% in 2010 from -2.1% in 2009

• The most synchronized world recession in history is being followed by

a slow, less synchronized recovery

• Problems in Europe and Japan will further cut developed country

growth, with Japan back in recession.

• But Asia continues to grow strongly

10.

All Fall Down

-4

-3.5

-3

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

2007Q4 2008Q2 2008Q4 2009Q2 2009Q4 2010Q2 2010Q4 2011Q2

US Japan Eurozone UK

(Percent change in real GDP, quarterly rate)

Source: Global Insight

11.

Synchronized Sinking

-8

-6

-4

-2

0

2

4

6

8

10

2007 2008 2009 2010 2011 2012 2013

(Real GDP, % change)

Source: Global Insight and Standard & Poor’s

12.

(Index)

Trade Gap And Reserve Diversification Will Send Dollar Lower

Source: Bureau of Economic Analysis and Federal Reserve, S&P projections

(Percent of GDP)

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

0.7

0.8

0.9

1

1.1

1.2

1.3

1.4

2000 2002 2004 2006 2008 2010 2012 2014

Net exports (right) Dollar index (major trading partners)

13.

Timeo Danaos Et Debitum Ferentes

Source: Standard & Poor’s from national sources

(Central government debt as percent of GDP, 2010)

14.

Budget Deficits Depend On Economy

0 2 4 6 8 10 12

Australia

Canada

China

France

Germany

Greece

India

Italy

Japan

Korea

Spain

UK

US

(Budget gap as percent of GDP, 2010)

Source: Standard & Poor’s CRISIL

15.

Deficits Are Mostly Cyclical

-12

-10

-8

-6

-4

-2

0

2

4

2000 2003 2006 2009 2012

stimulus ex stimulus

(Government deficit as % of GDP, fiscal years)

Source: Standard & Poor’s

16.

The Future Looks Bleak

69106

72 79 75

180

308

192 184155

415

753

431404 400

0

100

200

300

400

500

600

700

800

US Japan UK France Germany

2010 2030 2050

(Government debt as % of GDP)

Source: Standard & Poor’s, 2010

17.

Aging Populations Will Boost Government Spending

0

10

20

30

40

50

60

70

80

US Canada France Germany Italy UK Japan Australia China OECD

2010 2030

(Retirees as percentage of labor force)

Source: Organization for Economic Cooperation and Development

18.

(Percent of GDP)

State Budgets Sour

Source: Bureau of Economic Analysis

11%

12%

13%

14%

15%

1990 1993 1996 1999 2002 2005 2008 2011 2014

Receipts Expenditures

19.

State Pension Systems Are Underfunded

70% - 80% Under 70%

80% to 90% 90%+

(Percentage funded, 2008)

Source: S&P

20.

State Ratings Remain Strong

AA, AA+ AA-

AAA Unrated

(S&P rating, April 2011)

A-, A, A+

Note: for states that don’t have a GO rating from S&P, the chart assumes an equivalent from the short-term ratings

21.

(4-quarter percent change)

Weaker Employment Is Hurting Construction

Source: Bureau of Labor Statistics, Bureau of Economic Analysis, S&P projections

-6%

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

-40%

-30%

-20%

-10%

0%

10%

20%

2005 2007 2009 2011 2013 2015

Nonresidential construction Nonfarm employment

22.

60

80

100

120

140

160

180

200

220

240

Mar-84 Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08

Commercial Real Estate Price Declines Are Bottoming

Source: M.I.T. Center for Real Estate.

23.

(4-quarter percent change, and production as % of capacity)

Equipment Spending Follows Capacity Needs

Source: Federal Reserve, Bureau of Economic Analysis

(Percent)

60

65

70

75

80

85

-30%

-20%

-10%

0%

10%

20%

2000 2002 2004 2006 2008 2010 2012 2014

Business equipment (real, left scale) Capacity Utilization, mfg (Right)

24.

Can the Consumer Keep Spending?

• Consumer spending led recent expansions

• But wealth is down because home prices have dropped and

• Stocks are still below their 2007 peak

• Borrowing is more difficult, and home equity loans much

less available

• Confidence has dropped and unemployment risen

• Consumers are likely to continue to save more and

borrow less

• High oil prices hurt purchasing power and confidence

• Stimulus package provided some income boost

25.

Debt Is Dropping From Record Highs

(Percent of after-tax income)

Source: Bureau of Economic Analysis and Federal Reserve

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

0

1

2

3

4

5

6

7

2000 2002 2004 2006 2008 2010 2012 2014

Saving rate Debt/income (right scale)

26.

Wealth Slides With Home and Stock Prices

(Percent of after-tax income)

Source: Federal Reserve

0%

100%

200%

300%

400%

500%

600%

700%

1990 1993 1996 1999 2002 2005 2008 2011 2014

Net worth Financial assets

27.

0

1

2

3

4

5

6

7

8

9

2005 2005 2006 2007 2007 2008 2009 2009 2010 2011

Auto BankCard First Mtg Second Mtg

Auto BankCard First Mtg Second Mtg

(Percent)

Source: S&P/Experian

Default Rates Begin To Drop

28.

Bigger Than The Average Bear

• A great run from 1982 to 2000

• But the secular bear began in 2000

• Two largest bear markets since the depression

• Earnings were negative in 2008 Q4 for first time in history

• We think the rally will continue

• But the long-term cycle probably has another bear in it.

• World stock markets have generally become synchronized

• As money flows between markets in search of yield

29.

Everybody’s Down

(Percent change in stock prices, Aug. 18)

Source: Standard & Poor’s

-80

-60

-40

-20

0

20

40

60

80

100

World US Canada Lat Am Europe Japan Asia Pac Australia

Since March 2009 Oct 2007 to March 2009

30.

Bottom Line: The Economy Will Recover Slowly

• The recession is the longest and deepest since the 1930s

• Fiscal stimulus has supported the recovery

• But recovery is likely to be slow because of financial markets and

switch to higher savings

• If financial markets lock up again

• Fiscal stimulus ends abruptly

• Home prices continue to fall

• And oil prices continue to rise

• The recession could be longer and deeper

• With the risk of a “lost decade” similar to Japan in the 1990s

31.

Oil Prices Remain Down From Peak

($/barrel, WTI and deflated by CPI; household energy purchases as percent of disposable income)

Source: Bureau of Economic Analysis

3%

4%

5%

6%

7%

8%

9%

0

20

40

60

80

100

120

140

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Oil Price (WTI) 2005 Dollars % of disp. income

32.

The Unemployment Rate

Source: U.S. Bureau of Labor Statistics (BLS), Standard & Poor’s projections begin 2011Q1

Risks to the U.S. Economy

%

3

4

5

6

7

8

9

10

11

12

13

2002 2004 2006 2008 2010 2012

Pessimism Optimism Baseline