2008 Economic Preview: an Ugly Picture

As we end 2007 and start to look to 2008 the economy is not in very good shape. My hope for the upcoming year is we get through this mess with as little damage as possible.

Let's start with the great big mess that is the current housing market. For most of 2007 the main problem was a hug mismatch between supply and demand. And that mismatch continues. Here is a chart of the total inventory of existing homes on the market.

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And here is a chart of the months of supply:

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Bottom line: there is a huge glut -- which I call a super-glut -- of existing homes on the market. This is already impacting home prices:

Home prices in 20 major U.S. cities were down 6.1% on average in the past year as of October, according to the Case-Shiller price index released Wednesday by Standard & Poor's.

Since October 2006, prices in 10 cities fell 6.7% -- a record drop. The prior largest decline was 6.3% in April 1991.

"No matter how you look at these data, it is obvious that the current state of the single-family housing market remains grim," said Robert Shiller, chief economist at MacroMarkets LLC and co-developer of the index.

Eleven of the 20 metro areas posted a record low annual growth rate. Also, all 20 metro areas declined from the prior month as San Diego posted the largest decline -- 2.6%.

Forecasts for next year are not looking promising. The figures that I have seen for the foreclosures estimates are about 1.2 million. The best estimate I have seen for the Bush/Paulsen home bailout plan is it will help 600,000. Assuming both of those estimates are accurate, we're looking at another 600,000 homes coming on the market, bloating an already bloated inventory picture. In short -- I seriously hope that by the end of next year the housing market stabilizes at some level. But even if that happens, I seriously doubt the stabilization will occur at a level anywhere near previous levels.

The Federal Reserve could lower rates to help with the slowdown. But they are hemmed in by inflation caused by rising commodity prices. Note that agricultural prices

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and oil prices:

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Are in the middle of multi-year rallies. The Fed acknowledged this in their latest policy statement:

Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

I think inflationary concerns are a prime reason why the Fed opted for its open market auction operation rather than lower interest rates a further 25 basis points. They see the effect of rising commodity prices on consumers and they realize that lowering rates may lead to an acceleration of inflation.

The consumer -- who makes up 70 percent of U.S. economic growth -- is under increasing stress. As previously noted, home prices are dropping and inflationary pressures on necessities (food and energy) are increasing. As a result, we're starting to see cracks in consumer finances.

The value of credit card accounts at least 30 days late jumped 26 percent to $17.3 billion in October from a year earlier at 17 large credit card trusts examined by the AP. That represented more than 4 percent of the total outstanding principal balances owed to the trusts on credit cards that were issued by banks such as Bank of America and Capital One and for retailers like Home Depot and Wal-Mart.

At the same time, defaults -- when lenders essentially give up hope of ever being repaid and write off the debt -- rose 18 percent to almost $961 million in October, according to filings made by the trusts with the Securities and Exchange Commission.

Serious delinquencies also are up sharply: Some of the nation's biggest lenders -- including Advanta, GE Money Bank and HSBC -- reported increases of 50 percent or more in the value of accounts that were at least 90 days delinquent when compared with the same period a year ago.

The AP analyzed data representing about 325 million individual accounts held in trusts that were created by credit card issuers in order to sell the debt to investors -- similar to how many banks packaged and sold subprime mortgage loans. Together, they represent about 45 percent of the $920 billion the Federal Reserve counts as credit card debt owed by Americans.

And foreclosures are increasing year over year at very high rates:

U.S. home foreclosures rose 68 percent in November from a year earlier and may surge in 2008 as adjustable-rate mortgages leave subprime borrowers unable to meet higher payments, according to data compiled by RealtyTrac Inc.

There were 201,950 foreclosure filings in November, including default notices, auction letters and bank repossessions, down 10 percent from October's total, RealtyTrac reported today. California, Florida and Ohio had the most filings and Nevada had the highest foreclosure rate.

Interest rates increased on more than $87 billion of subprime mortgages in the third quarter, and another $84 billion will reset in the fourth quarter, according to New York-based analysts for Credit Suisse Group. Falling home prices have made it difficult for borrowers to refinance into better loans, said Paul Willen, an economist at the Federal Reserve Bank of Boston.

"We think the housing situation will get worse before it gets better,'' Willen said in a telephone interview. ``The real driving force here is home prices. How long it lasts depends a lot on how long it takes for prices to appreciate again.''

And while the employment picture isn't terrible, it's not that good either. Note the decline of year over year job growth since about April 2006:

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