Economist Predicts An Upcoming Slide Into Full Recession

Published November 26, 2007, 1:00 a.m. EST

Updated August 27, 2020, 1:31 a.m. EDT

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The U.S. economy is slipping into recession as a result of the imbalances seen over the past two to three years, according to a noted economist.

Christopher Thornberg, founder and principle of Beacon Economics and former author of the UCLA Anderson Forecast, said credit unions must make the proper decisions today to come out of the downturn in about a year.

"Economic growth is all about trends and bends," he told attendees of the California and Nevada CU Leagues' recent Annual Convention here. "Trends are long-run growth driven by demographics, productivity and policy. Bends are short fluctuations in the economy driven by imbalances."

The 2001 downturn was unusual in that it hit different areas of the economy in different ways, Thornberg explained. He said the housing market continued forward, and consumer spending did not slacken. Nearly all the trouble was felt in a sharp decline in business investment.

Today, the U.S. is in the 15th year of a consumer expansion, despite skyrocketing oil prices and slowing retail sales. Thornberg said the economy has been sending mixed messages over the past two quarters: GDP growth has remained at 3.7% or better and unemployment is low, but there are problems brewing thanks to the housing market.

"A bubble is defined as asset prices increasing when fundamentals say they shouldn't," he said. "In 2004, housing prices appreciated during a feeding frenzy."

It is "absolutely true" that bubbles come to an end, Thornberg continued. He said the American housing bubble ended in 2005 when sales dropped and inventories rose.

However, "bubbles are years in the making, and also years in the unmaking. The bubble ended in 2005, but today we are starting to feel the pain."

Thornberg offered four reasons why the housing market still is on the way down:

* It takes three years to clear on the construction side ("Which means we have one year still ahead of us.")

* Subprime mortgage lending ("About 14% of mortgages in recent years went to people who consistently show they cannot pay their bills.")

* Massive appreciation created unsustainably high prices, leading to people taking adjustable rate loans with a low "teaser" to start. Loan resets will peak in the third quarter of 2008 ("The worst is still in front of us.")

* Consumer spending was driven by the "house ATM" as prices appreciated dramatically-a driver that has vanished.

"Consumer spending worries me the most," he said. "Five percent of consumer spending has been driven by the house ATM, creating an imbalance. Consumers must pull back on spending, which will affect the economy in 2008."

In areas of California where home prices have fallen, taxable sales also have declined, he said. Both California and Nevada are states "driven by housing" in recent years, and prices will decline 20% to 30% in 2007-2008.

Credit unions have been "relatively conservative" through the housing bubble, as lending per member is up only slightly, Thornberg said. But he is worried about a surge in home equity loans by CUs.

"Many of those second mortgages written in the last two to three years may end up being worthless if prices fall. The housing market drop will knock the pins out from under consumers," he said.

In summarizing the economic outlook, Thornberg said productivity still is good, and exports are helping greatly thanks in part to a weaker U.S. dollar. On the down side, he predicted housing still has not hit bottom and will be a drag for some time to come.

"The 2008 forecast: bad," he said. "A recession is almost certain. For credit unions, conservative policies that avoided subprime lending are good, but credit unions still rely on consumers, which are in trouble, so these are rocky waters. Things will improve in late 2008/2009."