Only Terrorism Can Derail Continued Growth

Register now

The U.S. economy continues to recover from the recent recession, but according to one expert, improvement will remain slow.

David Wyss, chief economist for Standard & Poor's, told attendees at WesCorp's CU Outlook conference here the recovery has accelerated somewhat in 2004 after two years of sluggish expansion. Wyss foresees 3.5% growth this year, with continued low unemployment.

"It's pretty darn good, just not as good as the late 1990s," he assessed.

The forecast from Standard & Poor's calls for a gradual rise in interest rates in 2005, a slowdown in both housing starts and home prices, and a weak recovery for the stock market. A new recession remains a risk if terrorist attacks damage consumer and/or business confidence, if war disrupts oil supplies, or if world deflation forces slower U.S. growth.

What Bubble?

While home prices are high relative to household income, Wyss said the much-discussed "housing bubble" is a myth. In reality, he said, housing is the most affordable it has been since the early 1970s, thanks to low mortgage rates. The home ownership rate is over 68%-the highest in decades.

"Personally, the idea of a housing bubble is very silly. Affordability is measured by the monthly payment, and the average monthly payment is low."

"Even if mortgage rates go up to 7%, the first-time home buyer rate will stay strong," he suggested. "It is hard to have a 'bubble' in home prices, because if people don't get the price they want, they don't sell. The problem is not as big as people have been saying. Home prices are a bit high - mostly because people have been buying bigger and bigger houses."

Wyss expects home prices to stabilize, but not decline, for a few years until household income "catches up." He acknowledged the existence of some local bubbles in areas such as New York City, Boston, Washington, D.C. and the San Francisco Bay Area. Still, he said, housing looks less overvalued than other assets.

Debt, Spending Up

American consumers have been spending the extra cash freed up by tax cuts and lower mortgage payments, but Wyss said they aren't putting much away for the proverbial rainy day. Average household wealth is above where it was in March 2000, just before the equity markets began their long plunge. But, the saving rate in the U.S. is less than 1% of income.

"The average household has debt equal to 116% of annual income. But people say, 'So what?' because the total monthly obligation is low-only about 18% of after-tax income."

What happens when interest rates go up? "For most, not much," Wyss said, answering his own question. "Mortgages and car loans largely are fixed-rate loans. People should be able to pay the debt servicing. But, the real cost is, they will think twice about taking on that next loan at a higher rate. For example, they might keep their car for a few extra years."

Deficit Will Shrink

The federal budget deficit is projected to hit $521 billion in 2004. Wyss said the shortfall is due to several reasons, most importantly tax cuts and expenditures on war and security. Deficit spending helped get the economy back on track, but is only a short-term solution.

While the deficit is at a record level of dollars, he emphasized it is lower than the mid-1990s as a percentage of gross domestic product. In fact, the U.S. this year probably will have a lower deficit as a share of GDP than Germany. On the down side, the coming retirement of the "Baby Boom" generation will make matters worse.

"We've promised elderly Americans more than we can afford," Wyss said.

As the Baby Boom generation retires, Social Security and Medicare will run at huge deficits, he added. "Something is going to have to give. Either we pay the Baby Boomers less than promised, force them to retire later or institute tax increases."

The deficit has been an issue in the current presidential campaign, but Wyss said regardless of whom the winner is, the deficit will shrink over the next four years.

"If Bush wins, then he, like [former President Ronald] Reagan will change from tax cuts to tax reform in his second term. If Kerry wins, he will raise taxes and will let some of the Bush tax cuts lapse."

One aspect of the economy that troubles Wyss more than any other is the trade gap. The United States imports significantly more than it exports, and the difference has widened in recent years.

"The gap is bigger than the federal deficit, and, frankly, I don't see much sign of improvement," he said.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER