Economic prognosis from the state's forecaster

I watched Victor Moore and ChangMook Sohn in front of the Senate Ways & Means committee Wednesday. Moore is head of the Office of Financial Management and was outlining the governor's budget. Dr. Sohn is head of the Office of Forecast Council, and he was there to predict revenues and economic events.

Moore did a good job, but I've covered the budget elsewhere.

One Note: Low-income heating assistance has already passed both houses and been signed by the governor. The Guv had called for speedy action. She got it. Kudos.

Quite a difference from the disgrace in the other Washington, where in an apparent fit of pique over losing drilling rights in ANWR, Republicans took federal low-income heating assistance off the table. It had lost its meaning as a bargaining chip. See December 27, NPI "Payback ..." post or CBPP.

On the revenue side, Sohn's revenue update for January 10 shows another increase to the surplus. Real Estate Excise taxes were up 6.5% and Revenue Act taxes (retail sales, B&O, utility, mostly) were up 4.1%, netting a neat $27.8 million. The update displays a drop in school levy collections without explanation, and what is likely to be a continuing disappointment in cigarette taxes (as smokers avoid the tax by stopping or smuggling).

To the committee, Sohn was slow in his delivery, but he was pointed on one topic. He said that while the acceleration of housing activity would level off, the sector would continue to be strong, and would not collapse. This and continuing higher oil prices were the two primary economic determinants for the coming year.

When asked about interest rates, Sohn pointed to the rise in short-term rates due to Fed action, probably to 4.75% later this month, while long-term rates seem to be stuck at 4.5%. The good doctor did not fret, as some others have, about the so-called interest rate "inversion," (although it was covered in his November forecast). Short-term interest rates should always be lower than long-term rates, because of the risk premium.

Interest rates are a poser. As Sohn points out, short-term rates are rising. Long-term rates ought to be rising, too. But they're not. Is this a good thing? Or does it indicate basic weakness? (Or maybe strength? There are many who see it this way. Imagine stable, low interest rates as far as the eye can see. It's a worthy goal, but this is not how you do it. I am reminded of Dow 36,000 and the "New Economy" of the late 1990s, an economy which had finally outrun recessions.)

Long-term rates should be rising not only to reflect short-term rates plus risk premium, but because mortgages and federal debt are stoking demand, while at the same time the weakness of the U.S. trade situation should be weakening the dollar.

The fact that long-term rates are not rising means to me that there is plenty of supply. Which means investors want safety over return. Not a good sign. Boomers are scared out of the stock market. Asian countries are flush with the booty of huge trade surpluses and are stashing dollars. Wealthy individuals have tax cuts they don't know what to do with. It certainly ain't coming from working families, since household debt has increased markedly since Bush got in, and net savings went negative for the first time in history according to a December report by EPI.

A creative alternative explanation is available at the Economist's View blog. (Please keep in mind when reading this stuff that inflation has been dormant since the early 1990s, and Greenspan gets the credit no matter what he does, raise the rate to 7% or lower it to zero. Please review my previous takes on Maestro Magoo, and discard the idea that the market has confidence in the Fed.)

(The Economist's View blog and this one would be useful to compare over a period of time. The author believes housing is poised to take off again. I do not.

An end to the bubble or no?

Predicting an end is not so difficult. The alternative is to forecast a boom that goes on forever, like the .... Well, I guess we haven't had one. If it's a bubble, it will burst. This is my opinion. When houses stop appreciating, things will not flatten out, as Dr. Sohn predicts. They will begin to descend, because the speculative motive will have disappeared. Dean Baker of the Center for Economic Policy Research has shown that house prices are already well outside their historic relationship with the rental market. It is by no means the case that houses are being bought exclusively by first-time homebuyer. Quite the contrary. Prices are often outside the range of this group, except with the off-the-wall mortgage instruments.

Dr. Sohn's view is that this is not a bubble, but a run-up in housing that will level off benignly. Thee are plenty of folks who present this view. I hope so. Though if you've made your money, you might want to get out of the market now, just to be safe. You could always put your gains in ... government bonds.