Kicking the can

The fiscal cliff has been delayed for two months. Fears about how the government would handle the fiscal cliff — the tax hikes and budget cuts that were set to start on January 1st — frightened businesses into delaying capital spending and hiring, diminishing what little momentum the economy had going into 2013.

At the eleventh hour, Congress managed to pass a compromise bill. They extended the Bush tax cuts on all earners making less than $400,000, raised capital gains and estate taxes, extended unemployment benefits, ended the payroll tax holiday, and delayed the sequestration (deep cuts to military and domestic spending) for another two months. The next fight will be over raising the debt ceiling again to avoid the sequestration.

Businesses have reacted to this continued uncertainty by putting off key decisions on investment and hiring. Orders for nondefense capital goods excluding aircraft have tumbled over the past few months and are currently more than 7 percent below year-ago levels. Moreover, new orders are trending below shipments, which in the past has been a warning of recession. Hiring has not pulled back anywhere near as much, however, but hours worked have leveled off. A whole host of businesses have also announced plans to alter their employment strategy now that the new healthcare law is an absolute certainty. Even with these changes, we should expect nonfarm payrolls to rise roughly in line with their gains of this past year and look for the national unemployment rate to remain in line with the current rate through 2013.

Small businesses (which are responsible for about 50% of the national nonfarm, private sector GDP) remain unusually cautious. The Wells Fargo Small Business Index tumbled 28 points during the fourth quarter, which was the largest drop in four years. The quarterly survey, which was taken shortly after the presidential election, was led lower primarily by increased concerns about future conditions. Fewer businesses see revenue growing over the next twelve months, while more see them declining. Businesses are also concerned that they have less ability to control expenses, which has led to even more caution about investment and hiring decisions. For the eighteenth consecutive quarter, more businesses plan to reduce capital expenditures than increase them.

National GDP is expected to slow to an annualized growth rate of just 1.8% in the current quarter, according to The Wall Street Journal’s November forecasting survey, but then accelerate through 2013. By this time next year, the economy should be growing at a 2.7% rate, or about what it did in the third quarter just past. For the full year, however, GDP is expected to expand just 2.4%. That’s far enough above stall speed to keep recession worries at bay — but not nearly fast enough to make a dent in perniciously high unemployment.

That said, there are three economic positives going into 2013: employment, debt, and housing – three things that have been lacking for the past five years.

Jobs are coming back. Hiring is hardly robust, but the national unemployment rate is well down from its 10% peak. By this time next year, the economy should be adding 173,000 jobs a month, up from this year’s 157,000, according to the National Association for Business Economics.

Job growth here in Texas has re-bounded since the end of the recession and the state is expected to see even more growth next year. The Dallas Fed predicts statewide job growth of 2 percent to 3 percent in 2013, down slightly from this year’s estimated 3.2 percent growth, but up from 2011’s job growth of nearly 2 percent. Dallas Fed president Richard Fisher sent out the employment forecast — as well as outlooks on other state economic trends — after “a thorough briefing of the Texas economy” by his staff. Energy, exports, and construction have driven Texas employment above its pre-recession level this year, but growth has slowed since June as energy and export activity have declined.

Still most states and metros would be happy to have 2 to 3 percent job growth. How quickly we see a shift in economic uncertainty depends in part on how soon the fog over taxes and budget cuts lifts. Businesses are in a holding pattern, but they’re in far better financial shape than since the credit crisis.

Where will these jobs be? Low mortgage rates and tight inventories have boosted construction and related jobs. Texas leads the nation in construction job growth, adding 46,900 jobs in the 12 months through October, according to the Bureau of Labor Statistics. Last month, existing home sales were up 29 percent from a year earlier and the inventory of existing homes for sale fell to a five-month supply — the lowest level since February 2007, according to Texas A&M University’s Real Estate Center.

The Dallas Fed expects housing growth to continue at a strong pace next year. While industrial, office and infrastructure construction has been somewhat subdued this year, it recently picked up. In addition, a recent decline in office vacancies in Texas, particularly in Austin and Houston, suggests a gradual improvement in office construction could start in the next 12 months, according to the Dallas Fed.

Compared to the national unemployment rate of 7.8%, Austin’s 5.5% unemployment, San Antonio’s 5.6%, Houston’s 5.8%, and D/FW’s 6.4% lead the nation’s metros on low unemployment. Midland led the state with 3% unemployment. Below is how most of the cities in Texas fared through November of 2012. Most are the envy of the rest of the country.

While Midland had the state’s lowest unemployment, the highest was in Brownsville-Harlingen with 9.7 percent. 2013 should show continued improvement in these numbers.

The preliminary local jobless rates for November were:

The national unemployment rate is still elevated at 7.8% as of December 2012. For the last two years, we’ve been too pessimistic on the unemployment rate because most analysts were expecting some minor bounce back in the participation rate. Instead, the participation rate of the unemployment surveys have continued to decline. Maybe 2013 will be the year the participation rate increases a little, or at least stabilizes.

The recent recession was unusual in its depth and its duration. National labor market conditions have remained difficult for a long time. As a result, large numbers of discouraged workers stopped looking for jobs. A big unknown is whether these workers will stay out of the labor force permanently or enter as the economy recovers. If these workers join the labor force, increasing participation could have a major impact on the unemployment rate in the coming years.

As a result, the unemployment rate likely will stay uncomfortably elevated in 2013. Indeed, by this time next year, the unemployment rate is forecast at 7.5%, or just 0.2 percentage points below November’s reading. The economy is predicted to add 1.9 million jobs during the next 12 months — essentially just enough new jobs to keep up with population growth.

Nationally, with the current uncertainty, the national unemployment ‘headline’ (BLS – U3) will be hard pressed to be under 7%. Here in Texas, the continued strength of energy as well as the West Coast port labor problems should allow Texas to creep under a 6% average for the year. It continues to be a blessing to live and work in Texas.

Consumer debt continues to shrink. The balance sheets of American families look fairly healthy as well. Consumers have been working down their levels of installment debt, and that, combined with low borrowing rates for houses and cars, has eased payment burdens significantly. Consumers’ out-of-control debt loads helped spark the recession, but households are rapidly getting their balance sheets back into shape. To put it in perspective, before the recession, consumers went into the recession carrying debt of nearly double the nation’s gross domestic product. That’s down to below 85% now, and on pace to approach 75% by late next year. Consumers were spending more than they made, to put it simply.

Revolving debt, mostly credit cards, has fallen 19% since 2007. Revolving balances dropped at a 6.8% seasonally adjusted annual pace in July, after falling 4.5% in June. Non-revolving debt has risen, mostly because of student loans. The country has started saving again.

If consumer spending doesn’t come back strongly, it might be because incomes are still well below where they were before the recession, and that households lost about $7 trillion of home equity as housing prices plummeted. That could make them keep the brakes on spending for a while longer. On the plus side, low interest rates have pushed the ratio of consumers’ monthly rent and debt payments to their income to the lowest level since 1984. That’s a function of slightly lower debt and much lower rates, all good news.

Finally, housing is coming back. The best news coming out of the economy should be in the housing market. It has taken nearly seven long years since the bubble burst, but housing looks to have definitively stabilized, with more home-price gains ahead. Housing prices should post an annual gain of 3.43% on a national basis, a significant acceleration over 2012′s increase of 3.31. Because of that rebound strength, we here in Texas will continue to reap the benefits of a stronger real estate market through the year.

Nationally, the inventory of homes on the market is down 20% or more from just a year ago. Nationwide, there are 1.8 million houses for sale. At the peak, in the summer of 2007, that figure was more than twice as high. Sales of existing single-family homes, meanwhile, jumped 11% in the twelve months through November. Demand should remain elevated as the Fed keeps buying bonds so mortgage rates stay low. Why is this important? For most families, their home — not stock portfolios — is their biggest asset.

The wealth effect tied to housing can be quite powerful, as evidenced by the number of refinances in the sand states (California, Arizona, Nevada and Florida) from 2000 through 2006, where appreciation was so high sometimes running as high as 45% annual, year after year. That appreciation went away with the recession and lack of speculation in those markets sometimes to the tune of over 60% decrease in value.

That all has changed. Housing inventory is at its lowest level (4.8 months) since September of 2005. This represents 22.5% decrease as compared to the same time last year. Shadow inventory, the inventory of distressed properties coming to market, is also shrinking. This is for a number of reasons:

1. We are clearing more foreclosures and short sales nationally and locally.

2. Fewer families are falling behind in their mortgage payments.

3. Demand remained strong throughout the year. Home sales numbers continued to increase throughout the year suggesting that the country’s belief in homeownership still remains strong. Even the last “Existing Home Sales Report” from the National Association of Realtors revealed that home sales were up 5.9% from the previous month and 14.5% from the same time last year.

4. Prices first stabilized and then increased – nationally as well as locally, perhaps the biggest story of 2012 is that home values turned the corner and headed upward. By the end of the year, home values were up 10.1% compared to the end of 2011. And they shouldn’t slow down. Pricing of any item is determined by supply and demand. The supply of homes ready for is shrinking in all of our Texas Metros. There are only 5,700 for-sale listings in Austin and 3,500 rentals available with over 60,000 people annually moving here, with a population of 1.8 million. Houston has just over 35,000 listings and 94% rental occupancy with close to 100,000 people moving there annually. The same goes for the other major Texas metros – there is not enough supply for the demand.

Even in the areas that are still dealing with high foreclosure rates and short sales, prices have not tumbled dramatically. The increase in demand will absorb much of this inventory.

Because of this, in 2013 we will see the demand for housing continue to surge. The housing market has turned the corner and there is no reason to believe that buyer demand will not maintain momentum throughout 2013. Household formations shot up to boom-time levels in 2012 and are projected to increase at even a faster rate over the next twelve months. A lack of inventory will be more of a challenge to sales increases than will a lack of demand.

5. Fueling that demand is both move-up and move down sellers who are returning in great numbers. Perhaps what many will find as the biggest surprise of 2013 will be the return of the ‘move-up’ and ‘move down’ seller (often baby boomers seeking to downsize). Over the last several years negative equity has prevented many of these sellers from moving up to the house of their dreams. However, with prices recovering, more and more of these sellers will realize that now may be their greatest opportunity to make the move to a lifestyle they always wanted. Between plummeting property values, severe market depression, and falling incomes, the 2008-2009 recession had an enormous impact on the personal finances of middle-aged Americans. Overall, the median net worth for pre-retirement households fell 36%, reaching its lowest level since 1998, which hit those within one to two years of retirement particularly hard. The financial forecast is improving thanks to the gradual recovery of housing prices, but if that 45-64 demographic stays in the job market and maintains their high savings rate in an effort to shore up their personal finances, consumer spending and the subsequent economic growth could help the local markets dramatically.

6. The group under 40, called Generations X and Y, have been delaying household formation since the recession. What happened to all those buyers? Recent studies from the FHA and FNMA show that they believe in homeownership. Contrary to what many have hypothesized over the last few years, young adults (18-35 year olds) are just as committed to homeownership as previous generations. Recent studies have shown that 43% already own a home, 72% see homeownership as part of their personal American Dream, and 93% of those currently renting plan to buy a home

This, along with the increase in household formations mentioned above, makes us believe that 2013 and 2014 will be the year that many of these young adults will jump into homeownership.

All of this is good news: Housing starts surged to an annual rate of 872,000 this year (2012), the highest since the financial crisis. And that’s expected to rise to 900,000 in 2013.

The timing couldn’t be better. Historically, housing has accounted for 5% of GDP. Today it’s half that. If real estate investments jumps by a percentage point or slightly more of GDP next year, the economy could absorb the shock of the national fiscal austerity and hit its expected 2+% growth rate. Not great, but much better than the last 5 years.
And as Texas has shown the last 5 years, we should continue to lead the market in real estate opportunity.

The fiscal cliff in-depth

Talk of the impending fiscal cliff has been dominating the news cycle, and for good reasons.

First let me get this disclaimer out of the way – I am an analyst, not a CPA, lawyer, or lobbyist. I am an interested onlooker to the dysfunction in Washington. So keep that in mind as you read this. Also this is being written before Christmas, so a lot can happen as negotiations get closer to the deadline.

This budget brinkmanship will have an effect on the economy, Texas included. Try to imagine the effect of not receiving Federal funds will have on all states. Texas received about $55.1 billion during the 2010-2011 biennium money from the federal government. San Antonio, Austin, and Killeen would be greatly affected.

“Fiscal cliff” is the popular shorthand term used to describe the conundrum that the US government will face at the end of 2012, when the terms of the Budget Control Act of 2011 are scheduled to go into effect.

There are two major factors when combined that produce the ‘fiscal cliff’. The first factor is budget cuts. Back in August of 2011, Obama and Congress, under pressure from the ‘Tea Party’ and fiscal conservatives signed in to law the Budget Control Act of 2011. This was designed to cut the budget deficit in half by cutting $1.2 trillion across the board from the federal budget over ten years. This kicks in December 31st, 2012. According to many analysts, over 1,000 government programs – including the defense budget and Medicare – are in line for ‘deep, automatic cuts.’

The second factor is tax hikes. A host of tax breaks, including the Bush tax cuts which were signed in 2001 and extended by Obama for two years in 2010, are set to expire.

They include payroll tax cuts (workers will face a 2% tax increase if these expire) and changes to the Alternative Minimum Tax (which would in turn be a larger tax for many consumers). The pending expiration of estate and gift tax cuts has left many people of means scrambling to use what has been billed as a once-in-a-lifetime way to give tremendous amounts of money to heirs tax-free before death. The child tax credit would include lowering the amount of the child tax credit from $1,000 per child to $500 per child, narrowing the tax bracket for married couples causing them to pay more, and reducing itemized deductions and personal exemptions. These all expire at midnight, December 31st 2012. In addition, the beginning of taxes related to President Obama’s health care law will also go into effect.

Understand that we need deficit reduction. But cutting $700 billion – all at once and across the board – out of the Federal budget sets us up for another recession and rising unemployment. Those cuts are equal to about four percent of GDP, which is, according to the Congressional Budget Office, more than enough to throw us into a recession.

Economists and analysts disagree on exactly how quickly the recession would begin. That’s why the “cliff” metaphor is inappropriate. If financial markets freak out, it might happen very quickly, proving the “cliff” imagery correct. But it might happen gradually, affirming those who’ve argued it’s a “slope.”

Either way, both parties agree it shouldn’t happen at all. But that’s the rub. The reason that the fiscal cliff could push us into another recession in 2013 is because it enacts too much deficit reduction upfront, not too little. And yet, deficit reduction is something that most members of Congress and their voters support, at least in the abstract. So both sides want to replace the fiscal cliff with…something. The question is, with what? And can they come to agreement?

It’s important to recognize that this austerity crisis is a collision between deficit reduction and stimulus. The good news is that if you look at the various components of the fiscal cliff separately, you’ll see that the parts that do the most for deficit reduction do the least for the recovery, and vice versa. This suggests the possibility of “a la carte” approach to the fiscal cliff, in which we extend the most stimulative policies and wave goodbye to the most costly policies

What is the fiscal cliff in one sentence?

Too much austerity, much too quickly – like quitting the spending habit cold turkey. Not many addicts can quit cold turkey without harm from withdrawal.

If it’s not a cliff, what is it?

The term “fiscal cliff” comes from testimony Fed Chairman Ben Bernanke delivered before Congress earlier this year. A better name would be “austerity crisis.” That solves two problems. First, the danger the economy faces is too much austerity too quickly, so swapping the term “fiscal” for the word “austerity” actually better reflects the situation. Second, while we don’t know if it’ll be a cliff or a slope, we do know that it will, if permitted to go on for long enough, be a “crisis.” Thus, the “austerity crisis.” And yes if there is uncertainty, then job creation slows.

There are four types of spending cuts that take effect next year.

The sequester
The sequester was mandated by the Budget Control Act of 2011, better known as the debt ceiling compromise. This institutes a 2 percent cut in physician and other providers’ Medicare payments, and a 7.6 to 9.6 percent across the board cut in all discretionary spending, except programs for low-income Americans. The cuts are evenly divided between defense and nondefense programs, with most analysts predicting a crippling effect on all affected departments, agencies, and industries.

The sequester can be averted by repealing the portion of the BCA mandating the cuts, which amount to about $110 billion next year.

Budget caps
Also in the Budget Control Act, these set a firm limit on discretionary spending within which policymakers must operate. They are set to reduce spending by $78 billion next year.

Doc fix
The Medicare Sustainable Growth Rate (SGR) is a method currently used by the Centers for Medicare and Medicaid Services (CMS) in the United States to control spending by Medicare on physician services. This policy, passed every Congress for 15 years now but lapsing at the end of 2012, reverses temporary cuts that Congress passed, and former President Bill Clinton signed, as a deficit reduction measure in 1997. The cuts, known as the “Sustainable Growth Rate” or SGR, require that growth in provider payments not exceed growth in Gross Domestic Product. If the doc fix is not extended, physician payments would fall by an estimated 30%, dwarfing the cuts enacting as part of the debt ceiling deal. That would cut spending by $14 billion next year.

Unemployment insurance
Unemployment insurance was expanded following the recession, and due to the slow recovery this expansion has been regularly extended. Doing so again would cost $39 billion.

Debt ceiling
When exactly the debt ceiling is next reached depends on how much the government actually spends and taxes in the coming months. But most analysts think the next debt-ceiling increase will come due around February. The Bipartisan Policy Center estimates we’ll have to raise the debt limit by anywhere between $730 billion and $1.25 trillion to avoid the debt ceiling for all of 2013 (depending on whether the Dec. 31 fiscal changes measures are enacted or not) and between $1.3 trillion and $2.2 trillion in 2014.

A fiscal cliff deal is likely to include an increase to the debt limit. But in a world without a deal, an ongoing austerity crisis could be worsened by a default. The economic consequences of that are suggested to be along the lines of the financial crisis of what we saw in 2008.

What happens if we go over?

Analysts expect that the austerity crisis will weaken the economic recovery and quite possibly plunge the United States back into a recession. The CBO predicts that the US economy will shrink by 0.5 percent in 2013, and unemployment will spike up to 9.1 percent from its current level of 7.9 percent, if no fix is passed. However, if all policies, including the payroll tax cut, are extended, the economy will grow 2.4 percent.

Deficit reduction
If the austerity crisis hits in full, both short and medium-term deficit problems in the US would vanish. The CBO projects that under current law, debt held by the public will fall to only 58 percent of GDP by 2022, below the 60 percent mark that many economists warn against exceeding. By contrast, debt would climb to 90 percent of GDP if current policies continue, the highest point since after World War II.

Tax increases
The Tax Policy Center estimates that if we go over the fiscal cliff, the average American will see their tax bill rise by $3,446 in 2013.

That average obscures a bigger hit to the rich than the poor. Taxpayers making more than a million dollars will, on average, see a $254,000 tax hike, equal to about 11 percent of their income, while taxpayers making between $40,000 and $50,000 will see a $1,700 tax hike, equal to about 4.4 percent of their income, according to tax analysts.

Still, it’s a big hit to both groups, and that’s before you get into the effects of the spending cuts, which will hit the poor much harder than the rich.
Has Washington tried to solve the fiscal cliff in the past? The simple answer is yes, but so far with short-term solutions – which is the problem.

2010 tax deal
The Bush tax cuts were actually scheduled to expire in 2010. Republicans wanted to make them permanent when they were initially enacted in 2001 and 2003, but compromised to avoid a filibuster forced them to accept a 10-year expiration date.

In late 2010, both President Obama and Congress passed legislation extending the Bush tax cuts for two years, agreeing that the economy was too weak for a tax hike. Although the economy has improved, most analysts would agree that the economy can’t take this type of economic contraction. The deal was also contingent on a two-year extension of federal unemployment benefits, which were included in the 2009 stimulus, a one-year payroll tax holiday to replace another tax break in the stimulus (later extended to two years), and the extension of a few other tax breaks from the stimulus. All of these provisions are due to expire at the end of this year, which is why they’re part of the austerity crisis now.

Obama created the Simpson-Bowles commission in 2010, whose members created a recommended framework for $4 trillion in deficit reduction. But the plan did not attract the required 14-vote supermajority to be sent to Congress. Later, a bipartisan group of Senators known as the Gang of Six tried to build on Simpson-Bowles to formulate their own deficit reduction plan, but their effort, so far, hasn’t had any more luck.

Budget Control Act
Ultimately, to avoid a debt-ceiling crisis, Congress and the White House passed legislation in August 2011 known as the Budget Control Act, which had nearly $1 trillion in upfront cuts and established a Congressional committee to come up with $1.2 trillion more in deficit reduction by late November 2011. If the super committee failed to agree upon a deal, the across the board cuts to both defense and non-defense spending—i.e. the sequester—would be automatically scheduled to take effect after December 31st.

A 12-member super committee deliberated through the fall of 2011, but ultimately failed to come to an agreement by the deadline. The roadblock, once again, was revenue. Let’s just say that party lines were the disagreement with no compromise. Even after the super committee failed, Congress could have independently passed a deal that reduced the deficit by $1.2 trillion to avoid the sequester cuts. But the 2012 campaign soon took precedence and both parties agreed that nothing would get done until after the election.

That’s why we’re now facing the sequester, on top of the Bush tax cuts and other provisions that were already scheduled to expire on December 31st. They’re all policy decisions that Congress has made (or failed to make) over the past two years, piled onto a single deadline.

What do the parties agree on? They all agree it shouldn’t happen for all the right reasons…both parties agree that doing nothing and letting all the scheduled tax hikes and spending cuts to take effect for all of 2013 would be harmful for the economy, and something they want to avoid. No one likes the sequesters, which are described as indiscriminate, across the board cuts, and few want to raise taxes significantly on the middle-class.

What do they disagree on? They take traditional party lines. They don’t agree on taxes: Democrats want to hike taxes on the wealthy by about $1.6 trillion, and they want about $1 trillion of that to come from letting the top tax marginal tax rate snap back to its Clinton-era level of 39.6 percent. Republicans oppose tax increases in general and increases in marginal tax rates in particular.

The two parties also disagree about how and where to cut spending: Republicans want to make more dramatic reforms to Medicare, Medicaid, and other entitlement programs, as well as bigger cuts to domestic discretionary spending.

Now that we know what the fiscal cliff is, let’s examine some possible solutions.

Just go over
The simplest option for Congress and the White House would be to do nothing. Taxes would go up. The military and domestic spending cuts in the sequester would bite down. This would be the single largest act of debt reduction in American history, cutting some $1.2 trillion from the deficit over the next two years. Trouble is, that much austerity would likely also induce a recession. That’s why few policymakers advocate this scenario.
There’s another problem with this plan. Lawmakers can’t just sit back and do absolutely nothing. Even if the tax hikes and spending cuts kick in, Congress would still need to vote to lift the $16.4 trillion debt ceiling by February or so. Otherwise, the United States government would no longer be able borrow money to fund its obligations.

Go over and then make a deal
Another possibility is that lawmakers don’t reach a deal by December 31st, and we go over the cliff. But it’s only temporary. After all, those tax hikes and spending cuts don’t kick in with full force immediately. They’re spread out over two years. So there’s still time to make a deal when the new Congress convenes in January.

Why would lawmakers do this? It might make a deal easier. Right now, the two parties are having a tough time reaching an agreement because Democrats want higher taxes on the wealthy and Republicans mostly refuse to vote for any tax increases at all. But if we go over the cliff, taxes automatically go much, much higher than either party wants. Now the two parties simply need to debate how to cut taxes from this new baseline. That may be an easier discussion, in theory.

The downside is that Congress and the White House might not have much time to negotiate a deal in January or February before financial markets get nervous, which is never a good thing.

There’s nothing stopping Congress and the White House from postponing the fiscal cliff until 2013 or 2014. Congress would simply vote to extend all (or some) of the Bush tax cuts and payroll tax cuts. Then Congress votes to override the sequester, so that none of the military and domestic spending cuts kick in. Suddenly, the fiscal cliff is gone – or at least pushed back.

The upside here is that there’s no recession. The economy gets time to mend. The flip side is that deficit would continue to grow–the CBO estimates US debt would be $1.2 trillion higher over the next two years if Congress extends everything, compared with if we went over the cliff. Plus, we’d face another big showdown two years from now.

New deadline or trigger
One alternative to extending the fiscal cliff that wouldn’t require immediate deficit reduction, or the immediate formulation of a deal, would be to design a new trigger. There are several possible forms such a trigger might take, including cuts to tax expenditures, an increase in the capital gains tax, or more spending cuts.

Smaller chunks
Congress doesn’t need to make a big sweeping deal on the debt right now. It could do something smaller. One possibility being talked about is that Republicans would let the Bush tax cuts for income over $250,000 expire, as Obama wants. That would raise about $80 billion in 2013. In return, Democrats would find $80 billion in spending cuts. Then Congress extends (most) of the rest of the tax cuts.
That’s a small bit of austerity next year, but nothing like the full cliff. And lawmakers could continue working on bigger tax reform in 2013.

Grand bargain
At the moment, there’s a lot of talk in Washington about a “grand bargain” between Republicans and Democrats. This would involve avoiding sharp austerity in 2013. It would also involve some mix of spending cuts and tax increases that are gradually phased in over the next decade, so as to slowly bring down the national debt. It would also include substantial changes to entitlement programs like Social Security, Medicare and Medicaid. Examples of a “grand bargain” framework include the Simpson-Bowles plan, or the Domenici-Rivlin plan.

What about real estate? Here are four areas of concern.

Increase in Capital-Gains Tax

The White House wants “the rich” to pay more taxes. Republicans are opposed to any increases in taxes. But if the Bush tax cuts are allowed to expire, capital-gains tax rates will go up as of January 1, meaning anyone who sells their home could owe more on those sales. As a result, many sellers are racing to close before 2013. If the Bush tax cuts are allowed to expire, the current capital-gains tax of 15 percent will rise to 20 percent. Plus, the new federal health-care tax of 3.8 percent on investment income also kicks in next year for couples who make $250,000 or more. The combined tax-hiking impact of the Bush tax cuts ending and the looming 3.8 percent Medicare surtax.

Capital-gains rates could remain unchanged if a deal gets done in Washington. But don’t count on it.

Expiration of Mortgage Interest Deduction
The mortgage interest deduction — long considered the centerpiece of American homeownership — is on the chopping block. Presently, interest on loans up to $1 million can be deducted on primary and secondary homes. Be prepared for this Holy Grail of housing to either be eliminated or scaled back considerably.

Expiration of Mortgage Debt Forgiveness Act
Short sellers could be in for a big surprise come January 2013, if the Mortgage Debt Forgiveness Act expires. If this law perishes, short sellers will be taxed on unpaid mortgage debt, which the IRS considers taxable income.

If this law dies, thousands of distressed borrowers will avoid short sales (because of the tax hit) and simply walk away from their underwater homes, possibly sending foreclosure filings upward in 2013. Moreover, home sales would decrease nationwide, putting downward pressure on home prices.

Bailout of Federal Housing Administration
The Federal Housing Administration is nearly insolvent and it could require a taxpayer bailout next year. The 78-year-old agency is $34.5 billion short of its legal capital requirement.

These aren’t the only issues threatening the real estate market. Since Fannie Mae and Freddie Mac were taken over by the government in 2008, taxpayers have plowed $180 billion into them to keep them operational. A decision needs to happen within the next couple of years.

So what is the solution? Obviously, we cannot continue to delay decisions on the Federal debt. We’ve kicked this can down the road for too long. Some hard decisions need to be made, the question is when and which ones. There are no easy answers.

Where is the economy headed in 2013?

Discussion over the impending “fiscal cliff” and continued fiscal instability from the Eurozone, combined with a still sluggish recovery are leaving many Americans feeling pessimistic about our economic future. However, that fact remains that we are recovering, and there are some less-reported economic barometers that show we are moving in a positive direction. A great place to start is FRED, the economic research of the Federal Reserve Bank of St. Louis.

Household debt is way down over the last five years

For the quarter-century leading up to the Great Recession, American consumers accumulated ever-larger piles of debt, both in absolute terms and relative to the size of the economy. Home mortgages were the largest portion of that, but it also included credit cards, auto loans, and student loan debt. The good news is that in the past three years, Americans have made remarkable progress cleaning up their balance sheets and paying down those debts. After peaking at nearly 98 percent of economic output at the start of 2009, household debt was down to 83 percent of GDP in the spring of 2012. That represents debt reduction of $636 billion, or more than $2,000 for every man, woman and child. It should be noted that some of the decline came from debt being written down (such as in mortgage foreclosures), not from being paid off. But the simple fact is that excessive household debt played a major role getting us into this mess; we are well on our way toward fixing it.

A huge obstacle in recovering from this recession is decreased consumer spending. That trend may have reversed in the latter part of this year, particularly after a 12+% increase this last weekend over previous years in spending during Black Friday. For the first time since the Great Recession hit, American households are taking on more debt than they are shedding, a shift that might represent a more resilient recovery.

For two of the last three quarters, American households’ total outstanding borrowing on things like credit cards, mortgages and auto loans has increased after falling for 14 consecutive quarters. Many analysts even see an end to the long, hard process of deleveraging. That process has been a central reason for the sluggishness of the recovery.

Closely watched economic figures underscore households’ sense of strength. Despite tepid growth and still-high unemployment, consumer confidence has been up dramatically, and last month was at a five year high. It since has slacked off a little this week with concerns over the fiscal cliff, but it is still higher than it’s been in the last three years. Economic growth numbers for the third quarter showed household spending picking up pace as well.

The drop in overall debt is in no small part because of foreclosures. Delinquencies and write-offs by lenders are slowing but have not stopped. But the struggle to pay down old debts might not prove such a drag on economic growth in the future.

Now, with the economy more stable and interest rates at generational lows, Americans finally feel more comfortable taking out a loan on a new car or putting money down on a mortgaged home. With their finances more in balance, workers have started spending less of their paychecks paying off old loans and more on leisure or household goods.

Given the importance of consumer spending to the American economy, those changes translate into a more resilient recovery. Consumer spending still drives 65 to 70 percent of the US GDP growth. The end of deleveraging and the recovery of the housing sector will be strong engines for the United States economy.

Experts estimate that the overall level of debt, compared with income or economic output, would continue to fall for the next one to three years — with the earliest prediction for the end of deleveraging coming in mid-2013 and the latest at the end of 2015.

In addition to household debt being down, the cost of servicing that debt is way down. Not only do American families owe less money than they did a few years ago, the price of maintaining that debt is much lower than it once was. In late 2007, debt service payments added up to a whopping 14 percent of disposable personal income. Now it is down to 10.7 percent, about the same as in the early 1990s. That reflects both Americans reducing their debt burdens (see above), and ultra-low interest rate policies from the Federal Reserve that have reduced rates paid on debts. Translation: It costs Americans $403 billion less, or about $1,300 per person, to make their debt payments than it would if debt service costs were still at their 2007 ratio. Ultimately, the consumer is in a better place to purchase, ultimately driving our economy.

Electricity and natural gas prices have fallen

Americans who cook or heat their homes with natural gas are seeing big savings, thanks to falling prices for fuel. The retail price for consumers’ gas service piped into their homes is down 8.4 percent in the year ended in October. The lower wholesale price of natural gas is also pulling down electricity prices; they are off 1.2 percent over the past year.

A shale-driven glut of natural gas has cut electricity prices for the US power industry dramatically and reduced investment in costlier sources of energy.

These are both utility costs that people can’t control much in the short-run, so low prices here translates directly into more disposable income for Americans to use for everything else they want or need to buy. And in percentage terms, it is most helpful for the middle income and poor, who spend a greater proportion of their income on basic energy needs.

This may appear to be blasphemous in a state whose economic growth is so tied to energy and the natural gas boom. However, due to the quality of the natural gas produced in Texas, we have not been as hard hit as other areas of the country. There are different levels of natural gas generated off of natural gas produced from shale. The Eagle Ford shale south of San Antonio benefits from a higher amount of liquid yields across much of the play, which bring higher prices even while natural gas prices are low. Higher oil prices have helped spur development as oil, condensate, and NGLs (ethane, propane, and butane) all command better prices than natural gas pumped from other shale plays in North America that don’t have as much oil mix or liquid natural gas.

Additionally, although energy is a big portion of the Texas region GDP currently (around 10%), the amount of economic impact it has compared to the ‘Texas oil recession’ of the late 80’s has lessened when 20+% of the states GDP was directly tied to energy. Also unlike the late 80’s, there is a lack of real estate development ‘boom’ presently, potentially softening the economic risks we saw in the ‘oil region’ in the late 80’s.

Businesses quit laying off people

If you are in a Texas metro, you know that businesses are hiring. The national job market has been underwhelming in an economic recovery that officially began more than three years ago, and unemployment remains high at 7.9 percent. But there is some hidden good news in the jobs numbers. While businesses aren’t adding new workers at a pace that would put a dent in the millions of unemployed back on the job very rapidly, they also aren’t slashing jobs at a very rapid clip. Private employers laid off or discharged 1.62 million people in September, according to the Labor Department’s Job Openings and Labor Turnover data. That may sound like a lot, but it’s near the lowest level in the decade the data goes back. During the depths of the recession, employers were slashing more than 2 million jobs a month. And even during 2006, which was in theory a good year on paper for the economy, employers slashed an average of 1.66 million workers a month, more than they are now. It is a sign that even though employers aren’t adding jobs in large numbers, they also are reasonably happy with the workers they have and are not dismissing workers in unusually large numbers. It’s a good time if you already have a job.

In addition, government layoffs have slowed down, helping the economies of Austin and San Antonio who felt the effects of Federal and state budget cuts over the last few years.

Nationally housing is dramatically more affordable

People often speak as if higher home prices are an unambiguously good thing, but that can be misleading. Sure, a retiree looking to sell off a large house and live in a small condo benefits from high home prices. But as we all know, the majority of the ‘boom’ states saw homeowners taking equity out of their homes to fund a lifestyle, so when the market corrected, their was minimal equity left due to the homeowners spending. But most everyone else is better off when buying a home is more affordable rather than less. Six years ago, an average of 40% of each month’s wages were used to pay for housing. Today that amount is closer to 26% of the average private sector employee’s pay. For young people just starting out, young families, or those looking to buy a bigger place, that is hard to beat.

As the media has stated, a housing comeback is now underway; that much is clear. Adding to a steady drumbeat of positive data for the sector, the latest monthly data has showed steady gains in housing starts in the last three months.

The question now is how strong it will be and where it will take place. And to answer those questions it helps to look into the fundamentals of the major US housing markets. These numbers suggest the future for housing is looking bright in the Texas metro areas. But that’s getting ahead of things. A good way to look at which housing markets are potentially overvalued and which are undervalued—and where the market seems to be begging for new home construction and where there is still a surplus of unneeded houses—is to look at the relationship between rents and home prices. Over long periods of time, the price to rent a given house should rise at about the same rate as the price to buy one.

But over shorter periods of time, the two can diverge. And when they do, it is usually a sign that something is up in that market. For example, from 2000 to 2005, prices in the Miami metro area rose by 136 percentage points more than did rents, a sure sign that it was one of the nation’s most bubbly housing markets. Those numbers come from comparing changes in the S&P Case-Shiller home price index for different major metro areas compared with the Labor Department’s consumer price index measure of “Owner’s Equivalent Rent,” for those same areas. Owner’s equivalent rent is a measure of what it would cost to rent the housing stock that people in that city own.

Sure enough, in Miami, in the four years starting in 2005, rents kept rising, up 23 percent, while home prices fell 38 percent. Essentially, the imbalance reversed itself.

Few places have experienced booms and busts quite that dramatic, and we definitely did not see this type of appreciation in rents or home prices in Texas. Nevertheless, the same analytical tools can help explain what cities are poised for a rise in prices and construction in the future. When rents are rising faster than home prices, it is a sign that purchasing a home is becoming relatively more affordable, and so it will behoove people to seriously think about buying. That in turn should create upward pressure on prices in the future and coax builders into the market. These things can move in slow waves, so it’s not necessarily proof that the markets flashing green lights for improvement will get better next year. But over time, this is a solid indicator of where new construction ought to occur.

Here in Texas we never saw the rapid appreciation the rest of the country was experiencing. In the boom years of 2001 through 2006, Texas was 50th in appreciation according to OFHEO, which tracks each state’s residential appreciation. The best news out of this analysis, though, may be this: All of the Texas metros have housing markets that have been in pretty good balance over the last year, with prices rising at about the same rate as rents. And that may be the best sign for the housing market of all. After all these years of bubbles and busts, ups and downs, there finally is a measure of stability. And that is a shift that bodes well for the economy.

So where is the economy headed in 2013? We are optimistic. After the past five years it is easy to continue to be negative, everyone expects it. Third quarter GDP growth was announced this week at 2.7%. We’re not back to the ‘boom’ years, but we are improving. Housing is improving, employment is improving, GDP has some legs underneath it, and all in all the economy shows to be improved in 2013-14 with sustainable demand fueling its growth.

Getting ready for the next housing boom

Yes, you read that right.

Get ready for the next housing boom. With the negative media, political dysfunction, mortgage delinquencies and foreclosures we still have going on, and the record levels of housing inventory, how could we possibly have another housing boom, right?

Despite all the problems we are seeing today, pent up demand is creating the next housing boom. Demand for housing is closely tied to the rate of household formation which, if you hadn’t noticed, has been lacking the last five to six years. Any growing economy creates more households and more households eventually need more houses and more apartments. Right now, due to the challenged economy and jobs market, household formation is been on hold. This is one reason why the housing market continues to pick up.

A household is simply a residential unit of shelter. Everyone has to have shelter. It refers to a person or persons living under one roof. Traditionally, a household has been thought of as a nuclear family. Boy meets girl, boy marries girl, and boy and girl buy a house or rent an apartment. In this way, marriage creates more households and demand for more places to live. Divorce, too, creates more households and demand for more housing. People who get divorced do not want to continue living together under the same roof. Households are also formed when children grow up and move out. Most kids can’t wait to get their own place. The US still has population growth, driving employment growth, which leads to housing growth, and results in increased housing demand.

Much of this growth has been postponed. As we all know, employment remains depressed, particularly marginal manufacturing jobs, that have been shipped overseas (except in Texas). College graduates have been moving back with parents. The process of generating new households seems to have stopped or slowed down dramatically. Whether it is the poor economy or just the new norm, more people are postponing marriage. For the first time since 1940, less than 50% of households are maintained by married couples (per 2010 Census). Others are postponing divorce. And as much as they would like to be independent, many grown children are staying put. Some can’t find jobs even after graduating from college, so they are choosing to live with mom and dad just a little longer. Even those lucky enough to be employed are moving in with their parents in order to cut expenses.

This lack of household formation is good news for housing in the long run. It means there is a lot of pent up demand for housing and, based on the last Census, it is growing. Current household formation may be slower currently, yet potential household demand is strong. As the economy continues to pick up steam and more people start to find jobs, household formation will surge. Once that happens, demand for houses and apartments will also surge.

Let’s examine the primary drivers of this demand.

• Job creation is paramount – Texas leads the nation, having created (and still creating) roughly a quarter of all jobs in the US the last few years and projections suggesting that this should continue.

• Population growth – Texas, primarily the four metros, will double in population over the next twenty years. Austin alone is projected to add 60,000 people a year (160 people a day).

• Baby Boomers/retirees – Texas has a low tax burden (46th in the nation), no state income tax, and warm weather, making Texas the #2 destination for this age group. 46% currently own a home.

• Echo boomers – the biggest opportunity here is that 51% still rent (US Census Bureau). However according to the latest FNMA surveys, close to 70% still think that buying a home is something they want to do. Part of that demand is based on businesses discovering the cost savings of moving to Texas. With no state income tax and a low tax burden, estimated savings is close to 30% compared to most other states.

Looking at all the Texas metros, where is the opportunity?

• Austin is in a unique position with limited supply of residential inventory, developed lots, homes, apartments, and 95% to 98% occupancy for rentals in the five county area. All residential is tight. Office is strong; retail is stronger than other markets. Austin was named by HomeVestors as one of the top 25 areas to buy investment property.

• Inside Houston’s outside loop core we continue to have a unique market with strong appreciation and absorption. Also the Woodlands has seen explosive growth with Exxon moving their global headquarters there.

• San Antonio residential continues to improve with limited availability of new homes and development. Multi family continues to improve. Office, retail will remain flat with industrial having a tremendous boost from the Eagle Ford shale play.

• Dallas/Fort Worth has turned the quarter at 97% of pre-recession residential absorption. Multifamily is doing better, but continues to be challenged with short sales and foreclosures.

It’s happening. Locally we have seen the housing market tighten up tremendously as people from all over the country move here for jobs and the high quality of life Austin offers. Even still, in the Austin area and Texas, there continues to be challenged areas. So recovery may not happen for a few more years nationally (possibly 25+ years in some areas. Here in Austin there are some areas that have over 70 years of inventory still.)

This is not to say that any of this is imminent. More likely than not, the process could take a few more years. The United States continues to slowly improve. However many believe that the housing market will turn around. All that pent up demand for household formation should create a strong rebound in the demand for housing. That is, if we can avoid the coming fiscal cliff, which has the potential to undo all the recovery we have made and plunge the United States into a new recession.

The fiscal cliff and housing

If the federal government does not come to a budget solution, what could it mean for the home building and mortgage industry? As Republicans and Democrats brace for a budget standoff based on ideological differences on tax hikes and their impact on small business, lawmakers may find common ground by including housing market relief into discussions on how to grow Main Street America. Depressed home values remain a key constraint for small business creation and widespread negative home equity in many hard hit regions precludes real estate assets from being used a source of capital for hiring or expansion.

But that’s not to say trends aren’t improving, as the nation’s overall home equity surplus shows an increasing rate of recovery. In third quarter results released by the Federal Reserve in late September, home equity rose to its highest post-crisis level, even eclipsing 2008 levels.

Presently, the nation now faces something equally different and just as dangerous — falling off of the fiscal cliff. The outcome of our trip to the edge of or over the fiscal cliff has wide ramifications for our economy, yet the impact on the housing market could be among the most significant.

Quite simply, the fiscal cliff is the combination of automatic spending cuts and automatic tax increases that take effect either at the end of 2012, or the very beginning of 2013. It was a gimmick, known as the Budget Control Act of 2011, which was put in place by Congress and President Obama to attempt to force a budgetary compromise. It represents a “kick-the-can-down-the-road” approach to policymaking – which seems like the dominant way our national budget has been managed for the last decade.

Unable to reach an acceptable compromise by the deadline, our elected Congressional and administrative officials on both sides chose to vote for something they did not entirely support largely because it contained policies that their opponents also found intolerable.

Among the changes to current law set to take effect at midnight on December 31, 2012 are the end of last year’s payroll tax cuts (2% for most workers), the end of certain tax breaks for businesses, modifications to the Alternative Minimum Tax that would impact far more people, the end of the Bush tax cuts, including capital gains and estate tax cuts, and the initiation of taxes related to the Affordable Care Act.

Concurrently, spending cuts that were agreed upon as part of the debt ceiling deal of 2011 would commence. Estimates are that over one thousand government programs will face steep cuts, including $500 billion from defense over the next decade.

It is vital to remember the recent rebound in the housing market is a function of two primary factors. First, historically low interest rates served to prop up the ailing market. Second, the market has benefited from the sense that it has finally bottomed out, which buoyed consumer confidence. What impact would failure to avoid the fiscal cliff have on the housing market and the economy as a whole? In a word: disaster. Let’s examine how the fiscal cliff will directly derail the two factors that have driven the rebound in housing.

First, failure to address the cliff will end the incredibly low interest rates we have been enjoying. Let’s not forget the reason such massive spending cuts and tax hikes are being contemplated during this time in history is the existence of our nation’s $16 Trillion debt. According to figures from the U.S. Treasury from August 2012, approximately 53% of our current debt is owned by foreign investors. China accounts for 10% of U.S. debt ownership, but — and this is key — China appears to be reducing its holdings of U.S. treasuries.

The reason for China’s reduction in Treasury holdings is a belief on their part that the value of U.S. denominated debt will decrease over time based on the inability of U.S. officials to put a credible debt reduction plan in place that does not compromise economic growth. China and other foreign investors would be tempted to sell more U.S. debt and reduce their future purchases if it appears a responsible plan will not be adopted. When U.S. debt loses its appeal, interest rates have to be increased to lure purchasers. If that happens, our current period of historically low interest rates will end.

The second reason for the resurgence in housing has been a sense that the worst was behind us relative to the economy, the jobs market and property values. A new recession (caused by falling from the fiscal cliff) with as many as 1 to 2 million new unemployed Americans will devastate consumer confidence and risks another wave of home foreclosures. Moreover, the recent gains in home values would likely evaporate as the pool of potential buyers falls dramatically.

In order to avoid a catastrophic outcome, our political leaders must work out a compromise on taxes and entitlements that is amenable to both sides that sets our country on a fiscally responsible path. The alternatives – kicking the can down the road, or simply plunging over the cliff – are unacceptable.

After this hard fought political season, our political leaders difficult response to the crisis at hand is needed. Out of control entitlement, defense, and social spending needs to be a thing of the past. Compromise and working together need to be the mission. Anyone that has been in a successful relationship will tell you that compromise is paramount. If Congress is too late, they risk the wrath of global investors passing on Treasuries with potentially “rocky” consequences. Credible action must take place before the end of the year. It doesn’t have to be the final deal, yet it must be detailed enough and involve pledges from all parties that the deal will be resolved within a very short period of time.

The housing market continues to swim upstream in a sea of uncertainty and won’t be on its way to recovery until some sort of concrete forward-looking directional guidance is offered by an official source, good or bad! This mess can’t be cleaned up overnight, nor do we think it’s fair to expect a broad-based reform package to be implemented with one swipe of the President’s pen. What we do expect is better management of expectations and a clear voice of leadership in Congress or the administration. If the regulators are really having this much difficulty making a decision on the next move, then maybe they shouldn’t implement patchwork regulations just to appease outcries for reform. All that does is create more confusion, which only breeds more uncertainties and adds further barriers to the home loan qualification process.

The housing market is particularly vulnerable at this moment in its recovery. The potential consequences for housing include rising interest rates, dropping home values, a resurgence of foreclosures and a dramatic, perhaps generational long loss of consumer confidence. With stakes like these, all Americans, particularly homeowners and those dependent on the housing economy, must demand action from our leaders.

If no serious attention is given to housing finance reform until after the fiscal cliff, what are the implications on the broader economy? A clear solution is what is needed. It will take time for any solution to start the healing process, but if you continue the political haggling, it is like ripping the band aid off again and again. It slows the healing process.

Where does America, and subsequently Texas, now stand?

The election is over, and the cloud of uncertainty about the future of America’s leadership has passed. Many pressing political and business decisions had been delayed, as people waited to see what would happen. This indecision limbo is over, and now it’s time to get back to work. Where does America, and subsequently Texas, now stand?

The US remains as the sole global military superpower, the home to one-fifth of world economic output, the undisputed global reserve currency, and the world’s leading universities. This puts the United States in a unique position to export both its influence and its domestic problems. With Europe mired in its deepest-ever crisis and China absorbed by development challenges, US leadership in the economic sphere—whether exercised or not—remains essential. With the US elections over, the question is what kind of impact do we see the next US president— incumbent Barack Obama—and new Congress will have on the global economy.

Republicans maintained control of the House of Representatives while Democrats maintained a majority in the Senate. Democrats had held a 53-47 edge in the Senate previous to the election. Despite having several vulnerable incumbents, the Democrats managed to secure 53 seats to Republicans’ 45 in the Senate, while Republicans in the House had at least 233 seats and Democrats at least 193, with 9 seats still being counted.

Two crucial points emerge. First, even though Obama won and Democrats retained the Senate, they will still have to seek compromise with a Republican House. Second, neither party gained a filibuster-proof 60 seats in the Senate. This means that the president will have to try to compromise with Senators of the opposite party in order to pass meaningful legislation.

It follows that the implications of the US elections for the global economy depend less on precise electoral platforms than on the shape of the compromise reached on the big issues, and, against a background of fraying consensus, whether compromise can be reached at all. Thus, the US electoral outcome is likely far less predictive of policy than, say, the Socialists’ sweep in France in May or even last year’s Conservative/Liberal Democrat victory in the UK.

Lets look at how the presidents main issues affecting the global economy and a best guess as to the likely outcome.

Potential Fiscal Cliff

Both parties are sharply at odds over how to reduce the fiscal deficit, which reached 100% percent of GDP last year. Democrats advocate higher tax rates for upper-income taxpayers (those earning over $250,000 per year) as the key to reducing the deficit. The Republicans advocate cutting entitlements and lowering individual and corporate tax rates while broadening the tax base to make up for the lost revenue.
The immediate source of disagreement, however, is how to go about avoiding the “fiscal cliff”—a precipice consisting of automatic federal spending cuts and tax hikes, including the expiration of the Bush-era tax cuts and the payroll tax cut, scheduled to go into effect at the beginning of 2013. What is the “fiscal cliff”?
The term “fiscal cliff” refers to the simultaneous spending cuts and tax increases that are slated to take place at the end of 2012.

For instance, the Bush tax cuts are currently scheduled to expire at the end of 2012. In addition, provisions that limit the reach of the AMT (alternative minimum tax) and cut payroll taxes are also scheduled to expire at the end of the year. On top of that, automatic spending cuts, as per the language laid out in the Budget Control Act of 2011, are also currently planned for the 2013 fiscal year.

While the tax increases and spending cuts would reduce the size of the national deficit, most economists feel as though the sudden changes would plunge the country into another recession, especially given the fact that the country has been so dependent on fiscal stimulus over the past few years.

For that reason, many politicians want to avoid the “fiscal cliff” that is currently looming in the distance. While most Republicans propose making the Bush-era tax cuts permanent, the administration and the Democratic Party argues they should end for upper-income households earning more than $250,000 per year. However, neither has proposed preventing the $120 billion yearly payroll tax hike. Nothing happened before the election. Therefore, the ‘lame duck’ Congress that will convene in November could just agree to suspend the cutbacks and tax increases for a few months. This means that the shape of a final deal on the deficit will remain unknown until late 2012 at the earliest, more likely early 2013.

Obviously a compromise is needed and is bound to include some mixture of tax increases and reductions in entitlement and discretionary spending, as well as further deferrals of tough decisions to a point down the road. Of course, there is no guarantee that such a deal will materialize. In the meantime, especially if the US recovery remains hesitant, it is difficult to believe that policymakers will push the US economy over the edge.

Texans and Americans have to see this ‘fiscal cliff’ avoided to maintain the growth we have had over the last few years. Whatever happens, the chance for another ‘national recession’ is there.

European financial crisis

Since we have managed our own financial crisis so well (not), we have been happy to tell the Europeans how ugly their crisis is. Europe is believed to have the resources to address its fiscal and financial problems and, so far, have kept the option of US support off the table, including through the International Monetary Fund (IMF). However, while the current administration has pressed mainly for Germany and the troika (the European Commission, the IMF, and the European Central Bank) to step up help for troubled economies, presumably in the form of fiscal transfers and larger liquidity injections, the Republicans have argued mainly for austerity as a way to restore public confidence.

Unless a major cataclysm occurs, the United States will likely continue to take a backseat in the euro crisis by, for example, providing liquidity swap lines via the Federal Reserve.


The Obama administration supports an “all-of-the above” approach that calls for the development of all sources of energy but differs significantly over how quickly to exploit fossil fuel-based energy sources at home and over what safeguards should be imposed.

Obama’s approach includes developing domestic fossil fuel reserves as well as a range of alternative energy sources, including solar, wind, and biomass. For most Republicans, fossil fuels are crucial. They would allow the rapid development of shale gas and oil—and favors less regulation across the board—but also advocates greater investment in nuclear power. Additionally, Republicans are calling for a higher number of new oil and gas leases for offshore drilling.

Though Republicans would likely move to allow more aggressive domestic exploration and speed up the approval of the Keystone XL pipeline, fundamental shifts in US energy policy are unlikely which ultimately is good news for Texas and energy producing states.


Republicans will likely continue to chip away at the healthcare reform law passed in 2010, which was a significant step toward universal healthcare coverage. But it would be difficult to repeal the law entirely, even if there had been a clean sweep of the White House and Congress by Republicans. The Supreme Court in June upheld its constitutionality, and the Congressional Budget Office recently projected that repealing the law would increase federal deficits by $109 billion over the next decade.


Obama’s position on has not changed, especially on granting permanent residency to and lifting country-based caps and other quotas on visas for highly skilled immigrants. But the two parties deeply diverge on granting permanent-resident status to the 11 million illegal immigrants who are currently in the United States, which the administration favors but will likely have no luck pushing through a Republican Congress over the next four years.


The re-election of President Barack Obama may lead to some change on the housing-mortgage finance front. However, experts don’t expect this to happen any time soon. Don’t bet on Ed DeMarco, acting head of the Federal Housing Finance Agency, leaving his post anytime soon. At this point, changing what may be considered the most important post in mortgage finance could prove unnecessarily disruptive.

Mr. DeMarco has been and likely will continue to be a political ping-pong at this point for his firm stance against the FHFA allowing principal write-downs. And with Congress desperately needing a deal to stem the threat of the fiscal cliff in early 2013, most analysts expect the administration to distance themselves on DeMarco in the short term. Secondly there is currently no new nominee for DeMarco’s spot — no obvious replacement. This alone makes it unlikely that the president will use a recess appointment to replace DeMarco in the near future. The process of approval would be contentious, and presently the administration needs positive points in lobbying Congress.

In housing, lawmakers on both sides of the aisle may be willing to push forward with the Responsible Homeowner Refinancing Act of 2012, which is known as the Menendez-Boxer Bill. The bill would expand refinancing options – a deal that could prove a boon to lawmakers on both sides of the aisle who want to aid 3 million homeowners and claim the stimulative effects of $2,500 in savings for families through refinancing.

The Menendez-Boxer bill would take away reps and warrants risk for new servicers, eliminate up-front refinancing fees and appraisal costs and would be covered by a 10-basis points surcharge on refinanced home loans

But everything going forward on the housing front is masked in a high degree of uncertainty. The future of the government-sponsored enterprises (FNMA, FHA, etc.) is still undecided. And banks and financial firms reaction to the roll out and implementation of final Dodd-Frank rules in 2013 is something that the markets have been worrying about for two years now.

The US fiscal outcome will remain unknown until at least late in 2012, adding to the global economy’s jitters. But the US election most likely brings some investor reassurance in the short run but also bad news in the long run. The short run relief, under either candidate, is likely to come from the avoidance of a US fiscal nosedive in 2013, more attention to trade agreements, avoidance of a big trade dispute with China, and the continued development of new energy sources. For better or worse (likely for worse), Europe will be left to its own devices.

The bad news is that the post-election United States is unlikely to make significant headway on its thorniest economic problems: the long-term fiscal imbalances associated with aging, healthcare spending, and inadequate tax revenues that disproportionately show favor to corporations; and the legalization of its large undocumented migrant population. Moreover, the country’s lagging primary and secondary education system, which affects our international competitiveness and helps account for soaring income inequality barely made the cut for election debates.

In comparison to a badly aging Japan with a prolonged ( 20+ years) recession and the euro-challenged euro zone, the challenge of China’s state run economy, etc. the United States looks like the shining city on a hill, but before we admire lets realize it is not that pretty. Unfortunately, the hill lies on a deep fault line—a vanishing political consensus.

So despite the US economy’s size and vitality, its inability to implement a number of crucial structural and fiscal reforms is reflected in its failure to provide clear leadership on those issues and others to a global economy that is being transformed at unprecedented speed. A patchwork solution to the fiscal cliff is likely to provide some temporary reassurance. But the pattern of putting off a long-term solution to America’s fiscal woes significantly adds to the risk that, sooner or later, events like the 2008–2009 global financial crisis will recur, though in a different shape and with perhaps even more disastrous consequences.

So how does this affect us in Texas? Despite our energy resources, tech growth, low tax burden, and low state entitlements that help fuel growth, the economies of states and nations are intertwined. If the national economy falls into recession, Texas will surely follow with it. If the nation continues to recover Texas will continue to lead the way.

So here are some suggestions, none of them original, but all worth thinking about.

  • -Warren Buffet said “I could end the deficit in 5 minutes,” he told CNBC . “You just pass a law that says that anytime there is a deficit of more than 3% of GDP, all sitting members of Congress are ineligible for re-election.
  • -Think about it, the 26th amendment (which granted the right to vote to 18 year-olds) took only 3 months & 8 days to be ratified! Why? Simple! The people demanded it. That was in 1971 – before computers, e-mail, smart phones, etc. Of the 27 amendments to the Constitution, seven took one year or less to become the law of the land – all because of public pressure.
  • -Pass ‘no budget, no pay’ legislation that would dock legislators everyday that they fail to pass a budget on time. No extensions.
  • -No tenure, no pension. A Congressperson collects a salary while in office and receives no pay when they’re out of office.
  • -Congress (past, present & future) participates in Social Security. All funds in the Congressional retirement fund move to the Social Security system immediately. All future funds flow into the Social Security system, and Congress participates with the American people. It may not be used for any other purpose. There is no separation of retirement funds for any group in the US.
  • -Congress loses their current health care system and participates in the same health care system as the American people.
  • -Congress can purchase their own retirement plan, just as all Americans do. Again no separation from the public.
  • -Congress will no longer vote themselves a pay raise. Congressional pay will rise by the lower of CPI or 3%.
  • -All presidential appointees will be approved or disapproved within 90 days or the nominee is approved by default.
  • -End the use of filibusters. Period.
  • -If bipartisan committees are currently not set up, introduce them, have bipartisan seating, and a bipartisan leadership committee. Grade legislative members by the number of compromises that they work on. If we have to compromise everyday, why shouldn’t they?
  • -To create a new department, another has to close. No more redundancy of responsibilities within the govt.

I am just saying we ought to think about it.
If I have offended anyone, I apologize. This newsletter is my responsibility and Independence Title is kind enough to endorse it. So again, if you are in disagreement, please e-mail me. That said, I hope you enjoyed the discussion.