Fannie Mae’s Economics and Mortgage Market Group (EMMA group) believes the slowdown in economic growth and hiring witnessed so far this year, coupled with heightened financial market volatility, has put the U.S. economy on the edge of a recession. Consumers are pulling back based on uncertainty about their jobs and the value of their assets. At the same time, companies do not want to hire unless demand for their products picks up, creating a vicious circle that threatens to derail the expansion. The EMMA group’s current outlook assumes that the U.S. economy remains on a slow-growth path through next year, which will be insufficient to heal the labor markets and bring the unemployment rate down by any meaningful degree. As a result, the EMMA group believes the economy is very vulnerable to internal and external shocks and our best estimate now is that the odds of a recession are a coin toss.
The EMMA group sees many possible candidates for an economic or market shock that could trigger a recession, but at the current moment our best guess is that such a shock would be a financial crisis in Europe. The fractured political landscape there is making it increasingly difficult for European countries to come up with the kind of significant structural changes needed to put government finances on a sound footing. Insofar as many big banks across the Continent are exposed to the debt of more risky countries, and the global financial system remains highly integrated, the problems across the region have the potential to be similar in magnitude to the U.S.-led financial meltdown of a few years ago. Similar to what transpired then, there is a lack of transparency about cross-border exposures that heightens the uncertainty around these issues and is troubling to investors.
The role of housing in the current situation is quite a bit different from three or four years ago. In 2006-2007, housing values were inflated and the subsequent decline has brought prices down to levels that are much more in line with long-term fundamentals such as borrower income. That said, the housing market is not immune to further declines should the economy take a turn for the worse. At present, the consensus view is that further modest declines in home prices are in store into early next year, but a further decline of more than a few percentage points beyond this would likely have a negative impact on both consumer confidence and the balance sheets of financial institutions.
Vice President and Chief Economist
September 23, 2011