GMU economist expects a stronger economy by the third quarter

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The economy is showing signs of weakness as businesses and homeowners continue to cope with the fallout from a growing wave of subprime mortgage foreclosures. Virginia Business turned to Dr. Stephen S. Fuller of George Mason University in Fairfax for his insights on the direction of the economy. He is a University Professor and the holder of the Dwight Schar Faculty Chair at GMU and is the director of the Center for Regional Analysis at the university’s School of Public Policy.

How would you describe the current condition of the economy?
It is likely that the national economy contracted for the first three months of the year with payroll job losses being registered in each of those months (on a month-to-month basis). When part-time, self-employed and contract workers are included, the number of payroll jobs in March was 480,000 greater than in March 2007. However, the nation had 220,000 fewer total jobs in March 2008 than in March 2007, thus registering its first decline since mid-2001.  Most telling is the increase in first-time claims for unemployment compensation that exceeded 400,000 during the last week of March.  So, yes, the economy is experiencing recession-like conditions. 
It is unclear whether this pattern will extend for a second quarter, and a recession be declared.  The second quarter’s economic performance is likely to be very weak.  If consumers spend their tax refunds and their stimulus checks rather than paying down their debt, and energy prices moderate and new residential construction ticks up slightly, the national economy could turn positive before midyear and avoid the recession label.  Consumer confidence, which stands at a low not seen since the early 1970s during the oil embargo, needs to improve and consumer and business spending need to increase in order to escape a recession in 2008. 

Do you think proposals to revamp the financial regulatory system will prevent future credit crises?
Better oversight of the financial markets, especially the Wall Street banks and mortgage companies, would go a long way to protect against future credit crises similar to the one we are now in.  And, I believe we will see a tightening of this oversight with the Federal Reserve Bank taking the lead, at least initially.  Changes to the regulatory system within the executive branch will be more difficult to achieve as these will require congressional action, and there is no consensus between Congress and the administration, and it is an election year. Still, in the past, when the credit system experienced a meltdown, such as during the S&L crisis in 1987, important changes have been implemented that corrected those abuses.

Would?a bailout for consumers with subprime mortgages help or hurt the economy?
First, a bailout of homeowners with subprime mortgages would be extremely expensive.  The federal government cannot afford such a bailout (the federal deficit is already too big) nor can the financial institutions. Doing nothing also presents a major threat to the economy.
There are feasible and affordable proposals that would help homeowners in danger of losing their homes to foreclosure to refinance their variable-rate mortgages before they’re set to an unaffordable rate. The cost of refinancing these qualified loans would be small compared with the cost of letting these units slip into foreclosure. With financial counseling and specific performance checkpoints, homeowners with sufficient cash flow to carry a conventional mortgage in place of the flawed subprime could be saved and the threatened foreclosure problem significantly reduced. Still, the number of foreclosed units will continue to grow this year and that growth threatens the normalization of the housing market.  Tax incentives to encourage increased homeownership have had a positive effect in the past and should be adopted now in order to help find buyers for these foreclosed houses before the problem infects entire neighborhoods. 

Do you expect the economy stimulus package passed by Congress to be much of a factor?
The stimulus package will have little beneficial impact on the economy’s performance. We will see some increase in retail spending during the second quarter as a result of normal tax refunds as the 2007 tax season winds down and some gains in spending during the third quarter as a result of the stimulus checks. A substantial percentage of these funds may be diverted from consumer spending as some will be used to pay off bills and reduce debt load.
The one part of the stimulus package that will be beneficial is the raising of the conventional mortgage limits from the previous limit of $417,000 to a maximum of $729,000 in high-price regions. 

How do you expect Virginia to weather the?slowdown?
The Virginia economy has stronger fundamentals than the national economy, and its housing problems are not as great.  Consequently, I expect the Virginia economy to grow over the course of the year albeit at a much slower rate than in 2007.  I will be surprised if the state actually experiences two consecutive quarters of negative economic performance so I am still expecting it to escape the recession altogether.  This is not to say that there are not counties or submarkets across the state that will experience contraction.  The economic and housing problems we are experiencing are not evenly distributed across the state or the nation. Looking forward, I expect the second half of the year to be measurably stronger than the first half and for this reacceleration of the state’s economy to extend through 2009 and be even stronger in 2010.

When do you expect the economy to revive?
I believe the third quarter will be the beginning of a clear uptick in the economy at both the national and state levels. I expect the first quarter to have been the worst (negative nationally and possibly just very slow in Virginia) and the second quarter to be stronger. By the third quarter, there should be visible signs of a stronger economy.  Renewed growth will slowly accelerate in 2009 with 2010 projected to register a solid gain for both the state and the nation. 

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