Forget what economists have told you about how stimulus programs are supposed to function during a recession. You can learn a lot more from watching a master illusionist at work.
Take America’s US$8,000 tax credit for first-time homebuyers. Like any stimulus measure meant to jolt the economy out of recession, the tax credit was always more about smoke and mirrors than economic theory. When Washington created the program eight months ago, its aim was to conjure the illusion of stability in the housing market. Until the free fall in house prices could be halted, a broader economic recovery could never take hold.
So Uncle Sam began funnelling US$14 billion to buyers. The program has taken lots of knocks from critics along the way. An audit found thousands of cases of potential fraud and abuse. One house was even bought in the name of a four-year-old. Still, because of the sleight of hand, confidence materialized where none had existed before. In September, home sales rose 9.4 per cent to an annual rate of 5.57 million, the highest level since 2007. Prices have also registered three straight month-over-month increases. Low interest rates played a part, of course. But economists attribute most of the improvement to the tax credit.
Here’s where it all gets tricky. The tax credit is due to expire at the end of November. Lawmakers in Washington must now decide whether to extend it, gradually phase it out, or pull the plug entirely. The stakes are huge. After officials scrapped cash-for-clunkers, a scheme to encourage Americans to buy cars and trucks, automobile sales plunged 23 per cent the next month. Eric Sprott, the Toronto hedge fund manager, predicts that if the tax credit isn’t extended, the volume of home sales will plunge 30 per cent in January. So it’s no surprise the real estate industry in America is lobbying hard for another US$16 billion to carry the program through to next June.
But at some point the illusion has to end and reality must take over. The U.S. government can’t indefinitely prop up the housing market. How will the big reveal play out? And will the American audience stay in their seats, or make a mad dash for the exits? The next moves that Washington makes could well be the most important since the fragile recovery began last spring. The wonder of it all won’t be that billions of dollars could create the illusion of stability, but whether that stability will hold once the strings are cut.
GRAPH OF THE WEEK: Rebuilding the market
Balance is returning to the U.S. housing market, as sales increase and the glut of unsold homes shrinks. But sales are being driven by a US$8,000 tax incentive for first-time buyers, set to expire next month. Without it, can the rosy trend continue?
The Bank of Canada upped its outlook for the country, and now expects the economy to grow 3.3 per cent this quarter, up from its previous forecast of three per cent. The bank credited consumer spending for the country’s improving fortunes.
Speaking of consumers, retail sales in Canada rose 0.8 per cent in August from the previous month. The gains largely came from higher gasoline prices and automobile sales. Sales weren’t spread evenly across the country, though. The Atlantic provinces fared best, while Alberta saw sales plunge 9.4 per cent.
Off the dole
Happy consumers need jobs. Fortunately, the number of Canadians collecting unemployment insurance fell 2.4 per cent in August, from the month before. It was the second straight decline.
Lead the way
Economists cheered as the U.S. Conference Board’s index of leading indicators blew through their expectations in September. The index, a barometer of where the economy will be in three to six months, rose one per cent, more than the 0.8 per cent economists were looking for. The index got a big boost from rising consumer expectations.
America’s housing market is still rickety. Prices fell by 0.3 per cent in August, according to the Federal Housing Finance Agency. The agency’s index tracks houses guaranteed by mortgage finance firms Fannie Mae and Freddie Mac. Meanwhile, economists cheered when the Case Schiller house price index showed a 1.2 per cent gain from July to August, but the index was still down 11.3 per cent from the year before.
Try some restraint
Ontarians are now hearing a term they haven’t in years: fiscal restraint. With tax revenues plunging and spending on the rise, the province faces an astronomical $24.7-billion deficit this year. That works out to about $1,993 for every man, woman and child. The Ontario government said it would unveil an action plan to fight the deficit in time for the next budget. Get ready for “Dalton Days.”
Canadians have a love-hate relationship with rising commodity prices. They can mean higher gas prices, but they also saved our Canadian bacon when most of the rest of the world plunged into a deep recession. That’s why it’s worrisome to see the Scotiabank commodity price index fall in September by 1.8 per cent amid the sluggish global economy. Everything from agriculture and oil to minerals and uranium was down. The bank predicts the index will rebound in October.
SIGNS OF THE TIMES
- The U.S. housing bust has ravaged what’s left of Howard Hughes’s estate, dampening hopes of a final, big payout to scores of heirs and beneficiaries. The reclusive billionaire died in 1976 with no children and no will. Among the few remaining assets were some 7,000 acres of land in Las Vegas that was originally intended to house his aerospace interests. Once valued at US$2 billion, the property is now worth only a fraction of that.
- India’s Tata Motors, maker of the US$2,500 Nano minicar, represents one of the few bright spots in the beleaguered auto sector. The company doubled its earnings in the second quarter thanks to lower raw material costs and rising car sales in India. However, the numbers don’t include results of luxury brands Jaguar and Land Rover, which Tata Motors purchased last year from Ford.
- McDonald’s is pulling out of Iceland one year after the banking sector there collapsed and took the local economy down with it. While the fast-food giant has generally done well during the recession, the company said Iceland’s “very challenging economic climate” made doing business there financially impossible. All three McDonald’s restaurants are scheduled to close by Oct. 31.
- As if the economy needed another drag, a new study suggests employees who use Twitter or other social networking sites such as Facebook at work are costing businesses in the United Kingdom the equivalent of $2.4 billion annually. The office workers surveyed claimed to spend an average of 40 minutes a week on the sites.
The U.S. cracked down on executive pay at banks that received bailout funds, with some bankers expected to take pay cuts averaging 50 per cent. The news did little to calm anger about huge bonuses at other banks, and some warned affected banks will lose valuable employees. But most observers welcomed the clampdown.
“The idea that the people who move money around are some favoured class—and they are in this country, even in terms of taxes—is getting pretty far away from where we should be.”—Warren Buffett, CEO, Berkshire Hathaway
“These institutions have a set-up where it’s heads they win, tails the taxpayer loses.”—Bill Fleckenstein, president, Fleckenstein Capital
“We will not remind market participants of the many oaths they swore a year ago; nor do we expect scores of financiers to join religious orders. However, we do expect those fevered battlefield vows to be respected.”—Bank of Canada governor Mark Carney
“I don’t think there will be any charity cases on Wall Street.”— Barney Frank, chairman, House financial services committee
“These [earnings] are gifts, hidden gifts, from the government, so I don’t think those monies should be used to pay bonuses.” —George Soros, chairman, Soros Fund Management
THE WEEK AHEAD
Thursday, October 29: U.S. GDP figures will be released for the third quarter. Economists expect economic growth of 3.2 per cent.
Thursday, October 29: Statistics Canada will report payroll employment numbers for August.
Tuesday, November 3: U.S. auto sales for October will be released. Sales are expected to remain down following a sharp decline in September after the cash-for-clunkers program expired.