Gross Domestic Product Third Quarter 2008

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 0.3 percent in the third quarter of 2008, (that is, from the second quarter to the third quarter), according to advance estimates released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 2.8 percent.
The Bureau emphasized that the third-quarter "advance" estimates are based on source data that are incomplete or subject to further revision by the source agency (see the box on page 3). The third- quarter "preliminary" estimates, based on more comprehensive data, will be released on November 25,
2008.
The decrease in real GDP in the third quarter primarily reflected negative contributions from personal consumption expenditures (PCE), residential fixed investment, and equipment and software that were largely offset by positive contributions from federal government spending, exports, private
inventory investment, nonresidential structures, and state and local government spending. Imports, which are a subtraction in the calculation of GDP, decreased.
Most of the major components contributed to the downturn in real GDP growth in the third quarter. The largest contributors were a sharp downturn in PCE for nondurable goods, a smaller decrease in imports, a larger decrease in PCE for durable goods, and a deceleration in exports. Notable offsets were an upturn in inventory investment and an acceleration in federal government spending.
Final sales of computers contributed 0.06 percentage point to the third-quarter change in real GDP after contributing 0.17 percentage point to the second-quarter change. Motor vehicle output contributed 0.09 percentage point to the third-quarter change in real GDP after subtracting 1.01
percentage points from the second-quarter change.

Economists React: GDP Report Shape of Things to Come?

From the WSJ.
Economists and others weigh in on the 0.3% contraction in third-quarter GDP.

According to the BEA’s advance estimate, real GDP contracted at an annualized rate of 0.3% during the third quarter. Note that the advance estimate is subject to two rounds of revisions, which will almost surely yield a larger contraction in real GDP when all is said and done. Moreover, the third quarter offers a hint of what lies ahead for the U.S. economy, and we expect a significantly larger contraction in real GDP during the current quarter. –Richard F. Moody, Mission Residential


Consumption was grim, down 3.1%, while corporate capital spending dropped 5.5%. Housing investment plunged 19.1% but commercial structures continued to rise, up a hefty 7.9%. Still, the sector is slowing; expect an outright drop in the fourth quarter. This is the first of a run of negative GDP numbers; the economy is in recession. We tentatively expect GDP of -1% in the fourth quarter and first quarter of 2009. –Ian Shepherdson, High Frequency Economics
A shift should transpire. Consumers are getting relief at the pump and retailers and foreign exporters are ready to offer discounts. Net exports and business equipment will be drags. –Stephen Gallagher, Societe Generale
Despite a stronger dollar, net exports provided a substantial boost to GDP growth, adding 1.1% to the total number. Goods exports, much of which was likely the result of orders placed in a period of a weaker dollar, grew by 7.5%, while goods imports shrunk by 2.8% on energy costs which, judging by the average quarterly price of oil, decline by around 4.5%. There’s no reason to expect that export growth will provide any benefit in the fourth quarter, though the continued decline in oil, if it manages to sustain, should reduce imports rather sharply. –Guy LeBas, Janney Montgomery Scott
Output in the nonfarm business sector fell at a 1.7% annual rate (more steeply than GDP, which includes government expenditures), and we estimate that hours worked declined at a 2% annual rate, implying a sluggish 0.3% advance in productivity. –Alan Levenson, T. Rowe Price
The data imply that just about all sectors of the economy are in the process of a serious contraction with the capitulation of the consumer the primary catalyst behind what is clearly the first consumer driven recession in three decades. And what was behind that? A -8.7% decline in real disposable personal income in the third quarter in contrast with the 11.9% increase observed in the second quarter of 2008. The advance estimate of gross domestic product sets the stage for an operatic end to the recent business cycle in what looks to be a significant contraction in the fourth quarter in excess of 4.0% –Joseph Brusuelas, Merk Investments
The details of this report were worse than the headline growth figure might suggest, and the outlook for the fourth quarter and beyond is grim, dominated by a tapped-out consumer, ongoing weakness in housing, and an incipient downturn in capital spending that promises to gain momentum. Partly blunting the decline will be continued narrowing of the net export deficit and surging federal government spending. However, states and localities are busy slashing spending to try to balance budgets that are hemorrhaging red ink, so this will partly offset the federal government’s upward impetus. All in all, we look for a recession that is both longer and deeper than those in recent memory, lasting at least through 2009 and encompassing a string of negative GDP growth figures. –Joshua Shapiro, MFR Inc.
In other times, the inflation side of the report would have been troubling with core PCE prices up 2.5% year-over-year and chain GDP prices up 2.7% on the same basis — but the Fed has no inflation worries because of falling commodity prices and rising slack in labor and product markets (we are not sanguine about the long-term inflation consequences of the explosion in the Fed’s balance sheet, but now is not the time to worry about that). –RDQ Economics
Government statisticians cited a couple of special factors that influenced the economy during the quarter — hurricanes and the Boeing strike. However, based on underlying sales and shipments figures, we suspect that the impact associated with each of these factors was relatively minor. –David Greenlaw, Morgan Stanley
Compiled by Phil Izzo

Fed Cuts Rate to 1% to Avert Prolonged Recession

The Fed cuts its benchmark rate to 1 percent and leaves open the possibility of further cuts. How low will the Fed go?
Fed Cuts Rate to 1% to Avert Prolonged Recession
The Federal Reserve cut its benchmark interest rate by half a percentage point to 1 percent, matching a half-century low, in an effort to avert the worst U.S. economic downturn in the postwar era.
``Downside risks to growth remain,'' the Federal Open Market Committee said today in a statement in Washington. ``Recent policy actions, including today's rate reduction, coordinated interest-rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth.''
Central bankers worldwide are trying to revive credit and stop a self-reinforcing downturn in consumer spending and bank lending from triggering a global recession. Today's decision follows the half-point reduction the Fed coordinated with the European Central Bank and four other central banks on Oct. 8. Borrowing costs were pared today in Norway and China.
The U.S. economy shrank at a 0.5 percent annual rate last quarter, the most since the 2001 recession, the Commerce Department's report on gross domestic product will probably show tomorrow. Economists expect the slump to persist in the fourth quarter, according to the median estimate.
`Economy Weakens'
``If the economy weakens further, it may open the door for another 25 or 50 basis points in December,'' said John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina.''
Plunging commodity prices, including a 54 decline in the cost of oil from a record in July, have eased inflation pressures.
``The committee expects inflation to moderate in coming quarters to levels consistent with price stability,'' the FOMC said in today's statement.
The vote was unanimous. The Fed also lowered the discount rate a half point to 1.25 percent.
While cutting the main rate during the past 13 months from 5.25 percent, Fed Chairman Ben S. Bernanke, 54, has created six loan programs channeling at least $700 billion in cash and collateral into money markets as of Oct. 22.
``This Federal Reserve has been extremely aggressive in terms of providing liquidity,'' Frederic Mishkin, a former Fed governor and now a Columbia University professor, said in a Bloomberg Television interview before the announcement.
Confidence Weakens
Still, consumer confidence tumbled this month to a record low, and orders for durable goods, excluding automobiles and aircraft, dropped for a second straight month in September, reports showed this week. Home prices in 20 U.S. cities declined 16.6 percent in August from a year earlier as foreclosures climbed, according to the S&P/Case-Shiller home price index. The Standard & Poor's 500 Stock Index is down 36 percent this year.
``The intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit,'' the Fed's statement said. ``The pace of economic activity appears to have slowed markedly.''
The credit crisis that began in August 2007 with rising foreclosure rates has led to the collapse or forced mergers of some of Wall Street's biggest firms. Lehman Brothers Holdings Inc. filed for bankruptcy last month, while the government seized control of American International Group Inc. and put Fannie Mae and Freddie Mac under conservatorship. Wachovia Corp. agreed this month to be acquired by Wells Fargo & Co.
Global financial institutions have reported $680 billion in writedowns and credit losses on home loans, mortgage-backed securities and related assets.
Funding Costs
The spread between the cost of overnight loans in New York and three-month dollar loans in London widened to 4.02 percent on Oct. 10 as investors fled risk following Lehman's Sept. 15 bankruptcy. The spread averaged 0.27 percentage point for all of last year. It has since fallen back to 2.5 percentage points.
Bernanke and U.S. Treasury Secretary Henry Paulson gained congressional approval this month for the use of taxpayer funds for a $700 billion bank rescue. The Treasury plans to use some of the funds in the Troubled Asset Relief Program to buy equity stakes in banks.
The Fed redoubled its aid this month, agreeing to finance the commercial paper issuance of General Electric Co. and other corporations and help money-market mutual funds raise cash to meet shareholder redemptions.
Fed's Balance Sheet
The central bank's new loan programs have expanded assets on its balance sheet by 104 percent during the past year to $1.804 trillion, or 12.6 percent of GDP.
Borrowing costs have remained high. U.S. 30-year mortgage rates tracked by Freddie Mac were 6.04 percent last week versus 6.07 percent on Jan. 3. Banks are unlikely to compete for new loans and offer lower rates so long as the outlook for the economy is dim, economists said.
``We are in an environment where they lower rates, but then spreads widen so you get no net effect,'' Vincent Reinhart, former director of the Fed Board's Division of Monetary Affairs who is now a visiting scholar at the American Enterprise Institute in Washington, said before the decision. ``We are in a recession.''
Fed officials provided their forecasts for this year and the subsequent three years at the two-day meeting. The uncertainties surrounding the Fed's forecast are ``unusually large,'' and the economy may experience subpar growth ``for several quarters,'' Bernanke told the House Budget Committee on Oct. 20.
The economy ``looks terrible,'' Stephen Stanley, chief economist at RBS Greenwich Capital Markets Inc., said before the announcement. ``Consumer spending is going to be very negative in the fourth quarter, even with gasoline prices falling.''
Policy Tools
Now that their target rate is so low, Fed officials may have discussed alternative policy strategies such as the possibility of keeping rates low on short- and medium-term notes. Bernanke, as a Fed governor, was the top central bank official on research into ``non-traditional'' policy tools between 2002 and 2004, when the central bank last cut the benchmark lending rate to 1 percent.
The Fed has lost some control over the amount of reserves in the banking system because the total lending in some of its programs are driven by market demand. As a result, the federal funds rate has traded below its target every day since the Oct. 8 emergency rate cut.
The central bank raised the floor on the benchmark lending rate and said on Oct. 22 that interest on excess reserves would be equal to the federal funds rate minus 0.35 percentage point. The previous floor was 0.75 percentage point below the federal funds rate. Still, the move hasn't closed the gap between the target rate and the market rate.
To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net

Commercial Paper Market Still Shrinking

The WSJ has a piece showing that the Commercial Paper market is still shrinking. See the chart below.

This view contrasts with that shared in a post on Krugman's blog that suggests that the money markets are unfreezing.
Scott commenting on Kruman's post writes "As recently as Friday, I heard three different people in the industry describe the LIBOR rate as “notional” or “fictional”, and state that everyone was still largely hoarding cash, even among the banks. The transactions are apparently not happening at a sufficient volume to clear the market, regardless of the offered rate. I’ll believe that the markets are thawing when I hear the ice crack. "
Seems to me that Scott heard right.
The big problem in the money market for the US seems to be the weak economy. WSJ states "What’s worrisome, though, is that the decline in short-term commercial paper issuance may not reflect as much on the clogged money markets as it does on economic weakness. "

Below is a National Debt Graph courtesy of zfacts.com.


Zfacts.com points out that the "gross national debt compared to GDP (how rich we are) reached its lowest level since 1931 as Reagan took office in 1981. It skyrocketed for 12 years through Bush I. Clinton reversed it at a peak of 67%. Bush II crossed that line on Sept. 22 and hit 69% on Sept 30. That's the highest it's been since 1955 (53 years ago)."

Democrats have done a better job at reducing the national debt when compared to Republicans.

The US tax payer is indeed getting a lousy deal for his $125 bn capital injection

Willem Buiter agrees with Uwe Reinhardt's article that suggests that the US tax payer is getting a terrible return on the $125bn worth of capital that was injected on his behalf by US Treasury Secretary Paulson into the nine largest US banks. I agree with both of them. Paulson's bailout gift is blatantly unfair to tax payers and the action creates a moral hazard problem that could destablize the US financial system someday in the future.

The US tax payer is indeed getting a lousy deal for his $125 bn capital injection
Uwe Reinhardt is absolutely correct. The US tax payer is getting a terrible return on the $125bn worth of capital that was injected on his behalf by US Treasury Secretary Paulson into the nine largest US banks. This is surprising to me, because the complete or partial nationalisations of a number of US financial behemoths earlier in the year represented rather better value for money for the tax payer.
The nationalisation of Fannie, Freddie, AIG and pieces of the nine largest US banks (with more to come) was necessary to prevent a complete collapse of the house of cards we used to know as the American financial system.
Unfortunately, Treasury Secretary Hank Paulson’s injection of $125 billion into the nine banks (out of a total capital injection budget provisionally set at $250bn (but bound to rise to probably around twice that amount), carved out of the $700 bn made available (in tranches) by the 2008 Economic Stability Emergency Act, was almost a free gift to these banks. In this it was different from the case of AIG, where the Fed and the Treasury imposed rather tough terms on the shareholders and obtained pretty favourable terms for the US tax payer generally. It was also unlike the case of Fannie and Freddie, where the old shareholders are likely not to recover anything.
In the case of the Fortunate Nine, the injection of capital is through (non-voting) preference shares yielding a ridiculously low interest rate (5 percent as opposed to the 10 percent obtained by Warren Buffett for his capital injectcion into Goldman Sachs). Without voting shares, the government has no voice in the running of these banks. It also has no seats on their boards. By contrast, in the Netherlands, the injection of €10bn worth of subordinated debt into ING bank comes with a price tag that includes two government directors on the board and a government veto over all strategic decisions by the bank.
In addition, in the the case of the Fortunate Nine, there are no attractively valued warrants (options to convert, at some future time, the preference shares into ordinary shares at a set price or at a price determined by some known formula). Quite the opposite, the preference shares purchased by the US state, can be repurchased after three years, at the banks’ discretion, on terms that are highly attractive to the banks. The US tax payer is not only getting a lousy deal compared to private US investors like Buffett, (s)he is also doing much worse than the British tax payer in the UK version of Paulson’s capital injection (£37 bn so far out of provisional budget of £50bn). The UK preference shares have a 12 percent yield and come with government-appointed board members.
Even in the cases of AIG, Fannie and Freddie, unsecured senior creditors did not have to take an up-front haircut. Worse than that, even holders of junior debt and subordinated debt could come out of this exercise whole. There were no up-front haircuts, charges or mandatory debt-to-equity conversions.
That, I would argue, is scandalous, both from a fairness perspective and from the point of view of the moral hazard this creates, by boosting the incentives for future reckless lending to elephantesquely large financial enterprises. Unless not only the existing shareholders of the banks benefiting from these capital injections but also the holders of the banks’ unsecured debt (junior and senior) and all other creditors of the bank (with the possible exception of retail depositors up to some appropriate limit) are made to pay a painful penalty for investing in excessively risky if not outright dodgy ventures, we are laying the foundations of the next systemic crisis, even as we are struggling to escape from the current one.

The Fund must be a global asset manager

Michael Bordo and Harold James argue that the IMF must be a global asset manager.

The Fund must be a global asset manager
The chaotic, costly and ineffective international response to the current financial disorder has prompted French president Nicolas Sarkozy, British prime minister Gordon Brown and German president Horst Köhler, a former head of the International Monetary Fund, to call for a new Bretton Woods conference to design a new global financial system.
This is the first big crisis since the Bretton Woods conference in 1944, when the IMF was created, when the Fund has stood on the sidelines. Yet the origins of the crisis lie in some of the areas where it has a direct mandate – in particular, the large current account imbalances – as well as in the areas where it has recently been extending its mandate to cover financial stability.
The core IMF function should be multilateral surveillance. But at present this often means just talking. This is quite different from past visions. The IMF originally supervised the rules of the system of the par value of currencies under the Bretton Woods order, which disintegrated in 1971. The effectiveness of multilateral surveillance as it developed in the 1960s was linked to the IMF’s presence as a significant financial intermediary. It is this role that needs to be rethought.
In the past, the ability to give powerful advice to the systemically important countries, such as the UK, was enhanced by the dependence of those countries on IMF resources. It was the financial power of the IMF that gave it its bite, and that power was enhanced by its borrowing – at first from the Group of 10 nations that constituted the General Arrangements to Borrow.
In the years after the collapse of Bretton Woods, the IMF reinvented it­self as a vehicle for the management of the surpluses of the time. It borrowed from the new surplus countries, which as a consequence in part managed their new assets through the intermediation of the IMF. It was then able to lend to those countries that suffered shocks as a result of the increase in petroleum prices.
A very large financial actor can have a stabilising role. In the more distant past, market expectations were stabilised during panics by the counter-cyclical behaviour of very large private institutions. The multinational house of Rothschild made the first half of the 19th century stable. In the great panics of 1895-96 and 1907, the US economy was calmed by JPMorgan. At the time of the Great Depression in the 1930s, there was no house of equivalent power.
The IMF could be a powerful stabiliser in global markets if it managed a significant part of the reserve assets of the new surplus countries. It would be in a strong position to take bets against speculators, potentially in regard to speculative attacks on both countries and on financial institutions.
The stabilising action would benefit both the world economy and the interests of the owners of the reserve assets, which have (simply by the fact of the accumulation of the surpluses) a similar interest in world economic and financial stability. At the same time, the management of reserve assets by an internationally controlled asset manager would remove suspicions and doubts about the use of assets for strategic political purposes.
In order to carry out this new task, the IMF would need to regain the trust of its members. The rise in reserves in many Asian countries was a deliberate response to the 1997 Asia crisis, in which there was substantial disillusionment with the IMF. A precondition for acting as a global reserve manager would be governance reform in which the new surplus countries were able to exercise substantive influence through the IMF and feel secure that they were not being politically manipulated.
In particular, if the IMF were to be in a position of an asset manager that could shift assets from one market to another, it would need to be at greater distance from US influence and attempts at control: otherwise, it might be seen as a device for propping up the dollar or particular financial institutions for political economic reasons.
In a revised approach, votes in the IMF would be allocated or “bought” to a large extent through the assets held at the IMF. The proportion of votes determined in this way might be as high as 50 per cent, while the rest would be allocated in the traditional way. There is an analogy to this double determination of voting power in the US constitution, according to which all states have an equal share of Senate votes but very different numbers of seats in the House of Representatives, reflecting population differences.
Making a substantial part of Fund voting a reflection of the reserve positions held in the IMF would allow quick adjustments to new international realities. It would make the IMF more of a market institution, much like the ownership of joint-stock companies can change quickly and noiselessly.
A new version of the Fund could be a substantial contributor to stabilising market expectations. The IMF was conceived in 1944 in a world without major private capital flows, in which states would undertake all international transactions. Extending its mission to include some private sector rescues would be a recognition of the preponderant role markets now play. At the same time, the involvement of a rule-bound international agency would minimise the political poison associated with bank recapitalisations as well as currency interventions.