Lighting the path to Economic Recovery

A common refrain I hear often these days is that the media is to blame for the national economic downturn, that the sensational, hyperactive media somehow is causing the economy to grind to a halt by constantly proclaiming the sky is falling.

The implication being that if the media would just stop talking about all the negative aspects of our economy, those negative things would just go away.

Whenever I hear that, I smile and usually just bite my tongue. People, you’re blaming the messenger here.

The media did not create $4 gasoline.

The media did not cause the subprime foreclosure crisis.

The media did not cause General Motors Corp. to decide to close its truck production plant in Janesville and eliminate 2,400 jobs.

The media did not cause Midwest Airlines to undergo a painful restructuring that will ground 12 of its airplanes, reduce its flights, cut its salaries and slash more than 1,000 jobs.

The media did not force Delphi Corp. to close its Oak Creek plants and eliminate 1,000 family-supporting jobs.

And no media outlet in the world could persuade Harley-Davidson Inc. to lay off hundreds of its production workers.

Whether it qualifies as a recession or not, this economy faces some significant headwinds. There is no way to whitewash it.

•  The housing market is on ice and still getting colder by the minute. According to the Case-Shiller home price index recently released by Standard & Poor’s, home prices in 20 major U.S. cities have dropped a record 15.3 percent in the past year and are now back to where they were in the summer of 2004. That means millions of Americans bought homes that are worth less today than when they were purchased. The Harvard University “State of the Nation’s Housing” report says housing starts, new home sales and existing home sales are the lowest they have been since the World War II era. Furthermore, the fall in home prices and the rise in mortgage defaults are the worst on record since the 1970s, according to the Joint Center for Housing Studies.

• The impact of the subprime mortgage collapse is still being felt, and credit is no longer available to millions of Americans to obtain financing and pump new life into the economy.

• The banking industry is in turmoil, with large investment banks such as Bear Stearns being bailed out by the federal government. RBC Capital Markets is predicting that at least 150 banks will fail in the United States over the next two to three years, as they absorb the billions of dollars in bad loans they made in recent years.

• Investors have lost substantial portions of their savings in their individual retirement accounts (IRAs), 401k funds, mutual funds, annuities, life insurance policies and real estate investment trusts. The poor financials prompted the RBC Cash Index of U.S. consumer confidence to fall to its lowest point since it began tracking in 2002.

• The American automotive industry is in shambles, and it is bleeding over into other sectors.

• Health care costs show no signs of slowing down.

• Most national retail chains have put expansion plans on hold, and many are closing stores across the country.

• The U.S. dollar has flirted with historic lows, making American-made goods more affordable overseas, but putting many U.S. companies (such as Anheuser-Busch Cos.) at risk of hostile takeovers by foreign suitors.

• American manufacturers are facing the twin nightmares of record fuel costs and soaring prices for raw materials, with no relief in sight.

• The United States continues to fight wars in Iraq and Afghanistan. Nobel Prize-winning economist Joseph Stieglitz predicts America’s eventual cost of the Iraq war will reach the $3 trillion mark.

With all of that as our backdrop, we asked Sara Walker, senior vice president and portfolio management team leader with the Milwaukee office of Associated Trust Company N.A., a division of Associated Banc-Corp, to take the temperature of the American economy and assess the near future in the 2008 Small Business Times Midyear Economic Forecast.

The following are excerpts from that interview.

SBT: When you wrote your summary of the first quarter for investors, you commented that you were glad the first quarter was over. Now the second quarter is coming to an end. Are we still stuck in the muck?

Walker: “I would say we are. What I try to make clear to people and to remind myself is that we won’t be forever. But I don’t think this is something we’re getting out of quickly. There’s a lot of hope and optimism we’re getting close to the bottom, and I will say I’m in that camp, at least with one foot (laughs). I don’t know if I even have good reasons to say that. I go back to what I say that it’s bred into our economy. I have such admiration for our economic system because we really are resilient. And one of the reasons we are resilient is we let the market take care of the excesses. Unfortunately, when we have excesses, we have corrections that involve some pain. But we take the pain, and that helps us get through and move on much faster than if we intervene too much.”

SBT: To your point of excesses, the housing market?

Walker: “Housing. Housing was the outlet, but it was really, in my opinion, disregard for risk by investors on Wall Street and foreign investors through Wall Street. A year ago and further back, there was really a total disregard for risk.”

SBT: And in the financial services sector as well?

Walker: “No. I would say, not so much in standard banking, but in investors seeking out higher returns at almost any cost. We had a low-return environment, and the money was pouring in without any shred of return … In many respects, it was because of greed. Money was available. It goes to the path of least resistance. There it was.”

SBT: There was a feeling that, “Everyone was getting great returns, and I want mine?”

Walker: “Yes. Then the money just fanned the flames of excess. I will say that our commercial banks generally did a good job managing risks. Now, we are seeing some headlines, but I think, in general, the community banks did a good job of managing risk. Money from Wall Street fanned the flames, and that sucked in some of the community banks. Much of that money did go to the subprime area. That was a new avenue for mortgage brokers that popped up out of the blue, and they found willing clients. And the money came in, and investors were happy, so more money came in.”

SBT: Do you think there is still more absorption that needs to take place before the housing market is corrected?

Walker: “Yes. I do know the inventory of unsold homes is huge, and it’s getting bigger. One reason it’s getting bigger is that banks that foreclosed on homes are putting them on the market now. The foreclosed homes are adding to the inventory and pushing those prices down.”

SBT: From an investor’s standpoint, where’s the safe money? It’s not in the stock market, and it certainly isn’t in real estate. What’s an investor to do?

Walker: “That’s a great question. What the investor had been doing through March is running to treasuries (bonds). So, we saw the treasury yield curve running way down. Investors suddenly went from an embrace of risk to saying, ‘I will accept any yield if I feel that I’m not taking any risk.’ So, they just funneled into treasuries.”

SBT: That lowered the demand for stocks, as well. It took money off the table.

Walker: “It did. We talk to clients, and you’re right. They’re not real interested in stocks.”

SBT: For people who want to keep a portion of their investments in the stock market, are there any sectors that you believe are poised to perform better than the others in the second half of the year?

Walker: “Well, working for a financial institution, I’d love to say financial institutions (laughs). That could be a little early. I don’t think I’ll say that.”

SBT: The health care sector seems to be plodding along.

Walker: “It does. Large-cap pharma(ceuticals) is getting creamed. One area that we do like is health care that is anything but large-cap pharma, so it’s the distribution, it’s the diagnostic, it’s the testing. The stocks that we’re holding and actually interested in buying are companies that make products or services that can make other companies or the medical profession more efficient.

“In general, what investors should do, I would say let’s remember that line in the old TV show, ‘Hill Street Blues,’ when they would say, ‘Let’s be careful out there.’ So many reports I read say inflation is remaining contained because the cost increases that the manufacturers are experiencing are not being passed through. Well, that means they are being absorbed … I think that’s going to lead to some earnings disappointments.”

SBT: Do you think, Sara, that down the road, it will lead to some pent-up inflation? Manufacturers can only keep absorbing these costs of raw materials and energy for so long before they must begin to pass them along, just to survive economically.

Walker: “I think we’ll see some of that, yes.”

SBT: The U.S. dollar has been so weak that it has created a real competitive windfall for U.S. manufacturers. Do you see the dollar continuing to be so weak in the second half of the year?

Walker: “I do. I believe the dollar is getting very close to bottoming. I could see it maintaining and perhaps increasing some from the lows, but still on a relative basis, remaining overall weak. In the meantime, it will stay low, which tremendously benefits our exporters, as you mentioned. And that’s why, in my opinion, we are still debating about whether or not we are in a recession. We’ve had such great export growth, and that’s been so encouraging.”

SBT: The one exception to the bright side of manufacturing is the automotive sector. And in Wisconsin, that spills over into so many other sectors. Is the American automotive sector bottoming out, or is there more pain ahead?

Walker: “I think there’s more pain. In my opinion, and this is from the ivory tower, (laughs) look at what the auto companies have been doing. I am disappointed that there wasn’t any thought about what might we do should oil prices start to increase. As you could see the global economy growing, you would think, ‘What is the backup plan for higher fuel prices?’ I think Toyota saw it, and they’re prepared.”

SBT: What about unemployment in the second half of the year? Do you see any spikes there?

Walker: “I would say unemployment will continue to go up, not dramatically, but I think it will just be edging up, because you keep seeing closures, layoffs. The financial industry itself is going through mass layoffs. And then other industries, the automotive industry for instance, so many are cutting back.”

SBT: What about the Wisconsin economy, relative to everyone else? Is there anything about our economic reality that encourages you or discourages you, one way or the other?

Walker: “I would say that generally, I’m more optimistic than about some of the comments you read about the brain drain. I am aware of that happening. But I just think Wisconsin has an excellent work ethic that continues. Our education system is a good one. And then I believe that the awareness of the brain drain and the need to promote more diversity to attract all members of society is going to go a long way. I think that’s very positive for our future.”

 

SBT: Looking forward, it’s been my observation over the years that privately held companies, if they have the wherewithal, can zig when others zag during an economic downtown. By that, I mean that competitors may cut back on marketing and new product development and innovation. They become entrenched. But if you invest in your company and try to steal away market share during the downturn, your company can be better-positioned for greater growth when the economy does bounce back, because you’ve got the infrastructure and the pipeline in place. Does that ring true with you?

Walker: “Oh, definitely. The opportunity always comes about in turmoil. That’s something to not forget. There are many opportunities. And you’re right. The nimble companies that take advantage of that will do very well. In my opinion, there’s just no shortage of ideas out there, and ideas are powerful. You know, you get an idea, and it’s brought about by a job loss. How many times have we heard that story?”

 

SBT: It’s brought about by necessity.

Walker: “It’s brought about by necessity, yes. Suddenly there’s more interest in mass transit and suddenly there’s more interest in local cultural events (because of high gasoline costs). There’s all kinds of areas you can point to where opportunity has arisen because of difficulty. That gets back to the fact that we have the freedom to pursue it. That’s one of the things that is the backbone of our country. Businesses that are public sometimes have trouble taking advantage of those opportunities. That speaks to the reason why small businesses create most of the jobs in country.”

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