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Dallas Fed Official on ‘Wyle E. Coyote’ Economy

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The Federal Reserve Bank of Dallas came to San Antonio on Saturday for a session at FPA Experience 2012 on how we got to where we are in the economic crisis, and what’s next for the recovery. John Duca, Ph.D., an official with the Dallas Fed, presided over the hour-long session and described major happenings in the housing, construction and banking sectors. As all three are heavily intertwined, the presentation often overlapped on its coverage of the issues.

He noted the construction sector experienced the worst downturn since the Great Depression as a result of the housing boom and bust.

“After a steep rise it fell off a cliff like Wyle E. Coyote,” Duca said. “It hit bottom but the damage continued when the anvil fell on its head.”

He added that construction usually contributes 5% to the nation’s gross domestic product, but in the run up to the crash it contributed as much as 20% of the growth in overall output. 

He then noted how the “wealth effect” behaved during this period.

“Typically, people spend $4 more per year for every $100 or more increase in their earnings. This causes that increase in wealth to slowly be eroded over the remainder of their lives. When it comes to housing, which is more equitably distributed than, say, stocks, people spend $2 to $3 more per year for every $100 increase in the value of their home. With 65% of the American population owning homes, this significantly increased during the boom years with the ease of access to the home’s equity.”

He went on to explain that when the housing market crashed, the wealth effect “got slammed,” and housing held down the wealth effect from other sectors of the economy, one reason for the slow recovery.

“This affected investment and commercial banks,” he said. “They pulled back and credit standards tightened as capital became constrained. Consumer credit is finally starting to come back, and it’s looking more responsible [in its use], like for auto loans.”

He mentioned two other items negatively impacting the recovery—counter party risk and rollover risk.

Counter party risk is the idea that a particular consumer might have acted responsibly in the run-up to the crisis, and even the institutions with which they did business, but the other companies that institutions did business with did not.

Rollover risk is the fear “that no one else can afford to buy a particular item, so I won’t.”

Both conditions also led to a tightening of credit and widening of spreads. He added that by the spring of 2010, they looked to again be narrowing, but “bumps” like concerns over Europe then happened. This also caused companies to “pause” in their plans for hiring.

“Just as job growth took off, we got hammered by Greece,” he said. “Then we got back on track and concerns over Europe happened. We then got back on track a third time and concerns over Europe surfaced once again.”

Duca said he does not believe we will re-enter recession, but how long it will take to fully recover from the last recession “is really the question.”

“Profit margins are high and housing is starting to recover. It’s not going gangbusters, but it’s picking up.”

One of the more interesting exchanges came during the question-and-answer session, when Duca was asked about recent comments made by outspoken Dallas Fed president Richard Fisher in which Fisher called for the breakup of those banks deemed “too big to fail.”

“You’re going to see me do a delicate dance,” Duca said. “Dodd-Frank is an expression of the view among many that we should more heavily regulate big banks rather than break them up. But there is another view, expressed by [Fisher] and the prime minister of England and many others that if it’s too big to fail, make it smaller.”