Pan d e m ic S h o c ks S u p p ly
FROM ALL SYSTEMS GO TO A DEEP RECESSION IN ONE MONTH BY: ANIRBAN BASU, ABC’S CHIEF ECONOMIST Reprinted from Construction Executive,Tuesday, May 12, 2020, a publication of Associated Builders and Contractors. Copyright 2020. All rights reserved.
The first reported case of COVID-19 occurred in China in November 2019. At that time, the U.S. economy was humming, supporting a 50-year low in unemployment and approaching 2020 with what appeared to be irresistible force. Worker and skills shortages were impacting many industries, including construction, driving wages higher in conjunction with a growing number of companies, states and municipalities raising minimum wages for a variety of reasons.
pursue homeownership in an attempt to participate in the rally. This produced further home price increases in much of the nation.
The result was a consumer spending cycle that foretold of no immediate end. Rising home prices and a booming stock market intensified the spending power of economic actors and their confidence in the future, resulting in additional economic momentum. As if that were not enough, inflation and interest rates remained low, albeit steady, amid the lengthiest expansion in American history, keeping the cost of capital low. From the perspective of fomenting demand for the delivery of construction services, this represented a nearly perfect environment.
But to continue to make loans in large numbers and to generate the requisite levels of liquidity, bankers needed new sources of funds. Those making mortgages looked to Wall Street to package mortgages together, securitize them and sell them to investors in the form of collateralized mortgage-backed securities. As previously made mortgages were sold off in large amounts, the resulting proceeds could be used to fund the next series of mortgages.
Economists who had been predicting recession because of a set of emerging vulnerabilities (e.g., massive indebtedness at household and corporate levels, lofty asset prices) began to doubt their own projections. America’s economic expansion appeared indefatigable. RECENT HISTORY: A SHOCK TO DEMAND In an attempt to better understand the economic implications of the ongoing crisis, many people have attempted comparisons between the current period and other periods of economic distress. The most popular comparison appears to be with the 2007-2009 recession. Here’s what happened. Following the economic recovery after the 2001 recession—combined with low mortgage rates and demographics—created a demand for housing. Home prices drifted higher, inducing many renters to
Mortgage bankers, seeing an opportunity to generate income for their financial institutions, began expanding their lending. Because associated loans are backed by collateral (the American home), and because that collateral was becoming more valuable, perceived risk appeared low.
Major ratings agencies looked favorably upon these mortgage-backed securities, giving them a thumbs up. As if that were not enough, investors were able to buy insurance against default in the form of credit default swaps. This appeared to be a perfect setup, with more individuals participating in the American dream, investors safely earning returns and mortgage bankers, insurers, title companies, realtors and others earning large fees and commissions in the process. This was also a phenomenal period for construction firms, as commercial construction followed residential development. The problem was that some people were allocated mortgages they could not hope to repay. By late2005 and into 2006, more Americans were missing their payments. Predictably, credit began to dry up as lenders sought to avoid additional defaults and delinquencies. Suddenly, CONTINUED ON PAGE 14
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