EconSouth - Fourth Quarter 2007

The Southeastern Economy in 2008

Income Growth and Consumer Spending Strong Despite Housing Slowdown

photo of women looking at clothingStrong consumer spending, supported by an increase in personal income, has helped spur economic growth over the past year. However, modest employment growth and the possibility that consumption will be constrained by declining home values may pose some challenges to ongoing consumer spending strength in 2008.

Housing woes don't slow income growth
Growth in personal income—which includes earnings, dividends, interest, rent, and transfer payments—remained healthy in the Southeast through the second quarter of 2007 despite weakness in the housing market. In Florida, however, a noticeable deceleration in that state's personal income growth that began in late 2004 continued into 2007 (see chart 1). Given that the largest component of personal income is earnings, if Florida's employment growth continues to falter, as it has through 2007, personal income growth and consumer spending may also slip in the Sunshine State.

Consumer Spending
Real Estate

Retail spending moderates in Florida
Consumer spending behavior tends to mirror income patterns. Overall, Southeast retail sales in 2007 through the third quarter have matched national trends and remained at positive, healthy levels with the notable exception of Florida where consumer spending growth has stalled. However, retail growth in the Southeast has moderated from robust levels in 2005 and 2006 (see chart 2). Retail spending growth in Mississippi and Louisiana are predictably off their high levels of 2006, when it was buoyed by government resources and insurance payments.

As measured by sales tax collections, Florida's retail sales growth turned slightly negative in the first quarter of 2007 and remained negative through the third quarter, primarily as a result of weak construction and home-related sales. In Georgia, growth in retail sales tax revenue on a quarterly basis held steady at about 5 percent year-over-year through the third quarter of 2007, but state revenue officials noted a sharp drop in September collections, down more than 10 percent compared with September a year ago.

Related Links
On the Web:
U.S. Census Bureau economic indicators
U.S. Census Bureau income data

Tax officials attributed this downturn to weakness in home sales, which also has led to year-over-year declines in the building material and home furnishing industries. Retail sales revenue growth in Louisiana and Mississippi remained healthy but was lower in 2007 than in 2006, according to U.S. Census data and Southeastern revenue figures.

Auto sales taking a hit
The automotive retail market signals that troubles in the housing market might be affecting consumer behavior. Autos represent a major durable purchase that, to some extent, is discretionary. In times of financial worries, some households will repair rather than replace their aging vehicles.

As measured by new vehicle registrations, vehicle sales weakened dramatically in 2007 in the Southeast, dropping 6.3 percent. Nationally, vehicle sales were down only 2.6 percent compared with 2006. While Florida led the regional decline, all Southeastern states except Tennessee posted lower registrations than in 2006, and that state's 2007 gain comes after sharp declines in 2006.

Chart 1
Personal Income, 2004–07
Chart of personal income 2004-07
Note: Personal Income includes earnings (wage and salary disbursements, other labor income, and proprieters' income), dividends, interest, and rent and transfer payments. Dashed line implies interpolation of data.
Source: Bureau of Economic Analysis

Chart 2
Retail Sales Tax Revenue, 2004–07
Chart of retail sales tax revenue, 2004-07
Sources: Alabama Department of Revenue, Florida Office of Economic and Demographic Research, Georgia Department of Revenue, Louisiana Department of Revenue, Mississippi State Tax Commission, and Tennessee Department of Revenue

Weak retail demand for new vehicles in 2007 continued a trend from 2006. Unlike in 2006, however, both domestic and foreign brands saw declines at the retail level. Some import brand dealers did, however, expand fleet sales in 2007 to try to offset disappointing retail vehicle demand. Contacts from regional foreign brand distributors reported year-over-year sales below their companies' comparable performance nationally.

Looking ahead to 2008
With the possible exception of Florida, income growth should remain positive in 2008 and contribute to moderate retail sales growth. Auto sales, however, may dip again in 2008 as their sales likely depend more on the housing outlook and the availability of affordable credit.

Overall retail spending levels, including auto sales, are vulnerable to a significant downturn in the value of residential real estate. The extent of the so-called housing wealth effect is unknown, but it could cause some households—especially those with relatively low levels of equity in their houses, such as recent home buyers—to keep their purse strings drawn.

Banking Encounters a Challenging Year

Dramatic increases in mortgage foreclosures, lower profitability, tightening availability of credit, and a volatile yield curve with periods of inversion were some of the challenges the banking industry faced in 2007.

Slowing economic growth, driven by a widespread decline in the housing market and issues related to mortgage lending innovations, were key factors in 2007 affecting the region's banking industry. As widely reported, Florida absorbed the biggest hit from the housing downturn, and, as a consequence, the bulk of the banking woes are being felt there.

Related Links
On the Web:
Federal Deposit Insurance Corp.
Comptroller of the Currency
Mortgage Bankers Association

Subprime mortgages, tighter yields squeeze banks
The dramatic growth in subprime lending (see the chart) and other creative mortgage products finally took its toll on financial institutions and consumers alike, hitting homeowners hard and resulting in a spike in foreclosures. Florida, Georgia, and Mississippi led the region in foreclosure rates through the second quarter of 2007. The increase in foreclosures was mostly a consequence of the resetting of adjustable rate mortgages as well as speculators leaving the housing market once price appreciation stalled.

Subprime Adjustable Rate Mortgages Serviced, 2003–07
Chart of subprime adjustable rate mortgages
Source: Mortgage Bankers Association

The volatility of the yield curve, with its periodic inversions in 2007, exerted added stress on banking institutions. The shape of the yield curve is the difference between the interest banks earn from long-term loans and the interest banks pay for short-term deposits. Typically, when the yield curve flattens, bank profits are squeezed.

Lending standards get stricter
Another fallout from the turbulence in financial markets was the widespread tightening of lending standards. Such tightening made obtaining credit more difficult for borrowers with spotty credit, and nonstandard loans became much more difficult to get.

In addition, the number of loans secured by real estate in the Southeast declined to 5 percent in the second quarter of 2007, from 14 percent the previous year. Also, total growth in the region's deposits slowed from 13 percent in the second quarter of 2006 to 2.6 percent in the second quarter of 2007. The region saw solid increases in commercial and industrial lending and consumer credit card lending during the same time period.

The banking industry saw both some fundamental changes and shrinking profits in 2007, and 2008 is likely to be another difficult year as even more adjustable rate mortgages continue to reset. This reset should bring additional delinquency and foreclosure activity, which means banks will have to increase their loan loss reserves, squeezing profit margins further.

After the experience over the past few years, regulators are encouraging banks to work closely with distressed borrowers to avoid foreclosures and further deterioration in credit quality. These efforts should help to improve the longer-term outlook for banking.