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Federal Reserve Bank of Cleveland

Economic Trends
November 2007
(Covering October 14, 2006–November 8, 2007)

In This Issue
Economy in Perspective
Air Supply…
Inﬂation and Prices
September Price Statistics
Money, Financial Markets, and Monetary Policy
Financial Markets: Settling but Cautious
The Well-Anticipated Rate Cut
What Is the Yield Curve Telling Us?
International Markets
Is It the Best of Times or the Worst?
Economic Activity and Labor Markets
The Employment Situation
Union Membership
Housing Cycles
Third-Quarter GDP
Jumbo Mortgages and Mortgage Market Conditions
Regional Activity
The Cincinnati Metropolitan Statistical Area
Fourth District Employment Conditions, August
Banking and Financial Institutions
Mortgage Lending
Business Loan Markets

The Economy in Perspective

Living in a World of Contingency…
08.20.07
by Mark S. Sniderman
Air supply… Financial markets of all kinds have been unusually volatile in the past few months. In just the last
couple of weeks, investors were buﬀeted by three diﬀerent price movements: Oil prices soared, gold prices surged,
and the dollar continued its protracted slide. Investors showed their uneasiness about the future by pushing stock
prices steeply lower.
In the summer, price volatility was most evident in the stock prices of home builders and mortgage lenders, and in
the markets for asset-backed commercial paper and collateralized debt obligations. More recently, as a broader range
of ﬁnancial companies reported sizeable losses on assets in their portfolios, investors began to reassess their forecasts
and anticipate slower economic growth in the next several quarters. If commercial and investment banks are forced
to trim their risk exposure and shore up their capital positions, might they not scale back their extension of credit,
their provision of backup lines, and their willingness to make markets in risky securities? Could such a retreat precipitate a credit crunch severe enough to slow the economic expansion?
Credit crunches are periods in which borrowers have trouble obtaining credit from banks and capital markets at a
given interest rate. Some borrowers might be able to obtain credit on more restrictive terms than those that prevailed
before the crunch; others might be unable to obtain credit at any price. Crunches typically come about when lenders
suddenly revise their opinions about risk or do not have enough capital to add more assets to their balance sheets.
Restrictive monetary policy can also induce a credit crunch by limiting reserves to the banking system.
Credit crunches can pose serious risks to economic expansions because the rationing of credit will probably make
some investment projects infeasible, and could even squeeze highly leveraged borrowers to the point of business
failure. The resulting decline in production and employment, if it were to spread throughout the economy, could
contribute to a recession. This possibility has taught monetary policymakers to be wary of imposing restrictive monetary policies and credit controls during periods of credit market fragility.
Indeed, since August, when signs of ﬁnancial market distress emerged, the Federal Open Market Committee has
dropped its federal funds rate target by 75 basis points and reduced the spread between the funds rate and the primary credit borrowing rate by 50 basis points. These actions were designed, at a minimum, to avoid an inadvertently
restrictive policy at a time when lenders were becoming more cautious.
The Federal Reserve’s Senior Loan Oﬃcer Opinion Survey provides one gauge of credit market tightness and puts it
into some perspective over time. From the latest survey, we learned that nearly 20 percent of the respondents reported tightening standards for commercial and industrial loans to medium- and large-sized companies during the third
quarter. Nearly 40 percent of them reported increasing the spread of loan rates over their bank’s cost of funds. Senior
lenders reported that their restraint was focused primarily on commercial real estate and consumer installment lending. Importantly, however, the tightening is a recent development; similar surveys conducted earlier this year found
scant evidence of it. It is too soon to tell how long it will persist or how severe it might be.
There is little evidence, from the latest survey at least, of a widespread curtailment of credit. How telling that source
of information will prove to be is unclear because various other ﬁnancial institutions now play key roles in the
credit-extension process. If they are retrenching at a faster pace than commercial banking organizations, we might
see more credit market restraint than the survey suggests. At the same time, if the survey began to show a commer2

cial bank retreat and nonbank ﬁnancial ﬁrms stepped up their credit market activities, we might experience only a
modest credit adjustment.
Daniel Webster once remarked that “ Credit is the vital air of the system of modern commerce.”* Soon enough, we
will know what is in the air.

Inﬂation and Prices

September Price Statistics
11.07.07
by Michael F. Bryan and Brent Meyer

September Price Statistics
Percent change, last
1mo.a

3mo.a

6mo.a

12mo.

5yr.a

2006
avg.

All items

3.2

1.0

3.1

2.8

2.9

2.6

Less food and
energy

2.7

2.5

2.4

2.1

2.0

2.6

Medianb

3.0

2.5

2.8

2.5

3.1

16% trimmed
meanb

2.9

2.0

2.2

2.3

2.7

Finished goods

14.7

1.5

3.7

4.4

3.7

1.6

Less food and
energy

0.7

1.5

2.0

1.6

2.1

Consumer Price Index

Producer Price Index

a. Annualized.
b. Calculated by the Federal Reserve Bank of Cleveland.
Sources: U.S. Department of Labor, Bureau of Labor Statistics; and Federal
Reserve Bank of Cleveland.

CPI Component Price-Change Distributions
Weighted frequency
45
July

August
35

September

30
25
20

The Consumer Price Index (CPI) rose at a 3.4 percent annualized rate in September, after falling 1.7
percent in August, pushing the 12-month growth
rate from 2.0 percent to 2.8 percent. Although
oil prices exerted a considerable inﬂuence on the
monthly CPI report, general upward pressure was
evident across the consumer’s market basket. The
rise in the core CPI, the median CPI, and the 16
percent trimmed-mean CPI, at 2.7 percent, 3 percent, and 2.9 percent, respectively, were all above
their 3-, 6-, and 12-month averages.
A look at the distribution of the price changes in
CPI components bears this observation out. Over
the past three months, the percentage of CPI components showing outright price declines has fallen
steadily, from about 32 percent to 16 percent of the
consumer’s market basket, while the share showing
price increases of 3 percent or more has grown from
about 42 percent to 57 percent.
In its October 31 statement, the Federal Open
Market Committee reiterated its concern that
“some inﬂation risks remain” and noted that “recent
increases in energy and commodity prices, among
other factors, may put renewed upward pressure on
inﬂation.” “In this context,” said the FOMC, “some
inﬂation risks remain, and [the committee] will
continue to monitor inﬂation developments carefully.”

15
10
5
0
<0

0 To 1
1 To 2
2 To 3 3 To 4
4 To 5
Annualized monthly percent change

Sources: U.S. Department of Labor, Bureau of Labor Statistics.

Readings from the Producer Price Index (PPI),
which is subject to somewhat larger monthly
ﬂuctuations than the CPI, spiked 14.7 percent at
an annualized rate in September, taking back most
of August’s 15.3 percent decrease. However, the
PPI excluding food and energy only increased 0.7
3

Core Crude PPI*
Annualized percent change
300
250
1-month
200
150
100
50

12-month

0
-50
-100
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
*Core crude PPI includes all crude nonfood materials in the PPI, excluding
energy.
Source: Bureau of Labor Statistics

Non-Oil Import Price Index
Annualized percent change
10
8

3-Month

6
4

12-Month

2
0
-2
-4
-6
6-Month

-8

-10
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: Bureau of Labor Statistics

Household Inflation Expectations*
12-month percent change
6.0

percent, after rising 2.3 percent last month. Nevertheless, we’ve seen a variety of signiﬁcant price hikes
for crude materials other than energy over much of
the year, and that pattern seems to have continued
into the third quarter. Crude foodstuﬀs were up a
little more than 12 percent over the June-to-September period, as were nonfood and nonenergy
materials costs.
Among the potential contributors to a worsening
inﬂation outlook is the continued decline in the
dollar vis-à-vis foreign currencies. As the value of
the dollar declines, some upward pressure on import prices seems inevitable. How much, and how
persistent these price pressures might be, is unknown, and depends, among other things, on how
retailer and foreign margins adjust to the falloﬀ in
U.S. demand for foreign goods. To date, however,
the so called “pass through” of the declining dollar
to import prices has been diﬃcult to see in the data
with non-oil import costs trending rather steadily
at about 2 percent annually.
If inﬂation risks have heightened recently, the
change hasn’t been reﬂected in the survey data on
inﬂationary expectations. Household inﬂation
expectations, both short and longer run, have been
falling since May, according to the University of
Michigan’s Survey of Consumers. Expected average
short-run inﬂation (for the year ahead) fell from
4 percent to 3.5 percent in October. Longer-term
expectations (5 to 10 years out), which had been
holding just above the 10-year average of 3.4 percent since April, dropped to 3 percent during the
month.

5.5
One year ahead

5.0
4.5

Five to ten years ahead

4.0
3.5
3.0
2.5
2.0
1.5
1.0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
*Mean expected change as measured by the University Of Michigan’s
Survey of Consumers.
Source: University of Michigan.

Money, Financial Markets, and Monetary Policy

Financial Markets: Settling but Cautious
11.07.07
by John Carlson and Sarah Wakeﬁeld
Credit markets have settled a great deal since late
summer, when it became starkly apparent that subprime mortgages were much riskier than had been
previously thought. The value of a broad array of
assets fell dramatically, as market participants reassessed the price they were willing to pay for risky
assets more generally. Rates paid on credit default
swaps—indicators of the market’s appetite for
risk—jumped sharply in August but have declined
substantially in recent weeks, suggesting that markets have become more comfortable with taking on
some risk.

Credit Default Swaps
Index
550
500
iTRAXX Europe 10-year
crossover index

450
400
iTRAXX Europe 5-year
crossover index

350
300

Dow Jones CDX North
America crossover index

250
200
150
100

9/05

1/06

5/06

9/06

1/07

5/07

9/07

Source: Bloomberg Financial Services.

Commercial Paper Spread
Percentage points
3.0
Yield spread: Three-month financial
commercial paper minus the
three-month Treasury bill a,b

2.5
2.0
1.5
1.0

Yield spread: Three-month
nonfinancial commercial paper
minus the three-month
Treasury bill a,b

0.5
0.0
6/07

7/07

8/07

9/07

Many of the subprime mortgages had been repackaged into new asset-backed securities called collateralized debt obligations (CDOs). The CDOs are
essentially sliced into claims—called tranches—that
are structured in such a way so as to have diﬀerent levels of risk. Some of the “safer” tranches were
ﬁnanced through the issuance of asset-backed commercial paper. Unfortunately, even the safest slices
of mortgage debt proved to be much riskier than
originally thought. Spreads on commercial paper
over safe Treasury issues of comparable maturities
also jumped in August, as purchasers of commercial
paper became reluctant to buy new paper as the
old paper matured. Although the spreads may have
declined, lenders remain cautious, and spreads have
retraced some of their recent declines.

10/07

a. All yields are from constant-maturity series.
b. Financial commercial paper is issued by financial firms for
companies and nonfinancial commercial paper is issued by companies.
Source: Federal Reserve Board

It is widely accepted that although credit markets
have settled relative to last summer, the economy
is far from being out of the woods. The problem is
that no one really knows what the appropriate value
of assets is now or how deep the subprime mess
extends into ﬁnancial market institutions and beyond. Over the last two weeks, for example, several
major ﬁnancial ﬁrms surprised market participants
by writing down the value of mortgage-backed
assets by a much greater amount than had been
anticipated. Market participants are dubious about
whether the write-downs are suﬃcient.
5

S&P 500
Stock price index
1600

Stock price index
475

1450
Financial stock price index
425
1300
Composite stock price index

1150

375

325

1000

850
2003

275
2004

2005

2006

2007

Sources: Wall Street Journal, Financial Times.

CBOE Market Volatility Index
35

Asset write-downs are charged against earnings.
Thus, proﬁts in the ﬁnancial sector have taken quite
a hit. The recent decline in the Financial Stock Price
Index reﬂects the charge to proﬁts. Moreover, it appears as though the market anticipated some of the
tough sledding faced by ﬁnancial institutions. While
the broad S&P 500 Index has increased around 6
percent year-to-date, the Financial Stock Price Index
has fallen—beginning its descent in the spring.
The big question facing policymakers is whether
the eﬀects of the subprime mess will spill over to
the economy more generally. To the extent that
the S&P is forward-looking, the absence of further
declines in the broad composite stock index since
August suggests that the worst may be behind
us. Notwithstanding the recent increase in stock
market volatility, the gains in equity prices overall
suggest that the nonﬁnancial sector remains robust.
Moreover, analysts predict that the operating proﬁts
of S&P 500 ﬁrms will grow at healthy rates over
the next year or so. Operating earnings do not take
into account special write-downs like those made
by ﬁnancial ﬁrms, so they tend to be higher than
reported earnings.

30
25

20
15
10
5
01/07 02/07 03/07 04/07 05/07 06/07 07/07 08/07 09/07 10/07
Source: Wall Street Journal.

S&P 500
Earnings per phare a
30

Projected

Projections of operating earnings per share are
“bottom-up” aggregates, meaning that they are
share-weighted averages of analysts’ predictions
of individual ﬁrm earnings. As-reported earnings
projections, on the other hand, are top-down predictions made by equity strategists. The divergence
between the two estimates clearly indicates that the
strategists anticipate further write-downs next year
although “as reported” earnings are still projected to
grow for the broad index. These projections suggest
that the eﬀects of ﬁnancial turmoil are not spreading beyond the ﬁnancial sector.

20
Operating
15
10
As reported
5
0
1988

1991

1994

1997

2000

2003

2006

a: Earnings after 2007:Q3 are projections provided by Standard and Poors.
Source: Standard and Poor’s corporation.

Policymakers are keenly aware that the ﬁnancial
market turmoil could be prolonged and are monitoring ﬁnancial conditions carefully. If it appears
as though ﬁnancial conditions are worsening and
beginning to clearly undermine the economic expansion, central banks can use monetary policy to
oﬀset the macroeconomic risk. However, as Federal
Reserve Board Governor Frederick Mishkin said
on Monday, central banks are “powerless” when it
comes to “valuation risk.”
6

Money, Financial Markets, and Monetary Policy

The Well-Anticipated Rate Cut
10.31.07
by John Carlson and Sarah Wakeﬁeld
The Federal Open Market Committee voted today
to lower the fed funds target 25 basis points to 4.50
percent. One FOMC member dissented. Voting
against was Thomas M. Hoenig, who preferred no
change. The rate reduction action followed a 50
basis point rate cut at the September meeting. In
a related action, the Board of Governors unanimously approved a 25 basis point reduction in the
Discount Rate to 5.0 percent. This action followed
a 50 basis point reduction on August 17 and a 25
basis point reduction in September.

Reserve Market Rates
Percent
8
a
7 Effective federal funds rate
6
5

Primary credit rate

4
3
2
1

Intended federal funds rate b
Discount rate b
0
1999 2000 2001 2002 2004 2005 2006 2007
a. Weekly average of daily figures.
b. Daily observations.
SOURCES: Board of Governors of the Federal Reserve System,
“Selected Interest Rates,” Federal Reserve Statistical Releases,
H. 15.

Implied Yields On Federal Funds Futures
Percent
5.45
June 29, 2007

5.25

May 10, 2007
Aug 8, 2007

5.05
Sep 19, 2007

4.85

4.65

Oct 10, 2007

4.45
Oct 30, 2007
4.25
4.05
May

Jul

Sep

Nov

Jan

Mar

a. One day after FOMC meeting.
SOURCE: Chicago Board of Trade and Bloomberg Financial Services.

May

The Committee’s statement emphasized that
“Today’s action, combined with policy action taken
in September, should help forestall some of the
adverse eﬀects on the broader economy that might
otherwise arise from the disruptions in ﬁnancial
markets and promote moderate growth over time.”
The statement recognized that “readings on core inﬂation had improved modestly this year, but recent
increases in energy and commodity prices, among
other factors, may put renewed upward pressure on
inﬂation.” The FOMC noted “that some inﬂation
risks remain” and that the Committee “will continue to monitor inﬂation developments carefully.”
Prices of futures and options on fed funds had
indicated that market participants expected a rate
cut of 25 basis points today. Before the meeting,
the implied probability of a quarter-point cut was
about 70 percent, based on options data. The odds
of both a half-a-point cut and no change outcomes
were both between 10 percent and 15 percent.
The period since the September 18 FOMC meeting has seen markets settle some relative to the
previous intermeeting period. This was apparent in
term libor rates. Libor, which stands for London
Interbank Oﬀered Rate, is the rate of interest at
which banks oﬀer to lend money to one another in
the wholesale money markets in London. Because
these interbank loans are not secured by collateral,
rates on term lending rise relative to the fed funds
7

rate when markets become skittish. Since the last
FOMC meeting, both one-month and three-month
libor rates fell relative to the fed funds rate, indicating a greater willingness among banks to engage in
unsecured lending. Though risk premiums appear
to be lower, few participants believe that ﬁnancial
conditions are back to normal.

October Meeting Outcomes
Implied probability
1.0

Existing home sales

0.9

Employment situation

0.8
0.7

FOMC minutes
New residential construction
4.25%

5.25%

0.6
0.5
0.4

4.75%

0.3
4.50%

0.2
0.1

5.00%

0.0
8/06

8/15

8/24

9/02

9/11

9/20

9/29

10/08 10/17 10/26

Libor Rates
6.05
5.85
5.65
5.45
U.S. dollar - 3 month
5.25
Intended federal funds rate
5.05
U.S. dollar - 1 month
4.85
4.65
4.45
4.25
8/1

8/13

8/25

9/6

9/18

9/30

10/12

10/24

Source: Bloomberg Financial Services.

Reserve Market Rates
Percent
6.75

6.25

5.75

Moreover, the Trading Desk at the New York Fed
held rates much closer to the intended rate than
they had in the previous intermeeting period. This
signaled that the Trading Desk faced more normal
conditions in the market for overnight borrowing.
The settling of markets in the intermeeting period
and a strong employment report initially led market
participants to expect the Fed to hold rates steady
at today’s meeting. Such an expectation seemed to
be conﬁrmed by the FOMC meeting minutes that
were released earlier in the month. In recent weeks,
however, incoming data revealed that the housing
market was even weaker than had been anticipated.
The magnitude of the drop in residential housing
investment ampliﬁed markets’ fears that unchecked
momentum in housing could spill over into other
sectors, raising the risk of recession. Markets have
come to expect another rate cut in December of at
least 25 basis points.
In its assessment of risks, the FOMC statement
noted that the Committee “judges that, after this
action, the upside risks to inﬂation roughly balance
the downside risks to growth.” The immediate reaction to the statement was largely negative. Equity
prices fell, erasing gains on the day. Within minutes, however, market sentiment turned favorable
and equity prices rose to new highs on the day. The
Dow ended the day up 1 percent. Odds on another
rate cut in December backed oﬀ to less than 50-50.
The yield on 10-year Treasuries rose 9 basis points.

Prime credit rate

Intended federal funds rate
5.25

4.75
Effective federal funds rate
4.25
8/1

8/13

8/25

9/6

9/18

9/30

10/12

10/24

Source: Board Of Governors Of The Federal Reserve System, “Selected
Interest Rates,” Federal Reserve Statistical Released, H. 15.

December Meeting Outcomes with
January Options
Implied probability
1.0
0.9
0.8
0.7
0.6
4.25%
0.5
0.4 4.25%

Employment situation
Existing home sales
FOMC minutes
New residential construction

4.50%
0.3
4.75%
0.2
4.00%
0.1
5.00%
0.0
9/28 10/01 10/04 10/07 10/10 10/13 10/16 10/19 10/22 10/25 10/28

Money, Financial Markets, and Monetary Policy

What Is the Yield Curve Telling Us?
10.31.07
by Joseph G. Haubrich and Katie Corcoran

Yield Spread and Real GDP Growth*
Percent
12
Real GDP growth
(year-to-year percent change)

10
8
6
4
2
0
-2
-4
1953

Yield spread:
10-year Treasury note minus 3-month Treasury bill
1963

1973

1983

1993

2003

*Shaded bars indicate recessions.
Sources: U.S. Department of Commerce, Bureau of Economic Analysis; and
Board of Governors of the Federal Reserve System.

Since last month, longer-term interest rates have
increased with little movement in short rates,
increasing the slope of the yield curve. One reason
for noting this is that the slope of the yield curve
has achieved some notoriety as a simple forecaster
of economic growth. The rule of thumb is that an
inverted yield curve (short rates above long rates)
indicates a recession in about a year, and yield curve
inversions have preceded each of the last six recessions (as deﬁned by the NBER). Very ﬂat yield
curves preceded the previous two, and there have
been two notable false positives: an inversion in
late 1966 and a very ﬂat curve in late 1998. More
generally, though, a ﬂat curve indicates weak growth,
and conversely, a steep curve indicates strong growth.
One measure of slope, the spread between 10-year
bonds and 3-month T-bills, bears out this relation,
particularly when real GDP growth is lagged a year
to line up growth with the spread that predicts it.
The yield curve had been giving a rather pessimistic
view of economic growth for a while now, but with
the increasingly steep curve, this is turning around.
The spread remains robustly positive, with the
10-year rate at 4.67 percent and the 3-month rate
at 4.00 percent (both for the week ending October
12). Standing at 67 basis points, the spread is up
from September’s 38 basis points and well above
August’s −4 basis points. Projecting forward using
9

past values of the spread and GDP growth suggests
that real GDP will grow at about a 2.4 percent rate
over the next year. This is broadly in the range of
other forecasts, if a bit on the low side.

Yield Spread and
Lagged Real GDP Growth
Percent
12
10

One-year-lagged real GDP growth (year-to-year percent change)

8
6
4
2
0
-2
-4
1953

Yield spread:
10-year Treasury note minus 3-month Treasury bill
1963

1973

1983

1993

2003

Perhaps the decreasing probability of a recession
seems strange in the midst of recent ﬁnancial concerns, but one aspect of those concerns has been a
ﬂight to quality, which has lowered Treasury yields,
and a reduction in both the federal funds target rate
and the discount rate by the Federal Reserve, which
tends to steepen the yield curve.

Sources: U.S. Department of Commerce, Bureau of Economic Analysis;
and Board of Governors of the Federal Reserve System.

Predicted GDP Growth
and the Yield Spread
Percent
6
Real GDP growth
(year-to-year percent change)

5
4

Predicted
GDP growth

3
2
1
0
Yield spread: 10-year Treasury note
minus the 3-month Treasury bill

-1

-2
Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sources: U.S. Department of Commerce, Bureau of Economic Analysis; the
Board of Governors of the Federal Reserve System; and authors’ calculations.

Probability of Recession Based on the
Yield Spread*
Percent
100
90
Probability
of recession

80
70

Forecast

While such an approach predicts when growth is
above or below average, it does not do so well in
predicting the actual number, especially in the case
of recessions. Thus, it is sometimes preferable to
focus on using the yield curve to predict a discrete
event: whether or not the economy is in recession.
Looking at that relationship, the expected chance of
a recession in the next year is 14 percent, down from
September’s 17 percent and August’s 28 percent.

50
40

Our 14 percent chance is below the 26.2 percent
calculated by James Hamilton over at Econbrowser
(though to be fair, we are calculating diﬀerent
events: our number gives a probability that the
economy will be in recession over the next year;
Econbrowser looks at the probability that the ﬁrst
quarter of 2007 was in a recession).
Of course, it might not be advisable to take this
number quite so literally, for two reasons. First, this
probability is itself subject to error, as is the case
with all statistical estimates. Second, other researchers have postulated that the underlying determinants of the yield spread today are materially different from the determinants that generated yield
spreads during prior decades. Diﬀerences could
arise from changes in international capital ﬂows
and inﬂation expectations, for example. The bottom
line is that yield curves contain important information for business cycle analysis, but, like other indicators, should be interpreted with caution.

30
20
10
0
1960

1966

1972

1978

1984

1990

1996

2002

2008

For more detail on these and other issues related to
using the yield curve to predict recessions, see the
Commentary “Does the Yield Curve Signal Recession?”

*Estimated using probit model. Shaded bars indicate recessions.
Sources: U.S. Department of Commerce, Bureau of Economic Analysis; Board of
Governors of the Federal Reserve System; and authors’ calculations.

International Markets

Is It the Best of Times or the Worst?
11.07.07
By Owen F. Humpage and Michael Shenk

World Growth
Annual percent change
6

Standard deviation
16
Dispersion of growth

-1

2
World growth in per capita GDP

-2

1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
Note: Shaded bars indicate U.S. recessions.
a. Standard deviation of detrended GDP growth across countries.
Source: International Monetary Fund, World Economic Outlook, October 2007.

Real GDP Growth by Region
8
United States
6
4
2
0
Latin America

-4
1970

1975

1980

1985

1990

1995

August’s roiling of global ﬁnancial markets highlighted another aspect of the U.S. housing-market
meltdown: the fact that growing international trade
and cross-border ﬁnancial ﬂows have made the
world’s economies more interdependent. More than
ever before, events in one country can spill over
into others.
Over the past year, in two editions of its World
Economic Outlook,1,2 the International Monetary
Fund (IMF) has explored how closer economic ties
among nations have changed global business cycles.
This article summarizes some of the key points
made in those very interesting articles.

Annual Percent Change
10

-2

The continuing implosion of the U.S. housing
market has caused many forecasters to trim their
economic-growth estimates for this year and next.
Although none is openly using the R-word, most
expect a period of substandard growth extending
at least through the ﬁrst half of 2008. The great
uncertainty in the economic outlook is the extent
to which housing-related woes and the associated
ﬁnancial-market turmoil might impact other sectors, notably business investment and consumer
spending.

2000

Note: Shaded bars indicate U.S. recessions.
Source: International Monetary Fund, World Economic Outlook, April 2007.

2005

As worrisome as the current housing and ﬁnancialmarket turmoil may be, it comes during a time of
phenomenal worldwide economic activity. The pace
of economic growth is the highest in 30 years, and
the extent to which countries across the globe are
sharing in the prosperity, as measured by the low
dispersion in growth rates, seems unprecedented.
The volatility of the growth—both across the globe
and within most countries—has been moderating since at least the early 1980s, so much so that
economists have dubbed the phenomenon “the
Great Moderation.” In most countries and regions
of the globe, according to the IMF analysis, economic expansions appear to be lengthening, while
recessions are getting shorter and milder. Latin
America and Japan are notable exceptions. Deep
11

recessions—those resulting in an output loss of at
least 3 percent—seem a thing of the past in most
large developed countries, including Japan, as well
as in China and India.

Real GDP Growth by Region
Annual Percent Change
8
6

Sub-Saharan Africa

4
2
0
Euro area
-2
Emerging Europe
-4
-6
-8
1970

1975

1980

1985

1990

1995

2000

2005

Note: Shaded bars indicate U.S. recessions.
Source: International Monetary Fund, World Economic Outlook, April 2007.

Real GDP Growth by Region
Annual Percent Change
10
Emerging Asia
8
6
4

A hallmark of recent global prosperity is an improvement in monetary policy. Following the abysmal performance of the 1970s, monetary policy in
most advanced countries has focused primarily—if
not solely—on achieving and maintaining reasonable price stability. Governments gave their central
banks more autonomy, and central banks improved
the clarity of their operations. More recently, central banks in emerging and developing countries
have been showing similar improvements in their
monetary policies. Fiscal policies, which can have
monetary implications, have likewise improved,
becoming less volatile. Advances in countries’ ﬁnancial infrastructures also seem important. Financial
development can aid investment by spreading risk
and can help households smooth their expenditures
across good and bad times. Much of the moderation in world output volatility reﬂects a reduction
in the volatility of consumption spending, as the
IMF shows.

2
Japan
0
-2
-4
1970

1975

1980

1985

1990

1995

2000

Note: Shaded bars indicate U.S. recessions.
Source: International Monetary Fund, World Economic Outlook, April 2007.

2005

While global business cycles may have become
more docile, they haven’t lost their bite. The world
remains susceptible to economic developments in
the United States; if anything, globalization has
probably increased that vulnerability. The extent
to which a U.S. economic slowdown spills over to
the rest of the world depends, of course, on how
hard the United States is hit. Historically, when
the United States slips into recession, growth in
other countries and regions of the world signiﬁcantly slows, but usually most other economies
do not likewise experience a recession. The extent
of the economic moderation in any one country
mainly depends on its trade and ﬁnancial ties with
the United States. Other industrialized countries,
Latin America, and, to a lesser extent, Asia seem to
bear the brunt of a contraction in U.S. economic
activity. Over the past year or so, as its housing-sector problems have unfolded, the United States has
avoided a recession, but the rate of U.S. economic
growth has fallen below its potential pace. The IMF

suggests that when this happens, the global eﬀects
are fairly negligible and limited to other industrialized countries.

Real Imports of Goods and Services
Percent change, year over year
30
20
10
0
-10
-20
1970

1975

1980

1985

1990

Note: Shaded bars indicate U.S. recessions.
Source: Bureau of Economic Analysis

1995

2000

2005

These global spillovers depend on many mitigating
circumstances, but generally they slosh through two
conduits: trade ties and ﬁnancial linkages. The ﬁrst
is straightforward. When U.S. economic activity contracts, U.S. imports fall. The IMF suggests
that the relative importance of this conduit may be
waning somewhat. Regional trade ties—transactions with nearby neighbors—are growing more
rapidly for most countries than trade with the
United States. Nevertheless, the United States oﬀers
a huge market and remains the export destination
for nearly 20 percent of all internationally traded
goods. In addition, the recent sharp and broadbased depreciation of the dollar is likely to ramp
up any trade-related spillovers stemming from a
weaker pace of U.S. economic growth.
Financial linkages, however, seem a much more
important channel for the transmission of international shocks than trade ties, especially among the
large developed countries. Claims on the United
States represent a huge share of foreign portfolios,
and, likewise, U.S. investors maintain substantial
claims on foreigners. Prices of like ﬁnancial instruments are highly correlated across global markets,
and as the IMF reports, this correlation seems to
increase in weak markets. When shocks occur in
one segment of the global ﬁnancial market, such
as the commercial paper associated with subprime
lending, they can quickly spill across a broader array of assets with similar risk proﬁles. Uncertainty
and any associated ﬂight to quality can dry up
market liquidity and quickly aﬀect real business
investment and consumer spending across countries
with strong ﬁnancial linkages.
So we are left wondering: Is this the best of times or
worst?
1. International Monetary Fund. April 2007. “Decoupling the Train?
Spillovers and Cycles in the Global Economy,” World Economic Outlook, pp. 121–160.
2. International Monetary Fund. October 2007. “The Changing
Dynamics of the Global Business Cycle,” World Economic Outlook, pp.
67–94.

Economic Activity and Labor

The Employment Situation, October
11.14.07
By Yoonsoo Lee and Michael Shenk

Labor Market Conditions
Average monthly change
(thousands of employees, NAICS)
2004

2005

2006

Jan.–Oct.
2007

October
2007

Payroll employment

172

212

189

125

166

Goods-producing

−23

−24

Construction

−8

−5

Heavy and civil
engineering

Residentiala

−2

−6

−22

Nonresidentialb

Manufacturing

−7

−17

−21

Durable goods

−12

−13

Nondurable
goods

−9

−6

−4

−9

Service-providing

144

180

179

148

190

Retail trade

−3

−22

Financial activitiesc

PBSd

−1

−6

Education and
health services

Leisure and hospitality

Temporary help
services

Government
Local educational services

Average for period (percent)
Civilian unemployment
rate

5.5

5.1

4.6

4.7

a. Includes construction of residential buildings and residential specialty trade
contractors.
b. Includes construction of nonresidential buildings and nonresidential specialty
trade contractors.
c. Financial activities include the finance, insurance, and real estate sector and
the rental and leasing sector.
d. PBS is professional business services (professional, scientific, and technical
services, management of companies and enterprises, administrative and support,
and waste management and remediation services.
Source: Bureau of Labor Statistics.

Nonfarm payrolls increased by 166,000 jobs in
October. This is the largest gain since May and
doubled market expectations of a gain of 83,000.
The unemployment rate remained about the same
at 4.7 percent, and the labor force participation
rate was essentially unchanged (65.9 percent from
66.0 percent in September). The headline number
in this report suggests that the labor market remains stronger than economists expected, calming
fears about the ongoing decline in housing sectors
and the turmoil in ﬁnancial markets spilling over
to other sectors. However, stronger-than-expected
gains were not broadly observed across all sectors.
In fact, job gains in October were quite skewed,
centering on service sectors, which repeats a recent
pattern. Goods-producing sectors continued to
show weakness, shedding 24,000 workers. The loss
of 21,000 jobs in manufacturing puts the average
change over the last three months at -28,000 jobs,
the lowest three-month average since September
2003. Employment losses in durables (-12,000) are
concentrated in transportation equipment (-7,400)
and computer and electronic products (-4,300).
Overall, the construction industry lost 5,000 jobs
last month. Jobs in residential construction fell by
21,500, reﬂecting a sharp decline in the housing
sector. Nonresidential construction remained resilient, adding 15,000 jobs in October.
The gain in overall employment reﬂected a 130,000
increase in private payrolls and a 36,000 gain in
government payrolls. Most of the gains in government are from local educational services (35,000),
a sector that went through signiﬁcant revisions in
recent months (see August and September employment situations). In August, the BLS originally
reported a 32,000 loss in local educational services.
This number, after two revisions in September and
October, now stands at a 54,000 gain. As the BLS
catches up on unusual seasonal changes around the
start of the school year, the gains in September and
October are very likely to be revised again.
14

Average Nonfarm Employment Change
Change, thousands of jobs
250
Revised
Previous estimate
200
150
100
50
0
2004 2005 2006 2007 IV
2006

II
2007

III

Aug Sep Oct

Source: Bureau of Labor Statistics

Private Sector Employment Growth
Change, thousands of jobs: 3-month moving average
350
300

The private service sector continued to add jobs at
a slightly faster rate. The three-month moving average of employment growth in the sector accelerated
slightly (120,000 as of October), although this
pace was lower than earlier this year. Employment
gains were quite strong in Professional Business
Services (65,000 gains, up from 23,000 in September). Education and Health Services added 43,000
jobs in October, but the gains in September in this
sector were revised down from 44,000 to 29,000.
Leisure and Hospitality also continued to add jobs
(56,000) in October, along with 15,000 additional
gains in September due to the revision. However,
such strength in the service sector is not broadly
observed. Retail Trade continued to lose jobs during the month (-22,000). Recent turmoil in the
mortgage market has been a major issue in the
ﬁnancial markets. While lenders (credit intermediation and related service) cut 5,000 jobs, employment in ﬁnancial sectors did not change much.

250
200
150
100
50
0
-50
-100
-150
-200
2002

2003

2004

Source: Bureau of Labor Statistics

2005

2006

2007

Overall, this month’s report suggests that the labor
market remains stronger than most were expecting.
However, it is worth noting that monthly numbers
are volatile and subject to revision. In last month’s
report, the Bureau of Labor Statistics (BLS) revised away the 4,000 job loss originally reported in
August, raising that estimate to a gain of 89,000.
Although this report’s revisions to September (14,000) and August’s (4,000) employment numbers are relatively small, payroll gains in September
and October are subject to revision in the next
report. Excluding volatile government series, the
three-month moving average of private payroll
growth remains at the low end of the range it has
been in since 2004. In a positive sign, temporary
help employment, which is often used as a leading indicator of the overall labor market, grew by
20,000 after successive declines in recent months.
However, softness in goods-producing sectors remains a concern for the economy.

Economic Activity and Labor

Union Membership
11.09.07
By Yoonsoo Lee and Beth Mowry

Union Membership Rates
Percent of total employed
30

After the National Labor Relations Act became law
in 1935, organized labor unions experienced growing popularity and began to exercise their rights
to collectively bargain and take part in strikes. The
Act was a spin-oﬀ of President Roosevelt’s New
Deal, which was aimed at supporting prices and
stimulating recovery from the Great Depression.
Union membership increased steadily until 1954,
at which point more than a quarter of all workers
were unionized (17 million out of 60 million, or
28.3 percent). But since that peak, union membership has declined and stands at an all-time low of
12 percent (as of 2006).

28
26
24
22
20
18
16
14
12
10
1948

1958

1968

1978

1988

1998

a. Data after 1982 includes employee association membership
b. No data available 1981-1982
Source: Bureau of Labor Statistics

BLS Data

Work Stoppages
Number of strikes
500

Thousands of workers
3.0

450

2.7

400

2.4

350

2.1

300

1.8

250

1.5

200

1.2

150

0.9

100

0.6

0.3

0
1947

0.0
1957

1967

1977

1987

1997

2007

a. 2007 data is annualized data from the first three quarters
Source: Bureau of Labor Statistics

It is not just that union membership is growing
more slowly than overall job growth; the number of
union members has actually been declining. While
the number of people employed has increased 14
percent over the last decade, the number of union
members has dropped 5.6 percent. In 2006, out of
the 128.2 million workers employed, 15.4 million
were union members. Some economists attribute
the decline in union membership to the labor
force’s shift away from heavily-unionized industries such as manufacturing. Others argue that the
demand for union representation has declined over
time, as the public provision of social welfare beneﬁts by the government has increasingly substituted
for the beneﬁts of union service.

The number of work stoppages has followed the
same trend as union membership, declining sharply
in the 1970s. In 2006, there were only 20 major
work stoppages (involving 1,000 or more workers), compared to the 1970s, when more than 200
strikes occurred each year. The number of union
members involved in each strike has declined as
well: in the 1970s more than 1 million workers
participated in strikes each year, whereas in 2006
the number had fallen to only 70,000.

10
1986

On average, union workers and the members of
similar employee organizations still earn higher

Employer Costs: Total Compensation
Dollars per hour
40
35
Union
30
25
20
Nonunion

1989

1992

1995

1998

2001

2004

2007

BLS
Data
a. Data
is in constant dollars
Source: Bureau of Labor Statistics

hourly compensation, including retirement and
beneﬁts. Average hourly compensation including
beneﬁts was $35.69 for union members and $24.79
for non-union members in the second quarter of
2007. In 2006, weekly wages and salaries for union
members was $833, compared to the $642 for nonunion workers.

Union Membership Rates (2006)
Percent of employed
30

Fourth district states
National average

24.7% 24.4%

25
20

14.2% 14.2%

13.6%
9.8%

10
5

4.0%

3.3%

0
HI

Note: HI and NY - states with the highest membership rates; VA and NC states with the lowest membership rates
Source: Bureau of Labor Statistics

Rates of union membership widely vary across
states. In 2006, 24.7 percent of workers in Hawaii
belonged to unions or similar associations, while in
North Carolina only 3.3 percent workers did—the
lowest in the nation. Most of the Fourth District
states slightly exceed the national average membership rate (12 percent). Ohio’s 14.2 percent rate
was above the nation’s average and was a signiﬁcant decline from its rate in 2000 of 17.4 percent.
West Virginia, Pennsylvania, and Kentucky’s union
membership rates stand at 14.2 percent, 13.6 percent, and 9.8 percent, respectively.

Economic Activity and Labor

Housing Cycles
11.09.07
By Michael Shenk

Single-Family Housing Starts
Index, peak = 100
120
110
100
February 1990

90
80

September 1980
70
January 2006

60
50

November 1978

30
0

18
24
Months from peak

a: The November 1978 cycle is truncated due to its intersection with the
September 1980 cycle.
Source: Census

October’s housing data, which predominately
covers what happened in September, did little to
change our picture of the housing market. A look at
the recently released data shows that the downturn
in housing continued through September. While
this is not good news, some consolation can be had
by comparing this downturn to others in the past.
Looking at the last three housing slumps suggests
this one is pretty typical. In fact, the current downturn actually compares favorably in some metrics.
But then again, nothing indicates it is ending
anytime soon.
To compare housing downturns across time in a
meaningful way, it helps to look at various indicators of the market as indexes as opposed to raw
numbers. By indexing the data of the diﬀerent
series to their respective peaks, we can get a clearer
picture of the severity of each downturn over a
given time frame.
During the four most recent downturns, singlefamily housing starts have fallen at fairly compara17

New Single-Family Home Sales
Index, peak = 100
110
100
90

October 1978

July 2005

July 1989

70
60
August 1980
50
40
30
0

18
24
Months from peak

a: The October 1978 cycle is truncated due to its intersection with the August
1980 cycle.
Source: Census

Real Median Sales Price New
Single-Family Homes
Index, sales peak = 100
115
110

October 1978

100
95
August 1980
July 1989

85
0

18
24
Months from peak

a: The October 1978 cycle is truncated due to its intersection with the August
1980 cycle.
Source: Census

Existing Single-Family Home Sales
Index, peak = 100
110
January 1990

100

September 2005

90
November 1978

70
September 1980

60
50
40
0

As for new-single family home sales, their current
decline appears to be pretty typical as well. This
shouldn’t be particularly surprising, assuming that
there is a link between housing starts and new
home sales. The current cycle does diﬀer slightly in
the pace of the sales decline, which was somewhat
slower than the previous cycles through the ﬁrst
year and a half. And once again, around the 18month mark, each of the previous cycles bottomed
out, which has not yet happened in the current
cycle.

July 2005

105

ble rates. With the exception of the housing slump
beginning in 1990, which is noticeably shorter in
terms of its eﬀect on starts, the current position of
housing starts is very close to what it was in each
of the previous cycles. While the pace and size of
the decline are very similar in all of these cases, the
most recent downturn sticks out in terms of how
long it has lasted. In none of the previous cycles
had starts fallen consistently for more than a year
and a half without a noticeable uptick.

18
24
Months from peak

a: The November 1978 cycle is truncated due to its intersection with the
September 1980 cycle.
Source: National Association of Realtors

The real median sales price for new single-family
homes has historically been fairly ﬂat throughout
downturns in sales, with only a modest downward
trend starting about 12 months after the peak in
sales. Thus far, the current cycle does not seem to
be an exception to this trend, but prices do appear
to have been somewhat more resilient through the
ﬁrst 18 months of the cycle than in the past. The
resiliency of prices may partially explain why previous cycles saw an uptick in sales around this time
and the current cycle has not as of yet. (The median
sales price of new homes may not necessarily reﬂect
the actual cost of a new home. Sellers of new homes
often can adjust the actual cost of the home by offering nonprice incentives or discounts that are not
reﬂected in the sales price.)
The market for existing single-family homes, which
is considerably larger than the market for new single-family homes, also appears to be behaving typically for a period of decline, although a bit more
favorably than in previous slumps. Through the
ﬁrst 18 months of the current cycle, existing home
sales were doing considerably better than all but
the cycle beginning in 1990. (And that cycle would
have had a much sharper downturn if data from
18

December 1988 to June 1989 had been included,
as there was a sharp decline in existing home sales
during the period. The period was excluded, however, in order to keep the time periods consistent
with the downturns in starts and new home sales.)
As was the case with both housing starts and new
home sales, sales of existing homes, which in previous cycles began to bottom out around the year and
a half mark, have not shown any signs of reaching a
trough in this cycle.

Real Median Sales Price,
Existing Single-Family Homes
Index, sales peak = 100
115
November 1978

110
105
100
January 1990
95
September 2005
90

September 1980

85
0

18
24
Months from peak

a: The November 1978 cycle is truncated due to its intersection with the
September 1980 cycle.
Source: National Association of Realtors

Perhaps responsible for the more modest decline
in sales is the decline seen in the real median sales
price of new homes. The current cycle’s decline
tracks the price movements of the cycle beginning
in 1980 fairly closely. A notable diﬀerence between
these two cycles is that the real price decline in the
1980 cycle was accompanied by a much steeper decline in sales. Still, the current decline in prices may
be a little disconcerting for the typical homeowner,
as homes generally make up a large portion of a
household’s wealth. It also may be a point of concern from a macroeconomic perspective if the price
declines spill over into households’ consumption
decisions. Thus far, we have yet to see any signs that
the consumer market is being aﬀected by weakness
in home prices.
So is this the worst housing slump in the last 30
years? Although it is too soon to tell, so far it is
broadly similar to the ones we have seen before. Of
course, there is one important diﬀerence we haven’t
yet mentioned: all three of the previous housing
slumps were accompanied by recessions, while this
one, so far, has not.

Economic Activity and Labor

Third-Quarter GDP
11.01.07
By Brent Meyer

Real GDP and Components,
Third-Quarter Advance Estimate
Quarterly change
(billions of 2000$)

Annualized percent change, last
Quarter

Four quarters

Real GDP

110.6

3.9

2.6

Personal consumption

61.0

3.0

13.4

4.4

4.7

Durables

16.0

2.7

2.4

Services

Nondurables

32.9

2.9

3.0

Business fixed investment

26.1

7.9

4.8

Equipment

15.3

5.9

1.4

Structures

8.9

12.4

12.8

Residential investment

-26.8

-20.1

-16.4

Government spending

18.5

3.7

2.7

National defense

11.8

9.7

5.6

Net exports

27.7

—

Exports

52.7

16.2

9.6

Imports

25.0

5.2

2.0

9.9

—

Change in business
inventories

Source: Bureau of Economic Analysis.

Contribution to Percent Change
in Real GDP
Percentage Points
4

Last Four Quarters
2007:iiiq Advance
2007:iiq Final

3
2
1
0

Business
Fixed
Investment

Exports

Residential
Investment
Personal
Consumption

-1
-2
Source: Bureau Of Economic Analysis

Change In
Inventories

Government
Spending
Imports

Real gross domestic product (GDP) increased at a
3.9 percent annualized rate in the third quarter of
2007, following a growth rate of 3.8 percent in the
second quarter. Growth in personal consumption
expenditures (PCE) accelerated in the third quarter, from 1.4 percent in the second quarter to 3.0
percent in the third. Also contributing to the rise
in real GDP was an increase in exports, from 7.5
percent to 16.2 percent, driven by a 23.0 percent
spike in goods exports. Imports rose from –2.7
percent to 5.2 percent. Gross private ﬁxed investment was somewhat weaker in the third quarter,
rising only 0.8 percent, as residential investment
fell 20.1 percent and the growth rate in business
ﬁxed investment dropped from 11.0 percent in the
second quarter to 7.9 percent in the third. However, investment in equipment and software rose 5.9
percent during the quarter, to its highest growth
rate in six quarters. Of course, this information is
from the advance report, which is based on incomplete data and, in some cases, trend assumptions,
and is subject to further revisions.
Personal consumption expenditures contributed 2.1
percentage points to the annualized percent change
in real GDP during the third quarter, more than
doubling the 1.0 percentage point contribution
in the ﬁrst quarter. Of the 2.1 percentage points
contributed by PCE, services added 1.2 percentage
points, while durable and nondurable goods contributed 0.4 percentage point and 0.6 percentage
point, respectively. Exports, which usually contribute about 1.0 percentage point to GDP growth,
added 1.8 points this quarter. Also, net exports
added 0.9 percentage point, after a 0.9 percentage
point subtraction by imports.
The so-called “housing slump” has continued for
quite some time, but the level of residential investment is approaching the roughly $450 billion
average seen during the last recession. It stands at
$463.9 billion currently. Since its peak in the fourth
quarter of 2005, residential investment has lost
20

$143.3 billion. Over that same time period, business
ﬁxed investment has gained $132.7 billion.
The near-term consensus growth forecast, as seen
by the Blue Chip panel of economists, has GDP
dipping down to a growth rate of 1.8 percent, but
then rebounding to 2.9 percent by the end of 2008.

Real GDP Growth

Fixed Investment

Annualized quarterly percent change
6

Billions (Saar, chained 2000$)
700

Final estimate
Advance estimate
Blue chip forecast

Billions (Saar, chained 2000$)
1500
Residential

600
1250

4
500

Business
2

1000
400

1
0

750

300
Ivq Iq
2005

Iiq

Iiiq Ivq Iq
2006

Iiq

Iiiq Ivq Iq
2007

Iiq

Iiiq Ivq
2008

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: Bureau Of Economic Analysis

Source: Blue Chip Economic Indicators, October 2007; Bureau of Economic
Analysis

Economic Activity and Labor

Jumbo Mortgages and Mortgage Market Conditions
10.29.07
By Andrea Pescatori and Michael Shenk
Mortgage markets can have a big eﬀect on the
economy more generally, as recent turmoil in ﬁnancial markets—which began with turbulence in the
mortgage industry—aﬃrms. Conditions in mortgage markets are therefore followed closely. One
interesting indicator of mortgage market conditions
is the interest rate spread on jumbo mortgages.

Fixed-Rate Mortgages
Percent
9.0
8.5

Jumbo

8.0
7.5
7.0
6.5
6.0

All fixed

5.5
5.0
4.5
1999
Source: Bloomberg

2001

2003

2005

2007

Jumbo mortgages are loans too big to be purchased
by Fannie Mae and Freddie Mac, the two largest
secondary market lenders (together, they own or
securitize more than 70 percent of the residential
mortgage loans in the United States). Fannie and
Freddie are permitted to buy only those loans that
conform to a limit set by the Oﬃce of Housing
Enterprise Oversight—$417,000 for the continental United States since 2006 (higher for remaining
states and territories). Loans above the conforming
limits are usually purchased by ﬁnancial institutions
21

ranging from commercial banks to hedge funds, as
well as Wall Street conduits that provide warehouse
ﬁnancing for mortgage lenders.

Fixed-Mortgage Rate Spread:
Jumbo s minus Non-Jumbos
Percentage points
1.2
1.0
0.8
0.6
0.4
0.2
0.0
1999

2001

2003

2005

2007

Source: Bloomberg

Fixed Mortgage Rate Spread:
Jumbo -Total
Percentage points
1.1
1.0

BNP Paribas freezes 3 funds
ECB injects 94b euros
IKB bailout
$38b injected into reserves

0.9

Goldman, Rentec losses

0.8
0.7

Countrywide taps credit line
Discount rate cut, FOMC release
Geithner & Kohn call clearinghouse
payments company
Relax affiliate lending rules

0.6

B of A $2b to Countrywide
SOMA security lending

0.5

Clarified discount window
collateral

0.4

Home Depot LBO
Cheyne downgrade

0.3
0.2
7/1/07
Source: Bloomberg

8/1/07

9/1/07

10/1/07

Jumbo mortgage loans pose a higher risk for
lenders, and this risk is consistently reﬂected in
the spread between the interest rates on jumbo
mortgages and conventional mortgages, where the
historical average is about 30 basis points. The risk
reﬂected in this long-term average arises because it
is harder to sell a luxury residence quickly for full
price in the event of default. More generally, luxury
homes are harder to price, and their prices are more
vulnerable to market highs and lows; as a result,
prices are more diﬃcult to forecast. An increase in
the volatility of housing prices could also increase
the perceived risk associated with jumbo loans and
hence, the spread.
However, the spread between jumbo and conventional mortgage rates is aﬀected by more than
just the diﬀerent sort of homes that belong to the
jumbo pool. Interest rates on jumbo mortgages
also reﬂect changes in the liquidity of the secondary market and the willingness of investors to buy
its securities. Because Fannie Mae and Freddie Mac
don’t buy nonconforming loans, the secondary
market for jumbo mortgages is generally less liquid
than for conventional mortgages. In addition, the
liquidity of the conventional secondary mortgage
market is boosted by the implicit government guarantee investors believe the bonds issued by Fannie
and Freddie enjoy. These bonds are perceived as
having risk equivalent to government bonds (close
to zero), because Fannie and Freddie are government-sponsored enterprises (GSEs), even though
GSE securities are not, in fact, backed by the U.S.
government. Consequently, the spread between
interest rates on jumbo and conventional loans
also measures the premium which must be paid to
compensate investors for the lower liquidity of the
secondary market’s securities and should measure
investors’ appetites for jumbo mortgage-backed
securities.
The trends in average interest rates for both jumbo
and conventional mortgages are clearly determined
by the broad macroeconomic factors that aﬀect the
overall economy. By plotting the diﬀerence (spread)
22

between the two rates, we isolate information about
the premium paid for jumbo-based securities relative to conventional ones (note that our dataset includes loans called super jumbos, those that exceed
$650,000). This premium was pretty stable until
the summer of 2007. In fact, the only notable spike
before then was in the winter of 2001, just before a
recession and in the aftermath of 9/11.
However, the biggest jump ever in the spread series
happened only recently, in the summer of 2007.
This jump is clearly associated with liquidity conditions in the secondary mortgage market: outside of
Fannie Mae and Freddie Mac, buyers in the secondary market were ﬁnding it extremely diﬃcult to
resell mortgage-backed securities.
The premium on jumbo loans started to rise
abruptly at the end of July, and by the end of
August, it broke the 100 basis point threshold. The
sharpest increase in the spread anticipated many
August events, such as BNP Paribas freezing its
three funds and the Cheyne downgrade.
The high volatility of the spread persisted until
mid-September, when it began to slowly subside. At
the moment, we still seem far from “normal” times,
with a spread that is still about double the average
seen over the last eight years.

Regional Activity

The Cincinnati Metropolitan Statistical Area
Counties of the
Cincinnati–
Middleton MSA
Indiana
1. Dearborn
2. Franklin
3. Ohio
Kentucky
4. Boone
5. Bracken
6. Campbell
7. Gallatin
2
8. Grant
1
9. Kenton
3
10. Pendleton 7
Ohio
11. Brown
12. Butler
13. Clermont
14. Hamilton
15. Warren

11.08.07
By Tim Dunne and Kyle Fee
The Cincinnati-Middleton Metropolitan Statistical Area (MSA) comprises ﬁfteen counties in three
states, including ﬁve counties in Ohio, seven counties in Kentucky, and three counties in Indiana. It is
the twenty-ﬁfth-largest MSA in the country, with a
population of 2.1 million people in 2006.
12

14
4 9 6
8 10

13
11
5

Cincinnati’s distribution of employment across
industries is quite similar to the nation’s as a whole,
with a few important exceptions. Comapred to the
national economy, a greater share of Cincinnati’s
workforce is employed in professional and business
services and manufacturing, and a substantially
smaller share is employed in the information and
government sectors.
23

Location Quotients for Cincinnati-Middleton
MSA and the U.S., 2006
Natural Resources, Mining, & Construction
Manufacturing
Trade, Transportation, & Utilities
Information
Financial Activities
Professional & Business Services
Education & Health Services
Leisure & Hospitality
Other Services
Government

0.2

0.4

0.6

0.8

Note: A location quotient is the simple ratio of a given industry’s employment share in
one region to the industry’s employment share in the nation. A location quotient of
one indicates that the industry accounts for the same share of employment in the
region and the nation.

Payroll Employment since March 2001
Index, March 2001 = 100
106
U.S.

104

102

Cincinnati-Middleton MSA

100

98
96
2001

Ohio

2002

2003

2004

2005

2006

2007

Payroll Employment since March 2001
Index, March 2001 = 100
110
105
100
U.S. Nonmanufacturing
U.S. Manufacturing
Cincinnati Nonmanufacturing
Cincinnati Manufacturing

95
90
85
80
2001

2003

2005

2007

1.2

Cincinnati’s employment has grown less than the
national average since the last business cycle peak
in March 2001, but it has signiﬁcantly outpaced
overall state employment growth. During the 2002
recession, Cincinnati experienced less employment
loss than the rest of the country as well as Ohio,
and its employment rebounded relatively quickly.
By the end of 2002, Cincinnati’s employment had
recovered to pre-recession levels, whereas U.S. and
Ohio employment levels continued to fall well
into 2003. However, since late 2005, Cincinnati’s
employment level has been relatively ﬂat, as has
Ohio’s, while the nation’s has continued to expand
steadily.
Looking at the changes across broad economic sectors, Cincinnati’s weak employment growth relative
to the nation’s can be explained largely by weaker
growth in the nonmanufacturing sector. Cincinnati’s nonmanufacturing sector expanded about
2 percentage points more slowly than the nation’s
since late 2005. On the other hand, the pattern of
growth in manufacturing employment was quite
similar in Cincinnati and the country as a whole.
The MSA’s manufacturing employment showed a
steep decline of 16.7 percent over the period, while
the country’s fell 17.4 percent.
Breaking down employment growth into industry
components provides a more detailed look at Cincinnati’s labor market. Positive employment growth
for the MSA was driven largely by two sectors of
the economy—the education, health, leisure, government and other services sector, and the ﬁnancial,
information and business services sector. From
2001 to 2006, these sectors grew at average annual
rates of 1.5 percent and 1.3 percent, respectively.
Not surprisingly, Cincinnati’s manufacturing sector
acted as a drag on employment growth, showing
declines in all six years.
A year-over-year employment growth comparison
provides a snapshot of the employment situation
from September 2006 to September 2007. During
this period, the nation’s total employment increased
1.2 percent, whereas Cincinnati’s total employment was essentially ﬂat, rising only 0.1 percent.
The MSA lost goods-producing jobs faster than the
nation due to particularly sharp declines in manu24

facturing. Cincinnati’s service sector added jobs at
a much slower rate than the nation as a whole (0.5
percent versus 1.7 percent). This lack of job creation in the service sector has been at the heart of
slow employment growth in some of Ohio’s major
cities. Cleveland (on the) Rocks, a recent Federal
Reserve Bank of Cleveland Economic Commentary, looks at this issue in terms of Cleveland’s
employment growth.

Components of Employment Growth,
Cincinnati-Middleton MSA
Percent change
3
2

Retail and wholesale trade

Natural resources, mining and construction

Manufacturing

Financial, information and business services

Transportation, warehousing
and utilities

Education, health, leisure, government and other
services

U.S.

1
0

A look at unemployment rates over time reveals
that unemployment levels in the Cincinnati area
were below the U.S. average for quite a while—
1990 until late 2004. (In fact, between 1997 and
2001, Cincinnati’s unemployment rate was under 4
percent—a very low rate.) However, since the 2002
recession,the area’s unemployment rate has generally hovered between 4.5 percent and 6 percent,
and recently, they surpassed the nation’s. In August
2007, the area’s unemployment rate stood at 5.0
percent, 0.3 percent above the U.S. rate.

-1
-2
2001

2002

2003

2004

2005

2006

Payroll Employment Growth,
September 2006 - September 2007
Cincinnati-Middleton MSA

U.S.

Total nonfarm
Goods-producing
Manufacturing
Natural resources, mining & construction
Service-providing
Trade, transportation, and utilities
Information
Financial activities
Professional and business services
Education and health services
Leisure and hospitality
Other services
Government

-5

-4 -3 -2 -1 0
1
2 3
Year-over-year percent change

Unemployment Rate
Percent
8
U.S.
7
6

As with many other Midwestern MSAs, Cincinnati’s population growth has lagged the nation’s
over the last several decades. While the MSA’s
population grew 24.5 percent from 1970 through
2006, this growth fell well short of the nation’s 47
percent. Still, the Cincinnati metro area has grown
much faster than the state of Ohio as a whole,
where the population has grown only 7.7 percent
over the last 36 years.
A look at income trends shows that Cincinnati’s
personal per capita income has tracked the U.S.
rate closely over the last several decades. Compared
to Ohio, Cincinnati’s per capita personal income
growth has been somewhat stronger than the state’s,
especially since the mid 1990s. In 2006, Cincinnati’s per capita personal income was $36,366—very
close to the U.S. average ($36,629) and higher than
Ohio’s ($33,217).

5
4
Cincinnati-Middleton MSA
3
2
1990 1992 1994 1996 1998 2000 2002 2004 2006
Note: Shaded bars indicate recessions.

Population

Per Capita Personal Income

Index, 1970 = 100
150

Thousands of dollars
40

140
U.S.

Cincinnati MSA

130

30
U.S.

120
Cincinnati-Middleton MSA

110

Ohio
20

Ohio
100
90
1970

1980

1990

10
1980

2000

1985

1990

1995

2000

2005

Regional Activity

Fourth District Employment Conditions, August
10.29.07
by Tim Dunne and Kyle Fee

Unemployment Rates*
Percent
8
7
Fourth District

6
5
4

United States

3
1990 1992 1994 1996 1998 2000 2002 2004 2006
a. Seasonally adjusted using the Census Bureau’s X-11 procedure.
* Shaded bars represent recessions. Some data reflect revised inputs, reestimation,
and new statewide controls. For more information, see
http://www.bls.gov/lau/launews1.htm.
Source: U.S. Department of Labor, Bureau of Labor Statistics.

The district’s unemployment rate remained at 5.5
percent for the month of August, exceeding the
national rate by 0.9 percentage point. The district’s
rate has been higher than the national rate since
early 2004. Since last year at this same time, the
district’s unemployment rate has decreased 0.1 percentage point, as has the national unemployment
rate.
Of the 169 counties in the Fourth District, 17 had
an unemployment rate below the national average
in August and 152 had a higher one. Rural Appalachian counties continue to experience high levels of
unemployment; Fourth District Kentucky is home
to ﬁve counties with double-digit unemployment
rates. Fourth District Pennsylvania had the lowest unemployment in the district in August at 4.7
percent, which was slightly higher than the national
average. In contrast, Fourth District Kentucky
(5.7 percent), Fourth District West Virginia (5.4
percent), and Ohio (5.7 percent) all had unemployment rates that were well above the national rate.
Fourth District unemployment rates for the district’s major metropolitan areas ranged from a low
26

Unemployment Rates, August 2007*
U.S. unemployment rate = 4.6%

3.6 - 4.5
4.6 - 5.5
5.6 - 6.5
6.6 - 7.5
7.6 - 8.5
8.6 - 14.2

* Data are seasonally adjusted using the Census Bureau’s X-11 procedure.
Source: U.S. Department of Labor, Bureau of Labor Statistics.

Changes in Unemployment Rates
since January 2000

< 0.0%
0.1 - 0.4 %
0.5 - 0.8 %
0.9 - 1.2 %
> 2 X national change*

* Change in U.S. unemployment rate since January 2000 = 0.6%
Source: U.S. Department of Labor, Bureau of Labor Statistics.

of 4.4 percent in Lexington to a high of 6.1 percent
in Cleveland.
Looking at the change in unemployment rates
since January 2000, the Fourth District’s rate has
increased 1.3 percentage points (from 4.2 percent
to 5.5 percent). The national unemployment rate
increased 0.6 percentage point (from 4.0 percent)
over the same period. Of the 169 counties in the
Fourth District, 124 had changes in their unemployment rates which exceeded or equaled the
change in the national rate, while 45 had less. In
fact, 21 counties saw decreases in unemployment
rates over the period. For the most part, the western
part of the Fourth District saw greater increases in
unemployment rates than did the eastern part.
Lexington is the only metropolitan area in the district where nonfarm employment grew faster than
the national average over the past 12 months (Lexington: 2.0 percent; national average: 1.2 percent).
Dayton, on the other hand, is the only major metro
area where nonfarm employment decreased (–0.2
percent). Employment in goods-producing industries increased only in Akron (1.1 percent), while
Cincinnati lost 2.2 percent of its goods-producing
jobs. Nationally, employment in goods-producing
industries declined 1.2 percent. Service-providing
employment increased in seven of the eight major
metropolitan areas, with Lexington posting the
strongest growth by far (2.3 percent). Information services expanded strongly in Lexington (6.5
percent) and Toledo (4.9 percent) but contracted
in Cincinnati (–3.2 percent) and Pittsburgh (–2.2
percent). Employment in professional and business services grew faster in Columbus (2.1 percent),
Pittsburgh (1.6 percent), Toledo (2.6 percent), and
Akron (2.3 percent) than in the nation as a whole
(1.6 percent). All major Fourth District metropolitan areas posted job gains in the education and
health services industry but only Cincinnati posted
stronger growth than the nation (Cincinnati: 3.6
percent; nation: 3.4 percent).

Payroll Employment by Metropolitan Statistical Area
12-month percent change, August 2007
Cleveland
Total nonfarm

Columbus Cincinnati Pittsburgh

Dayton

Toledo

Akron

Lexington

U.S.

0.0

0.6

0.0

0.3

-0.2

0.5

0.9

2.0

1.2

Goods-producing

-1.4

-2.2

-1.1

-0.4

-0.3

1.4

-0.6

-1.2

Manufacturing

-2.2

-1.0

-1.3

-1.1

0.0

-0.4

1.1

-1.1

-1.4

Natural resources, mining, construction

1.3

-2.1

-4.1

-1.4

-1.9

0.0

2.5

0.8

-0.8

0.3

0.8

0.5

0.6

-0.2

0.7

0.8

2.3

1.7

0.0

0.1

-0.4

-0.3

-1.6

-1.1

0.3

-0.9

1.1

Service-providing
Trade, transportation, utilities
Information

0.0

-1.6

-3.2

-2.2

-0.9

4.9

0.0

6.5

1.0

Financial activities

-0.5

-1.5

-1.1

-0.9

1.5

-1.4

0.9

1.0

Professional and business services

-0.5

2.1

0.6

1.6

-0.9

2.6

2.3

-0.7

1.6

Education and health services

1.4

1.5

3.6

2.0

0.5

1.6

1.8

2.6

3.4

Leisure and hospitality

0.1

2.5

1.1

0.6

0.0

-0.6

-0.3

7.7

2.8

Other services

0.9

-1.3

1.2

-1.8

0.6

0.0

0.7

0.0

1.0

1.1

-1.0

0.8

0.6

1.3

0.7

5.9

1.1

6.1

4.7

5.0

4.7

5.7

6.0

5.0

4.4

4.6

Government
August unemployment rate (sa, percent)

Source: U.S. Department of Labor, Bureau of Labor Statistics.

Banking and Financial Institutions

Mortgage Lending
11.09.07
by Ed Nosal and Saeed Zaman

Mortgage Originations
Billions of dollars
1,400
1,200

Percent
80
70

Refinancing share

Originations

1,000
800

60
50
40

600
400

30
20

200

0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Source: Mortgage Bankers Association

Mortgage bankers originated $631 billion of new
mortgages in the ﬁrst quarter of 2007 and $694 billion in the second quarter, the lowest second-quarter increase since 2002. Relatively stable mortgage
rates left little incentive for new reﬁnancing, which
constituted 49 percent of originations in the second
quarter, a signiﬁcant drop from their peak share of
74 percent in the fourth quarter of 2002.
The share of mortgage-related assets (mortgages
and mortgage-backed securities) on banks’ balance
sheets has lessened in recent quarters but is still at
historically high levels. Currently, mortgage-related
assets make up 28 percent of commercial banks’
assets.
Mortgage loan proﬁtability, as approximated by the
spread of the eﬀective mortgage rate (interest plus
fees) over savings banks’ cost of funds, has been on
the down swing since August 2006, after remaining
stable for some time since the fall of 2003. Cur28

rently, the spread is at 2.94 percent. While the cost
of funds as been increasing in step with the increase
in the fed funds rate, banks did not fully pass the
increasing costs on to their mortgage borrowers.

Mortgage and Commercial Lending by
Commercial Banks
Percent
20
Commercial and industrial
18 loans/assets

Since their peak in popularity, the share of adjustable-rate mortgages (ARMs) in total originations
has decreased steadily from 40 percent in June
2004 to 8 percent in September 2007. ARMs depend on short-term rates, whereas ﬁxed-rate mortgages (FRMs) depend on long-term rates. ARMs’
drop in popularity over the years has resulted
primarily from the rise in short-term rates and the
decrease in the spread between ﬁxed and adjustable
mortgage rates. The other likely reason for their
sharp decline in popularity in recent months is the
blame ARMs are being assigned for the mortgage
market turmoil.

16
14
12

One to four family residential
mortgages/assets

10
8
Mortgage-backed securities/assets

6
4

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: Quarterly Bank Reports on Condition and Income

Spread of the Effective Mortgage Rate Adjustable-Rate Mortgages
ARMs, percent
Spreads, percent
Over Cost of Funds
45
3.5

Percent
4.5
4.0
3.5
3.0
2.5

Ten year/one year treasury spread

3.0

FRM-ARM spread

2.5

2.0

1.5

1.0

0.5

10
2.0
1.5
1.0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

0.0
ARMs in originations

-0.5

0
-1.0
19961997 199819992000 20012002 200320042005 20062007
Source: US Department of the Treasury, Office of Thrift Supervision;
Federal Housing Finance Board

Source: Federal Housing Finance Board

Banking and Financial Institutions

Business Loan Markets
11.09.07
by Ed Nosal and Saeed Zaman

Domestic Banks Reporting Tighter
Credit Standards
Net percent
60
50

Medium and large firms

40
30
20
Small firms

10
0
-10
-20
-30
2000

2001

2002

2003

2004

2005

2006

2007

Source: Senior Loan Officer Opinion Survey on Bank Lending Practices,
Board of Governors of the Federal Reserve System, October 2007.

Domestic Banks Reporting Stronger
Demand
Net percent
45
30

Small firms

15
0
-15
Medium and large firms

-30
-45
-60
-75
2000

2001

2002

2003

2004

2005

2006

2007

Source: Senior Loan Officer Opinion Survey on Bank Lending Practices,
Board of Governors of the Federal Reserve System, October 2007

The Federal Reserve Board’s October 2007 survey
of senior loan oﬃcers (covering the months of
August, September and October), found considerable tightening of standards for commercial and
industrial loans. About one-ﬁfth of domestic banks
and one-third of foreign banks tightened standards
for commercial and industrial loans to large and
medium size ﬁrms, while the remaining fraction
reported little change in lending standards in the
period surveyed. The reasons cited for tightening
included a less favorable economic outlook, a reduced tolerance for risk, and decreased liquidity in
the secondary market. A large fraction of domestic
and foreign banks increased the cost of credit lines
and the premiums charged on loans to riskier borrowers. About a third of the banks surveyed raised
lending spreads (loan rates over the cost of funds).
Demand for commercial and industrial loans has
continued to weaken over the period surveyed,
though the fraction of banks reporting weaker
demand is smaller than the in previous survey.
Those who reported weaker demand cited decreased
investment in plants and equipment as the reason,
while those who reported stronger demand cited
diﬃculty in getting other forms of credit such as
commercial paper, and increased activity in mergers
and acquisitions.
Bank balance sheets have yet to reﬂect the decline
in businesses’ appetite for bank loans in the face of
tightening credit standards. The $52 billion increase in bank and thrift holdings of business loans
in the second quarter of 2007 marks the thirteenth
consecutive quarter of increases in bank and thrift
holdings of commercial and industrial loans. The
sharp reversal in the trend of quarterly declines in
commercial and industrial loan balances on the
books of FDIC-insured institutions prior to the
second quarter of 2004 is still going strong.
The utilization rate of business loan commitments
(drawdowns on prearranged credit lines extended
30

Quarterly Change In Commercial and
Industrial Loans
Billions of dollars
60
50

by banks to commercial and industrial borrowers)
held at 36.05 percent of total commitments. This
could indicate the declining importance of bank
credit to commercial borrowers as a result of easier
access to capital markets, as well as lower demand.

40
30
20
10
0
-10
-20
-30
-40
2001

2002

2003

2004

2005

2006

Source: Federal Deposit Insurance Corporation, Quarterly Banking Profile,
Second Quarter 2007

Utilization Rate of Commercial and
Industrial Loan Commitments
Percent of loan commitments
41
40
39
38
37
36
35
34
2001

2002

2003

2004

2005

2006

Source: Federal Deposit Insurance Corporation, Quarterly Banking Profile,
Second Quarter 2007

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Full text of Economic Trends (Federal Reserve Bank of Cleveland) : Economic Trends - November 2007

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