Housing inventories
We would not look for house prices to stabilize until inventories reach eight months’ supply. Until that level is reached, we see price declines of 3% per quarter. What will cause inventories to fall given the underlying weakness in the economy and tight credit conditions? Simply put, demographics. We see an underlying rate of new home demand of 520,000 units per year. With housing completions likely to fall below that figure late this year, we could begin to see modest declines in housing inventories starting next year.

Collateral stabilization
Consumer loan collateral generally consists of two main components – houses for mortgage loans and future income for other consumer loans. Stabilization in housing will increase confidence on the part of banks regarding collateral values and open the door for lending against this collateral base. Stabilization in the labor market would do the same for consumer income “collateral.” Over the course of 2009, we expect to see the unemployment rate jump three percentage points, to approximately 10%. During 2010, we anticipate a further rise of 0.5pp. Once the worst of the job losses are thought to be behind us, banks should have increased confidence in the stability of consumer cash flows. That increased confidence should result in a greater willingness to lend.

Bank lending
We see bank lending as a proxy for the velocity of money. An increase in bank lending will allow the growth in the monetary aggregates we have witnessed to flow more fully into the economy and allow for a higher rate of economic growth going forward. Commercial bank lending growth has slowed from a peak level of 13% year over year reached in March to a growth rate of just 1.0%. This movement is consistent with the rate of growth seen during previous credit crises, reflecting a combination of falling asset values, a tightening of credit standards and, importantly, a drop in consumers’ willingness to borrow due to what we see as a structural shift in their appetite for debt.

End game
The end game for the recovery is, of course, not simply a matter of cyclical indicators beginning to show signs of perking up. Rather, the structural realignment of the balance sheet – consumer, banking and country-wide – is part of a longer-term process of lowering debt service and rebuilding domestic savings that will likely weigh on economic growth for some time to come.