US Treasury is Requesting Lenders Help Those Facing Big Resets

Henry Paulson, Secretary of the US Treasury, is asking that the various mortgage lenders help those that are about to lose there homes due to big resets. However, how this was to be accomplished was not discussed in detail. Unless there is something going on behind the curtain, I am not sure what he thinks these comments will accomplish. From Yahoo:

Treasury Secretary Henry Paulson said on Wednesday a recovery in the subprime mortgage market will be slowed by a wave of interest rate resets and urged lenders to help troubled borrowers.

Speaking to mortgage servicing executives at the Treasury, Paulson called on lenders to expand the range of mortgage products to refinance loans made unaffordable by resets. What can you do besides put them into 30-year fixed, assuming they qualify.

"Unlike periods of financial turbulence I've witnessed over many years, this turbulence wasn't precipitated by problems in the real economy. This came about as a result of some bad lending practices," Paulson said.

Paulson said turbulence in some markets would be worked out more quickly than others. "The subprime market will take longer than other markets because of a number of these resets taking place over the next 18 months to two years," he said. (my emphasis)

He said he was discussing options to expand the availability of mortgage products for this purpose with the government-sponsored housing enterprises Fannie Mae and Freddie Mac and other mortgage product providers. However, he did not mention any specifics.

Paulson said the Bush administration's efforts to provide assistance to financially stressed borrowers was not focused on helping housing speculators caught out by the real estate downturn.

"We're focused on homeowners where it's their primary residence, finding ways to keep them in their home," he added.

Fed’s Split View on Rate Reductions

What bothers me about this rate decision is that if the Fed drops the rate the business community will take it as a signal that they are being “bailed” out, when in fact it is purely a monetary policy issue. The business community does not appreciate how serious the economic situation in the US is and as usual they are just looking at their bottom line. Note that a rate cut in September will not really help out the people with mortgage problems, it is being done to stimulate the economy. Personally, I believe that a rate cut is probably already too late. From Bloomberg.

Federal Reserve Governor Frederic Mishkin joined San Francisco Fed President Janet Yellen in flagging an increasing threat to consumer spending, differing with officials who still see signs of economic strength.

Mishkin said late yesterday in New York that ``heightened uncertainty'' in markets could hurt consumers, after Yellen said demand is under ``downward pressure.'' By contrast, Dallas Fed President Richard Fisher was ``generally encouraged'' about the economy, and Charles Plosser of the Philadelphia Fed said Sept. 8 there are ``a lot of conflicting data.''

The scope of remarks may reflect debate inside the central bank over whether to lower the benchmark interest rate on Sept. 18 by a quarter-percentage point, or a half-point as some investors expect, Fed watchers said.

``They might be legitimately still debating, even with the market way out in front of them,'' said Chris Rupkey, a senior financial economist at Bank of Tokyo Mitsubishi UFJ Ltd., who was present at Mishkin's address to the Money Marketeers of New York University. ``The Fed is a very deliberative body.''

Rupkey said there's no ambiguity in the Treasury market, with the two-year note yield at 3.84 percent, indicating traders anticipate a series of rate cuts. The yield is more than 1.25 percentage points below the Fed's 5.25 percent target rate for overnight loans between banks.

Policy makers are trying to gauge the economy's state after the first loss of jobs in four years in August. Atlanta Fed President Dennis Lockhart said the data now show that job growth started slowing in June. In an Atlanta speech yesterday, he backed away from remarks he made four days before that the housing slump was having a limited impact.

``It sounds like everyone's marked down their growth outlook, and everyone realizes the credit-market events are something that require a Fed response,'' said Michael Feroli, an economist at JPMorgan Chase & Co. in New York who used to work at the Fed. ``It's just a question of magnitude.''

Employers cut 4,000 workers in August, the Labor Department said Sept. 7. Revised figures showed job gains diminished from a 188,000 pace in May to 69,000 in June and 68,000 in July. Mishkin said private payrolls growth has slowed to 70,000 on average in the past three months, from 165,000 in the second half of 2006.

Payrolls are one of the main indicators, along with sales, wages and production, which help determine the start of economic contractions.

Mishkin and Yellen acknowledged some areas are doing better than others. Consumer and business spending appear to be holding up ``reasonably well'' based on some recent indicators. They indicated that the risks to the outlook would sway their decision on rates.

``It is critical to take a forward-looking approach -- gauging the effects of recent developments on the outlook, and, importantly, the risks to that outlook,'' Yellen said in a speech to a conference in San Francisco. Yellen, 61, is a former Fed governor and head of the White House Council of Economic Advisers in the Clinton administration.

Mishkin said that outside of housing, growth ``could be affected more severely in other sectors should heightened uncertainty lead to a broader pullback in household and business spending.''
``That scenario cannot, in my view, be ruled out, and I believe it poses an important downside risk to economic activity,'' said Mishkin, 56, who joined the Fed Board a year ago.

Others played down the surprise loss of jobs, which economists said indicated that the sell-off in credit markets and deepening recession in housing is having a broader impact.

``Our economy appears to be weathering the storm thus far,'' Fisher said yesterday in a speech in Laredo, Texas. ``As yet, tighter credit conditions do not appear to have had a major impact on overall economic activity outside of real estate.''

Moody’s Says the Housing Slump Will Last Through 2009

I have been utterly amazed at the news that I have seen for the last week. Any optimistic outlook is being squeezed out of all serious public pronouncements. This is the first sign of recovery. You can’t get better until you admit where you are at. However, the market still needs to go through its doldrums (or depression stage, as in we need Prozac). From Yahoo.

Credit rating agency Moody's Investors Service said Monday it expects the housing-market slump to last at least until 2009, likely precipitating numerous ratings downgrades at publicly traded homebuilders.

"Our current thinking is that the downturn, currently two years in the making, will last until 2009, with any sector recovery likely to be sluggish for some time after that," said Joseph Snider, senior credit officer at Moody's.

The agency predicts an increase in the number of downgrades and changes in ratings outlooks over that period, after already cutting nearly all of the public builders in recent weeks.
"Many of these companies may see further downgrades, with multiple-notch downgrades possible for homebuilders," Moody's said.

Ratings are used by lenders to set the terms of credit. Lower ratings generally mean it is more expensive for a company to borrow money.

Moody's said it expects builders to violate the terms of existing credit agreements as conditions on the housing market remain poor. That will lead lenders to "tighten restrictions on credit facilities, either through taking collateral, reducing the size of the facility, or restricting borrowing base calculations," the agency said.

The Fed’s Yellen States That the US Economy Faces Increased Risk of a Slowdown

The San Francisco Fed President, Janet Yellen, stated recently that the economy faces higher risk of a significant slowdown. I found her comments interesting because the Fed is now beginning to get the message out that things may not be as rosy as previously thought. The excerpts below come from a Market Watch article or you can read her original speech at the NABE (National Association of Business Economists). The entire speech is worth a read because Yellen goes into the recent history of the capital markets and how these are effecting the economy.

The U.S. economy faces increased risks of a significant slowdown from a worsening housing sector and tight financial markets, San Francisco Fed President Janet Yellen said Monday.
"To sum up the story on the outlook for aggregate demand, I see significant downward pressure based on recent data indicating further weakening in the housing sector and the tightening of financial markets," Yellen told a group of business economists in San Francisco.

She noted that conditions in financial markets could change quickly, for the better or worse, "so it's hard now to speak with a great deal of confidence about future economic developments," she said. However, Yellen also warned that illiquid credit markets threaten to make the housing downturn worse, which in turn could hurt consumer spending.

"Financial market turmoil seems likely to intensify the downturn in housing," she said.
Yellen was hopeful that the turbulence in the financial markerts could be contained to Wall Street and not hurt Main Street. "Financing for capital spending for most firms remains readily available," she said. She noted that other periods of financial market upheaval, particularly the 1998 Russian default, have been resolved without much impact on the economy.

"A big issue is whether developments in the relatively small housing sector will spread to the large consumption sector, perhaps through declines in house prices," Yellen said. "Should the decline in house prices occur in the context of rising unemployment, the risks could be significant." (my emphasis)

Near Perfect Storm in the Housing/Mortgage Industry

The following excerpts from an article at Yahoo are from a speech given by a member of senior management at Washington Mutual (WAMU). Finally, the lending industry is stating it the way it is.

Washington Mutual Inc said on Monday that most U.S. housing markets are weakening, creating a "near perfect storm" that may force the largest U.S. savings and loan to set aside more money for bad loans.

Chief Executive Kerry Killinger . . . . speaking at a Lehman Brothers Inc. financial services conference, said the housing market faces rising delinquencies and foreclosures, higher borrowing costs, tighter underwriting standards and tough capital markets, "creating what we call a near-perfect storm for housing.

"Most housing markets appear to be weakening, to us," Killinger said. "We would not be surprised to see declines in housing prices in many regions of the country ... for the next few quarters." He said corrections in the housing and credit markets will last longer than the thrift expected.

Retail Sales are Up in August, But Is It That Strong?

Just a quick note on retail sales for August. Using the table in the WSJ article it is clear that same store sales compared to August 2006 are up for the higher-end retailers such as Saks, Neiman Marcus, Nordstrom, etc. But, the same store sales for the “bread and butter” stores (where everyone else shops) such as J C Penney, Kohl’s, etc. are down from last year. If you assume an inflation rate of 2.5% the “real” sales growth at other large retailers is not that strong.

This coupled with a loss of jobs in August is not a demonstration of the strength of the economy.

This Weekends Contemplation - You’d Think They Could Leave Statisticians Out of the Politics

As a statistician I often found myself in the middle of political “wars” concerning various decisions or directions that senior management wanted to pursue. The reason I was often in the middle was not because I wanted to be, but because I could access “objective” numbers that would substantiate one direction or another. My favorite process was for senior management to make a decision and ask my team to provide the numbers to substantiate their position. This ran contrary to the way I was trained. Being a classically trained statistician, I was taught to allow the data to do the talking. As my advisor once told me, “the data leaves a trail, your job as a statistician is to learn how to follow it.”

By the way, the article below from the WSJ uses the war in Iraq as an example of how data is used. The purpose of this post is not to discuss the war in Iraq and I have no “public” opinion on the issue of the war in Iraq.

Most of us go about our daily lives without having to handle sums in the billions and trillions. So when advocates, politicians or business leaders want to get a rise from us over, say, wasteful spending, they have to figure out how to get us to understand what their studies have uncovered -- and to see it their way.

These days, one of the numbers we hear most often in the news is that the federal government has spent more than $400 billion on operations in Iraq. That figure, calculated by the Congressional Budget Office, is frequently cited by opponents of the war when they urge troop withdrawal.
The challenge is to make that number provoke shock and awe.

One Web site divides the cost among U.S. adults, showing visitors how each adult could have bought two pairs of Manolo Blahnik patent-leather pumps, or 1,858 longneck bottles of Bud or Bud Light beer. A blogger conjured up the notion that $400 billion would buy enough golf balls to fill all the tractor-trailers it would take to reach across a 13-lane highway, bumper-to-bumper, from Los Angeles to New York.

Readers of the Reason Magazine blog offered their own analogies, such as the number of Reason subscriptions (nearly 17 years' worth for every person on the planet) that could be purchased for $2 trillion -- an economist's projection of the past and future cost of the Iraq war -- after a writer for the magazine said his "head is too small" to comprehend figures that big.

He's not alone. Human beings really do have a hard time understanding big numbers. The figures used in newspapers and political debates can seem like confusing abstractions, cognitive psychologists say. "The brain probably didn't evolve to process very big numbers," says Michael McCloskey, a Johns Hopkins cognitive scientist.

Mathematician John Allen Paulos, author of several books about numbers and how they are used, says his students at Temple University in Philadelphia often can't grasp the scale of large figures. He has told them a million seconds is equivalent to 11.5 days, and then asked how many days contain a billion seconds. "I often get answers like twice as much or 10 times as much." (It's 11,500 days, or about 31.5 years.)

Michael Ranney, a cognitive scientist at the University of California, Berkeley, says journalism students in his number-training class who should know the U.S. population is 300 million sometimes guess California has one billion people (instead of 36.5 million).

For those looking to use policy figures to stun rather than edify, one popular device is to describe a stack of bills stretching into space. Ronald Reagan used that image -- a tower of $1,000 bills 67 miles high -- in 1981 to depict the national debt, which was headed toward $1 trillion. In a 1998 Brookings Institution report, Stephen Schwartz wrote that the total cost of nuclear weapons to that point equaled a stack of dollar bills stretching to the moon and nearly back.

But "people don't have much of a grasp of the distance from here to the moon," Prof. McCloskey points out. He suggests making numbers small, such as figuring costs per person.

Mr. Schwartz, editor of the Nonproliferation Review, admits to hesitating before using the stacking image. He decided to bring several bricks of dollar bills to a news conference about his report and recalls those went over well.

Robert Siegler, a Carnegie Mellon cognitive psychologist, calls the stack-in-space image "silly" and adds, "It doesn't provide any more intuition than people already had."

These days, Stephen Crockett, an online co-host at Democratic Talk Radio, keeps the actual heights of such stacks vague when he asks listeners to picture one million stacks of one million $1 bills, representing projected war costs of $1 trillion. That's because he recalls visiting the Bureau of Engraving and Printing when he was in high school and seeing stacks of bills -- not singles -- worth $1 million. "They were not that high," he confesses. (Using the bureau's formula, a stack contains about 233 new bills per inch.)

Other war critics note how much the budget for Iraq could buy in, say, port security or teachers' salaries. This line on war costs suggests that federal spending is a zero-sum game, meaning that money spent on the war could easily be substituted elsewhere in the budget.
That's not entirely the case, but then the purpose of such arguments is often more to advocate than to explain.

UCLA economist Lee Ohanian says the Iraq war is a "drop in the bucket," about 5%, of the federal budget, especially compared with World War II, which consumed at least 70% of federal expenditures from 1942-1945. The WWII figure, however, includes all defense spending for the period. "No matter what the number is, you need to put it in perspective," says Prof. Ohanian.
Numbers can have a powerful impact. Prof. Ranney says the real statistics behind controversial topics often surprise people -- and sometimes provoke them.

"By giving people numbers, you can change what they prefer," he says. "What can be more empowering than that?"

Credit Market Fall-Out #25 – The Rating Agencies

Based on articles in the WSJ ( #1, #2, and #3) earlier this week it appears that now that the Congress is back from vacation they plan to tackle the “mortgage mess”. Amongst a whole list of issues that will be tackled from predatory lending to efforts to save home owners from themselves Congress will be tackling rating agencies. The following is an excerpt from the Opinion Page of the WSJ written by someone from the S&P rating agency. Having graded loans when I worked at banks, I can say that the “political” pressure can be very intense. I am not sure how the rating agencies will do in the bright lights, but I am dying to see the alternative to the current system (if they come up with one).

The fallout over subprime mortgages has provoked a rush to judgment, and some are now blaming the credit-rating agencies for the recent market turbulence. These charges reflect both a misunderstanding of the work carried out by rating agencies, and a misrepresentation of the overall credit performance of securities backed by residential mortgages.

Much of the recent commentary has missed several critical facts. For example, our recent downgrades affected approximately 1% of the $565.3 billion in first-lien subprime residential mortgage-backed securities (RMBS) that Standard & Poor's rated between the fourth quarter of 2005 and the end of 2006. This represents only a small portion of the mortgage-backed securities market, which in turn represents a very small part of the world's credit markets. Additionally, our recent downgrades included no AAA-rated, first-lien subprime RMBS -- and 85% of the downgrades were rated BBB and below. In other words, the overwhelming majority of our ratings actions have been directed at the weakest-quality subprime securities.

The fundamental service provided by a rating agency such as S&P is to issue an independent opinion on the creditworthiness of securities, which speaks to the likelihood that investors will receive payments of interest and principal on time. Our ratings are based on the facts available to us at the time these opinions are made.

Ratings are designed to be stable. Unlike market prices, they do not fluctuate on the basis of market sentiment. But they can and do change -- either as a result of fundamental adjustments to the risk profile of a bond or the emergence of new information. Ratings are not recommendations to buy, sell or hold a particular security. They simply provide a tool for investors to assess risk and differentiate credit quality.

Rating agencies such as ours often are criticized for being paid by the issuers of the bonds we rate. Investors value this approach because it enables us to make our ratings widely available for free -- providing access to information that helps them make informed investment decisions. Today, investors and others can access, evaluate and even criticize the hundreds of thousands of ratings that we make publicly available each year. While rating agencies that use a subscription-only model do not typically make their ratings public, our approach promotes transparency of our criteria and our opinions.

Furthermore, this approach does not affect how we assign our ratings. Our criteria are publicly available, non-negotiable and consistently applied. In fact, we do not rate financial instruments that do not meet our criteria. Like newspapers and other media, we maintain a separation between the analytical and commercial activities associated with any given rating, to ensure the independence of our opinions. We also specifically structure our analysts' compensation so that it is not dependent upon the fees related to the ratings they assign.

Most important: Reputation and integrity are our most valuable long-term assets, which would make it imprudent for S&P to provide anything other than fair, objective and independent ratings opinions. A report published by two Federal Reserve Board economists in December 2003 recognized this, saying there was "no evidence" of rating agencies acting in the interests of issuers due to a conflict of interest.

Indeed, the report concluded that "rating agencies appear to be relatively responsive to reputation concerns and so protect the interests of investors." Numerous other studies have come to similar conclusions.

As part of the ratings process, we do engage in open dialogue with bond issuers. This dialogue helps issuers understand our ratings criteria and helps us understand the securities they are structuring, so we can make informed opinions about creditworthiness. We strive to make sure issuers and investors are fully aware of how we determine creditworthiness and believe that all parties are better served when the process is open and transparent.

Credit enhancement plays an important role in our ratings, helping to offset potential losses by providing a security with excess cash flow. To achieve an investment-grade rating, therefore, we require a security with a relatively weaker pool of collateral to have a higher level of credit enhancement than a security backed by a stronger collateral pool.

These are the basics of the rigorous process that we employ whenever we issue a rating -- regardless of the risk level and regardless of the type of investment vehicle. Indeed, in the RMBS market, our process involves an analysis of individual loans, a simulation of the cash flow generated by the deal, a review of both originator and servicer operational procedures, and a surveillance process that enables us to monitor performance.

Recently, there's been considerable attention devoted to so-called "piggyback" loans -- where a second loan is used to make the down payment on a home. We recognized an inherent risk in mortgage pools that were too heavily weighted with such loans as far back as 2001, and we announced at the time that any subprime pool in which piggybacks accounted for more than 20% of total loan value would face a ratings penalty.

We began to see evidence that conditions in the mortgage market were changing -- including looser lending practices, the slowing housing market and the deterioration of subprime credit performance -- and that some mortgage loans within RMBS might pose greater risk. As a result, we continued to review our ratings. In April 2006, S&P informed the market that it was raising the level of credit support required for riskier subprime deals and adjusting its surveillance standards for RMBS.

This evaluation continued, with a focus on whether high levels of mortgage payment defaults by borrowers in some loan categories might have been isolated events or indicative of market trends. When these default levels persisted, we provided the market with additional guidance highlighting our more negative outlook, and continued to take ratings actions including the downgrades of roughly 500 first-lien subprime RMBS since July 2007.

Should we have acted sooner?

For those who would say "yes," it is important to remember that unlike many others in the capital markets -- who can take action on the basis of speculation -- we base our opinions on documented facts. We are continually reviewing and refining our processes, and we make adjustments to our ratings when the facts demonstrate the need to make adjustments, and not a moment sooner. And while we always strive to move with all deliberate speed, our highest priorities are the thoroughness of our processes and the integrity of our ratings. Our actions in the subprime market have been fully consistent with these priorities.

A rising rate of mortgage defaults has been an unfortunate byproduct of the downturn in the housing market, and while they are painful for all involved, they do remind us of something elementary about capital markets: Risk can never be entirely removed from an investment. By offering products that feature a range of risk, issuers give investors the opportunity to achieve varying levels of return. Helping investors assess that risk is part of the value that rating agencies bring to the market.

More Talk About a Recession Amongst the Heavy Hitters

Excerpts below from an article in Market Watch, gives some opinions and perspective on a potential recession. Clearly when it many of the heavy hitters are increasing the chances for recessions.

With job growth upended, the housing market still sinking fast and credit problems mounting on Wall Street, a growing number of economists say the risks are growing that a recession will hit the U.S. economy in the next 12 months.

"I think the probability of recession is higher than it used to be," said St. Louis Fed President William Poole in a conversation with reporters in London on Thursday.

The majority of economists, however, say the economy will weather this storm, as it almost always does. It's hard to put the resilient U.S. economy into a recession, they say. Over the past 17 years, the economy has been in recession for just eight months. That's less than 4% of the time. (some interesting perspecitve)

The U.S. economy is extremely diverse. A slump in one sector or region can be offset by growth elsewhere. The economy is also less prone to recession than it used to be. As the economy has moved away from relying on cyclical industries, such as agriculture, mining and manufacturing, to more stable services, recessions have become less frequent and shallower.

The way economists see it, there's only about a 35% chance of a recession in the next year, according to the median estimate of 25 economists surveyed by MarketWatch this past week prior to Friday's employment report. That's up from about a 23% chance estimated by economists surveyed by the Blue Chip Economic Indicators in early July, but it's still well below 50%.

It may be comforting to know that the odds are still tilted against a recession, until you remember that the economics profession as a whole has never predicted a recession. One reason economists assign such a low probability to a recession is that they expect the Fed to act forcefully to prevent it, by lowering the federal funds rate.

The idea behind a Fed rate cut is that lower interest rates could prop up the housing market just enough to avoid a big increase in foreclosures and layoffs from construction companies. In the short run, lower rates could also boost liquidity and confidence in financial markets, which would also lead to more borrowing and spending.

But critics say the Fed's rate cuts can't produce a miracle.

The credit crunch on Wall Street reflects an unwillingness to lend because of a lack of trust, not a lack of funds. Until the markets get rid of the chaff, the price of credit isn't going to be that important.

So far, the Panic of 2007 isn't like your grandfather's recession. Credit Suisse economist Neal Soss calls it "new allergy to structured finance."

"You're not going to cure that with a cut in the federal funds rate," Soss said. (my emphasis)

The most prominent exponent of the "recession is coming" view is Martin Feldstein, one of the grand old lions of macroeconomics, who spoke to all the Federal Reserve policy-makers at the Jackson Hole retreat last weekend.

When Feldstein told them that the problems in housing "point to a potentially serious decline in aggregate demand and economic activity," you can bet they listened, even if they didn't fully agree.

Feldstein told the Fed officials that they should cut the federal funds target rate immediately by as much as a full percentage point, and even that wouldn't be guaranteed to work.

Economist Edward Leamer of UCLA told the same gathering that economic forecasters have systematically ignored the primary role of housing in the business cycle. Of the past 10 recessions, eight have been preceded by overinvestment and then a slump in housing, Leamer said.

Housing isn't just some fringe part of the economy, but a major driver of the business cycle, Leamer argued.

Feldstein says that the housing sector is at the root of three major concerns, any one of which could significantly slow economic growth.

First, he said, the drop in home prices has devastated the home-building sector, costing thousands of jobs and slicing output. The decline in residential investment has shaved about 1 percentage point off growth in each of the past two years.

Second, the collapse of the subprime-mortgage industry has spiraled into a wider credit squeeze, hurting the ability for companies outside of mortgage and housing businesses to obtain the credits they need to operate.

Third, consumer spending could be reduced significantly by the inability of homeowners to borrow against their home equity, closing off what has been a big source of disposable income for consumers.

There's not much disagreement about Feldstein's first point -- that home building has been a big drag on the economy. It's his other two points that are debatable.

So far, there's little evidence that the problems in the credit markets have had any impact on the ability of consumers or companies to get credit, outside of mortgages. But if the problems persist, the crunch could hurt the broader economy.

Bernanke agreed with Feldstein, up to a point.

In his speech at the Jackson Hole conference, the Fed chairman said that if the credit crunch didn't ease, then "the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally."

There's a big disagreement among economists about the role of mortgage-equity withdrawal in consumer spending over the past five years. Contrary to Feldstein's position, some don't believe it's had any impact at all. (my empahsis)

Investors will find out soon enough, because equity-takeout mortgages are now "officially dead," according to Alec Crawford, a market strategist in mortgage-backed securities for RBS Greenwich Capital.

What makes this episode different is that the inventory overhang isn't just in physical assets, such as houses, cars and widgets. It's also in complex financial instruments, which are so novel that no one really knows how to liquidate them.

"Lenders have been flushing assets into the financial system's plumbing like there is no tomorrow," said Anderson, the Wells Fargo economist. "But now that plumbing system is backing up, and if lenders and the Fed aren't careful, they will be left with a hell of a mess to clean up."

How a Recession is Defined?

Below is an excellent article from Market Watch defining a recession. It has been my experience that everyone wants to talk about recessions and depressions, but many people do not know how they are actually defined.

As investors and policy-makers puzzle over the threat of a recession, it's time once again to revisit how a recession is defined.

As a way to keep politics out of it, by convention, U.S. recessions are determined by a committee of academic economists who belong to the National Bureau of Economic Research, which, despite its official sounding name, has no link to the government.

Martin Feldstein is the president of the group. He and Ben Bernanke were on the business-cycle-dating committee that determined the beginning of the 2001 recession. Bernanke had left to join the Fed by the time the committee determined the end of the recession.

Many people have heard that a recession is marked by two consecutive quarters of negative growth, as measured by gross domestic product. That description is close, but not quite accurate.
The official definition comes from the NBER: "A recession is a significant decline in economic activity spread across the economy, lasting more than a few months." Or in the words of business cycle forecaster Lakshman Achuthan of the Economic Cycle Research Institute: A recession is a "pronounced, pervasive and prolonged" slowdown in the economy. Pronounced means deep, pervasive means wide and prolonged means long.

To measure economic activity, the NBER uses four monthly indicators: payroll growth, real income growth, industrial output and real business sales. (my emphasis)

Another common definition of a recession goes something like this: A recession is when you don't have a job; a depression is when I don't have one.

It's not surprising that the NBER uses employment as one of major business cycle indicators. Employment is a major sign of economic health. When jobs are plentiful, most families enjoy a rising standard of living. But when the unemployment rate rises, anxiety mounts even for those who retain their jobs.

The employment picture has worsened. Payrolls fell in August, the first decline in four years. Looking at the longer trend, payrolls are growing at the slowest pace in about three years, and the unemployment rate has risen to 4.6% in August from 4.4% in March. Even with the slowdown, payrolls are 1.2% higher over the past year, slightly slower growth than the 1.3% increase in the adult population.

Industrial production is the other major indicator NBER uses to gauge whether the economy is expanding or not.

The manufacturing sector, while not as large as it once was, is still attuned to the business cycle. Many companies or individuals won't buy long-lasting durable goods when they are unsure of the future.

But because of improved inventory techniques and productivity gains in manufacturing, the business cycle doesn't affect manufacturing nearly as much as it used to. In the 1975 recession, for example, industrial output fell 12.8% from peak to trough, while in the 2001 recession, output dropped just 6.3%.

In the past year, output has grown 1.4%, only half the growth rate seen as recently as February. Just like with employment, industrial production is growing, but at a much slower rate.

Economist Edward Leamer of UCLA argues that the U.S. will avoid a recession this time because there aren't enough superfluous workers left in the manufacturing sector to be laid off. Typically during a recession, manufacturing employment plunges, then recovers most of the loss. After the 2001 recession, however, manufacturing employment fell and never recovered.

Personal incomes are up 4.4% in the past year after adjusting for inflation, and have actually accelerated in recent months after dipping in the spring when gas prices sent inflation through the roof.

Incomes were decelerating sharply well ahead of the 1990 and 2001 recessions. The strong growth in incomes this year is one reason many economists believe consumer spending won't falter if even home prices continue to fall, and that will keep the economy out of recession.

Real business sales faltered earlier in the year, but have bounced back on strong sales at the wholesale and retail levels. Total sales are up 1.2% in the past year.