October 8, 2010 William R. Emmons Adjunct Professor of Finance Washington University in St. Louis & Assistant Vice President and Economist Federal Reserve Bank of St. Louis The Economic and Financial Outlook for Arkansas and the Nation Arkansas College Teachers of Economics and Business 1

The Economic and Financial Outlook for Arkansas and the Nation  The economic recovery continues, but is at risk in Arkansas and the Nation  Short-term indicators of a slowdown  Co-incident (real-time) economic indicators have been slowing nationwide since May, and since July in Arkansas  Leading (forecast) indicators suggest growth could slow significantly as we move into 2011  Impediments to recovery  Recoveries after financial crises are especially difficult  Banks and households must repair balance sheets  Limits to government support  Real-estate markets remain deeply troubled 2

 These comments do not necessarily reflect the views of the Federal Reserve Bank of St. Louis or of the Federal Reserve System. Important Reminder 3

US Index of Leading Indicators Signals Continuing Growth, Albeit Slowing 4 Indexes equal 100 in 2000 NBER recession periods indicated by gray shading Monthly through August 2010 US lndex of Leading Indicators US lndex of Co-incident Indicators  Manufacturing hours  Unemployment claims  Orders for consumer goods  Delivery speeds  Nondefense capital goods  Building permits  Stock prices  Money supply  Term spread  Consumer expectations  Nonfarm payrolls  Personal incomes less transfer payments  Industrial production  Manufacturing and trade sales

The US Economic Outlook Deteriorated In Spring 5 Percent change from two months ago NBER recession periods indicated by gray shading Monthly through August 2010 Apr. May Aug. Jun. July

US Growth Forecasts Have Been Revised Downward Since Summer 6 Percent change from year ago July 2010 FOMC projections Sept Macro Advisors forecasts

Unemployment Forecasts Have Been Revised Upward Since Summer 7 Percent of labor force July 2010 FOMC projections Sept Macro Advisors forecasts

Falling Long-Term Bond Yields May Signal Slower Growth Ahead 8 Oct. 6, yr. 2.40% 3-mo. 0.11% NBER recession periods indicated by gray shading Percent

 The Philadelphia Fed publishes monthly forecasts of six-month growth rates in overall economic conditions for all 50 states  Statistical model designed to predict growth in each Philly Fed “State Co-Incident Index”, comprising:  Nonfarm payroll employment  Average hours worked in manufacturing  Unemployment rate  Wage and salary disbursements adjusted for inflation  Latest forecasts are for the Aug Feb six- month period  Nationwide forecast is +0.64% (not annualized), down from +2.06% just three months ago  Growth in Arkansas during the next six months is projected at -0.12%, down from 2.03% two months ago Leading Indicators Point To Slowing Growth In Arkansas and Surrounding States 9

Economic Conditions Vary Widely 10 Continuing recession through early 2011 Strong growth through early 2011 Moderate growth Moderate declines everywhere else Moderate growth Moderate declines everywhere else

11 AR Source: Federal Reserve Bank of Philadelphia Monthly through August 2010 Index levels equal 100 at peak during 2007 US NBER recession periods indicated by gray shading Arkansas Economy Contracted In August, Following US Slowdown By 2 Months

12 AR Source: Bureau of Labor Statistics Monthly through August 2010 Index levels equal 100 at average level during 2007 Little Rock NBER recession periods indicated by gray shading Arkansas Statewide Employment Declined Sharply in August NW AR Pine Bluff

AR, MO, TN, and LA Expected To Decline; MS, OK, and TX Still Growing 13 AR TN MO MS TX LA OK Source: Federal Reserve Bank of Philadelphia Monthly through August 2010 Percent Forecast Of Change in Economic Activity During Next Six Months (Percent)

14 AR MO TX Source: Bureau of Labor Statistics Monthly through August 2010 Percent OK NBER recession periods indicated by gray shading Arkansas Unemployment Remains Below US Average and Most Neighboring States

15 MS TN Source: Bureau of Labor Statistics Monthly through August 2010 Percent LA NBER recession periods indicated by gray shading AR

Arkansas Economic-Recovery Prospects Have Dimmed 16 Forecasted six-month growth of economic activity in Arkansas ending this month Source: Federal Reserve Bank of Philadelphia Monthly through July (forecasts), Aug (actual) Actual Growth Of Economic Activity During Previous Six Months Vs. Forecasted Growth Actual six-month growth of economic activity in Arkansas ending this month Percent

Impediments to Recovery: The Aftermath of Financial Crises 17

 35-percent decline in house prices over 6 years  Our experience so far: -31%  55-percent decline in stock prices over 3.5 years  Our experience so far: -56%  7-percentage-point increase in unemployment rate over 5 years  Our experience so far: +5%  9-percent decline in real per-capita income over 2 years  Our experience so far: -8% (excluding taxes & transfers)  86-percent increase in government debt over 3 years  Our experience so far: +100% Reinhart & Rogoff-Based Predictions Based on Historical Crisis Experiences 18

Arkansas Has Avoided the Worst of the Financial-Crisis-Related Fallout 19 Index equals 100 at average level in 2007 Quarterly through Q AR house-price index for conventional-conforming mortgages only US house-price index for conventional-conforming mortgages only

Meltdown of the Household Sector: $17-Trillion Net-Worth Decline 20 $65.8 trillion $48.8 trillion - $17 trillion, or 1.5 years of Q disposable household income - 26% Index values

Leverage Magnified Loss of Home- owners‘ Equity As House Prices Fell 21 Market value of owner- occupied housing Billions of dollars Home-mortgage debt outstanding Source: Federal Reserve BoardQuarterly through Q Homeowners’ equity: All homeowners (about 75 mn.) Q $13.5 trillion Q $5.9 trillion

22 Market value of mortgaged owner- occupied housing Billions of dollars Home-mortgage debt outstanding Source: Federal Reserve BoardQuarterly through Q Homeowners’ equity of homeowners with mortgage debt (about 50 mn.) Q $5.9 trillion Q $0.5 trillion 50 Million Households With Mortgage Debt Lost 92% of Equity

23 How Leverage Magnifies the Effect of Falling House Prices on Homeowners’ Equity Changes between Q and Q All owner-occupied houses: About 75 million households Mortgaged homeowners only: About 50 million households (estimated) Percent change in market value of owner- occupied houses -27% Percent change in homeowners’ equity -56%-92%

Negative Homeowners’ Equity Is Much Less Common in Arkansas Than Elsewhere 24 Little Rock Tulsa St. Louis Memphis Percent Quarterly through Q2.2010

Millions Source: Mortgage Bankers Association; Annual data through 2009, adjusted for MBA’s 80% coverage mn mn mn mn. M ortgages that were delinquent or in foreclosure at June 30, 2010: 8 mn. Millions of US Homeowners Already Have Lost Their Houses; Millions More Will Foreclosure starts 2006: 1.0 million 2007: 1.6 million 2008: 2.4 million 2009: 3.0 million Total: 8.0 million Number of households with mortgages in 2006: 54 million

The Foreclosure Pipeline Continues To Fill 26 Source: Mortgage Bankers Association Quarterly through Q2.2010

Arkansas Mortgage-Delinquency Rates Following US Rate Higher 27 Source: Mortgage Bankers Association. Annual through 2009 Periods of NBER recession indicated by vertical gray bars AR US Percent

Home-Mortgage Debt Is Contracting, Making Housing Recovery More Difficult 28 Billions of dollars NBER recession periods indicated by gray shading Quarterly through Q2.2010

In Sum: The Outlook for Arkansas and the Nation Is Challenging  The economic recovery continues, but is at risk in Arkansas and the Nation  Short-term indicators signal a significant slowdown since Spring  Impediments to recovery include  The aftermath of a serious financial crisis  Severely troubled real-estate markets 29