How to Spot an Economic Recovery

Home prices are still falling, but there have been positive glimmers. The volume of sales has started to rise, and housing starts have at least leveled off. But many economists still aren’t convinced. An increase in home sales volume sounds nice, but buried in the housing numbers is the fact that a huge chunk of the sales are in the “distressed” category, either foreclosures or short sales. As long as prices remain depressed, looking at home-sales data is like tracking sales at a pawn shop — even if they’re on the rise, that’s not necessarily a good sign.

Same with housing starts. Recently single-family permits (a basic measure of home construction) have been leveling out at about 350,000 a month. Some people have tried to interpret that as a good sign. But about 250,000 homes a month are actually presold custom houses, so a flattening a tad above that number is not a meaningful indicator of a rebound, says Diane Swonk, chief economist at Mesirow Financial in Chicago and a former president of the National Association of Business Economics.

So the most accurate thing to track is not sales or starts but prices. It’s the more reliable indicator of health in the real estate market — buyers willing to open their checkbooks and pay more for a home than it could have fetched a month or so earlier. The complication here is that prices move up or down by region, and they’re still very much linked to consumer confidence (see below), which can be fickle. “Mortgage rates are falling, but unemployment is still very high,” Swonk says. “I wouldn’t count on a lot of GM executives getting approved for home loans right now.”

But stabilizing home prices are key to resolving the credit situation — and by extension, to jump-starting the recovery — and here’s why: Right now banks that hold toxic mortgage-backed securities have no idea how much they’re worth. So they’re holding on to capital to make sure they’ll still be OK if it turns out these securities are worth very little. As long as home prices keep dropping, millions of people are at risk of foreclosure, or even merely remaining underwater on their mortgages, and all that mortgage-backed debt remains toxic.

But once home prices bottom out, the homeowners’ financial stability will be a little clearer, and all the mortgage-backed debt will have a bottom-line, worst-case scenario value. The problem doesn’t magically go away, but the uncertainty does. And then banks will start lending more freely again.

Most economists studying the credit market are focused on whether Secretary Treasury Geithner’s plan to remove bad loans from bank balance sheets through the Term Asset-Backed Securities Loan Facility, or TALF, will work. “What I’m looking for right away is for private money to be coming off the sidelines to get these assets off the books,” says Mark Thoma, who teaches economics at the University of Oregon and writes a popular blog on macroeconomic issues.

The first round drew a handful of investors, who received about $5 billion in government financing, but Thoma says that number may not be an accurate gauge of interest, as the Treasury Department likely lined up those investors in advance. So the true test is how the program does over the next few months.

The program released the second round of funds in mid-April, and the results were underwhelming. The Federal Reserve paid out a total of just $1.7 billion, well below expectations, and it only covered securities in two categories — auto loans and credit-card debt. So there’s a lot of bad debt still hanging around on bank balance sheets. Experts say that a major reason why the program has not gained more speed is that investors are hesitant to partner with the government in a situation where the rules of a deal might change quickly.

The next round closes in early May, and the best-case scenario is that more investors are tempted to sponge up some of the toxic debt, ideally in all categories, including small-business loans. And at some point in the future, the government will start including mortgage-backed securities, the most problematic debt. If the Treasury Department can help banks offload that debt, that will be a huge boon to the credit markets.

Unemployment is the metric that feels the most real to people, but unfortunately it’s the one that takes the longest to rebound. The classic recovery pattern is that companies start selling more goods, and only after they’re convinced that there’s legitimate, growing demand for their products do they start to hire more workers. But by then, the recovery will be in full swing, since those newly employed workers start to spend money, reinforcing the whole virtuous cycle.

For that reason, the actual unemployment numbers are more of a confirmation than an indication. By the time they register as good news, you’ll probably already know the recovery’s here. So if you want a leading indicator, try consumer confidence numbers, which try to measure the degree of optimism consumers have about the economy and their finances. So much of the economy hinges on the psychology of people — what John Maynard Keynes called “animal spirits” — that how consumers feel is considered a decent sign of what they’ll do with their money. If they reopen their wallets, demand for goods will rise, and companies will start hiring workers again.

The University of Michigan puts out one number, called the Consumer Sentiment Index, which includes surveys with 500 families. But a more representative sample based on a 5,000-family survey comes from the Conference Board, which publishes a monthly report summarizing its Consumer Confidence Index. That number currently stands at about 26. (For comparison, it was at 100 back in the summer of 2007.)

One catch: consumer-confidence indices are extremely subjective — they summarize how people say they’re feeling, rather than tracking actual expenditures. Because of that, the data is a little squishy, and many economists prefer to look at longer-term trends in the indices (meaning three months or so), rather than individual reports.

Realize that the economy is incredibly complex and there won’t be any easy fixes — the current recession has been building for a long time — but these three numbers should give you a decent idea of when the pain might ease up.