HAWAII ECONOMIC TRENDS

June 30, 2009

prepared by
Paul H. Brewbaker, Senior Economic Advisor
Bank of Hawaii

https://www.boh.com/econ/512_539.asp
 Economic Summary
June 30, 2009

• From the economic freefall that was underway in Hawaii during fourth quarter 2008 a transition to
emerging stabilization began to appear in second quarter 2009. As a reminder that progress towards
economic recovery will be uneven, the biological surprise of the H1N1-A influenza pandemic late in
April 2009 added new economic uncertainty to Hawaii’s economic outlook. Historically, biological
events such as the SARS episode in 2003, which set back international travel to Hawaii almost as much as
the 9/11 event, have had the potential to undermine the economic forecast. Coming just as this report was
to be published in early-May, the H1N1 pandemic required a tourism forecast recalibration. At least one
published Hawaii economic forecast had to be revised in the wake of H1N1; this report takes into account
about two months of daily international passenger arrivals data from late-April through late-June to take a
first stab at a tourism forecast revision.

• The dominance of tourism in Hawaii’s changing fortunes during the last four quarters was not just the
consequence of tourism’s importance as the island economy’s principal export, comprising 15-20 percent
of Hawaii value-added. Tourist volumes were moving more than anything else in Hawaii’s economy
(except petroleum prices) for the last five quarters. Unlike the early-1990s, when domestic air lift to
Hawaii was gradually reduced by roughly one-quarter, the shutdown of Aloha Airlines and ATA in
March/April 2008 instantaneously reduced capacity by nearly one-fifth. Rising oil prices and consumer
retrenchment meant that this lift was not replaced, and the April 2008 tourism forecast—which
anticipated a “9/11-like” impact—proved to be premature: the sharp initial drop in April’s forecast for
tourist volume more than doubled by the time of the November 2008 forecast revision.

• The sharper “9/11-type” decline in 2008 travel to Hawaii means that the tourism recovery extends to
several more years than previously envisioned in the April 2008 forecast. Airline shutdowns, consumer
recession, and the post-Lehman Brothers financial panic all contributed. In the end, 2008 Hawaii visitor
arrivals (by air) declined 12.2 percent on the domestic side, and 6.1 percent on the international side. In
first quarter 2009 domestic and international arrivals were down 17.7 percent and 5.2 percent,
respectively.

• Second quarter 2009 Hawaii tourism performance entered the window “one-year-since” the Aloha/ATA
shutdowns occurred in spring 2008. From this point forward, comparisons to one year earlier will exhibit
more muted losses; domestic arrivals changed −3.6 percent in April and −2.2 percent in May 2009, year-
over-year, and turned upward in summer. Official data are not seasonally-adjusted but, in fact, the trend
for seasonally-adjusted domestic arrivals since late-summer 2008 actually has been flat to up slightly.
This rising pattern continued in spring 2009.

Hawaii daily international passenger arrivals growth, April 2009 through June 26, 2009
(percent change, year-over-year, from comparable days of the week one year earlier; the H1N1-A influenza virus
gradually emerged, eventually to global pandemic status, beginning in the final weeks of April 2009)

40%

20%

0%

-20%

-40%
4/1/09 5/2/09 6/2/09

2 Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009)

 Bank of Hawaii semi-annual Business Confi- University of Michigan Index of U.S. consumer
dence Survey results: diffusion index sentiment
(positive sentiment above zero; neutral equals zero) (monthly, first quarter 1966 = 100)

100 120

110

50 100

90
0
80

70
-50
60

-100 NBER recessions shaded 50 NBER recessions shaded

1990 1995 2000 2005 2010 90 95 00 05 10

• International travel experienced a sudden but temporary drop after the collapse of Lehman Brothers in
September 2008, but by year-end was rebounding on a seasonally-adjusted basis. Stabilization was
beginning to appear in seasonally-adjusted data until the H1N1 virus appeared. Now, after eight to ten
weeks of daily international arrivals data (graph at bottom of page 2) it seems as if the H1N1 pandemic is
not having as dramatic an impact as did SARS six years ago. Thankfully, the widespread incidence of
this viral pandemic does not appear to have been matched by its severity. The new tourism forecast in
this report anticipates shrinking losses in international travel (reported on page 4).

• Just as the transition through economic stabilization in mid-2009 to economic recovery at year end is
forecast for annualized U.S. real GDP growth, the transition from negative to positive year-over-year
growth began in domestic passenger arrivals in May and most of June 2009. The long, slow tourism
recovery will be damped by challenges on the international side. Consensus Hawaii tourism forecasts
anticipate improvement from −12 percent domestic arrivals growth through May 2009. Second half gains
should be sufficient for domestic annual arrivals growth of −3 percent; gains will extend into 2010.
Views are less uniform regarding the international arrivals forecast, but modest cumulative losses of 6 to
9 percent in international arrivals from now trough end-2010 are expected.

• The 2008-2009 recession continued to play out in Hawaii economic data through mid-year. Hawaii
unemployment through the end of second quarter 2009 hovered at a seasonally-adjusted 7.4 percent of the
labor force, about two percentage points below the national average, and about a percentage point below
the forecasts for Hawaii in 2010 included in this report. Private job loss this cycle was particular sharp,
worse than in past downturns, although the annualized growth rate of seasonally-adjusted payroll
employment did decelerate from −3.35 percent in December 2008 to −2.91 percent through May 2009.
Public sector workforce reduction is expected to extend economy-wide job loss through year-end 2009 in
Hawaii, which will likely see continued employment erosion even after the recovery has begun.

• Sentiment probably began to shift from negative to neutral in second quarter 2009, based on surveys and
the revival of investor interest in global equity markets earlier in the spring. Economic forecasts between
second quarter 2009 and first quarter 2009 were not revised very much, also marking a widening
perception of stabilization when compared to downward forecast revisions late in 2008. Recovery can
only come after the economic declines have ended—though lagging indicators (employment,
foreclosures, bankruptcies) will remain fodder for pessimism. Just as Hawaii went into the downturn in
step with the U.S. mainland, so is it likely that economic recovery by end-2009 will push through in 2010
and beyond, both in the islands as well as nationwide.

Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009) 3

 Comparative Hawaii economy 2009-2010 forecasts
June 30, 2009

Annual Jobs Personal Income CPI

percent (real) Honolulu
changes 1 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010

Brewbaker 2 2.5 1.9 -0.4 -2.9 -1.3 0.9 1.8 -0.3 -2.5 -1.1 4.6 4.6 4.6 -0.2 1.2
3
UHERO 2.6 2.1 0.0 -2.9 -0.6 1.1 1.6 -0.2 -2.7 -0.6 5.1 5.0 4.5 0.5 0.3
4
DBEDT 1.9 0.0 -2.1 0.0 1.8 -0.2 -1.1 0.0 4.5 4.2 1.2 1.5
6
Laney 2.5 2.0 -0.3 -1.2 2.0 1.0 -1.0 -1.5 5.0 5.0 5.0 3.5
Actual(p) 2.6 1.3 -0.9 1.4 1.0 0.2 5.9 4.8 4.3

Total Domestic International

Annual Visitor (UHERO: US) (UHERO: Japan)
percent Arrivals by air Arrivals by air Arrivals by air
changes 1 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010

2
Brewbaker -0.5 -1.6 -10.6 -3.1 3.7 1.7 -0.1 -12.6 -2.7 5.7 -5.9 -5.3 -4.7 -4.4 -1.8
3
UHERO 0.4 -1.1 -10.8 -6.8 3.1 2.4 -0.8 -14.2 -3.2 1.7 -8.6 -3.4 -9.8 -13.8 5.7
4
DBEDT -0.8 -10.1 -5.9 1.2
6
Laney 0.5 -0.5 -9.0 -5.0
Actual(p) 0.6 -1.2 -10.6 3.3 0.0 -12.2 -4.8 -4.7 -6.1

Total
Annual Visitor Unemployment rate Construction5
percent Expenditures (UHERO ; see footnote) (UHERO ; see footnote)
changes 1 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010

Brewbaker 2 4.0 7.9 8.4 8.9 -1.2 0.2 -11.2 -15.5

3
UHERO 2.7 2.5 3.9 7.4 8.1 -3.7 -19.4 -10.3
DBEDT 4 2.0 -6.4 -7.9 5.2
6
Laney 2.8 2.5 4.2 5.5
Actual(p) 4.0 2.6 -11.4 2.5 2.7 12.6 11.7 5.8

Notes:
1
2006-2008 "forecasts" are taken from last published forecasts prior to end of each year
2
Paul Brewbaker (TZ Economics), Senior Economic Advisor, Bank of Hawaii (https://www.boh.com/econ/512_803.asp); construction forecasts are unpublished, as
prepared for Hawaii Council on Revenues
3
Professors Carl Bonham and Byron Gangnes (University of Hawaii Economic Research Organization), "UHERO Hawai'i Quarterly Forecast Update:
State Budget Crisis Threatens Recovery," (June 12, 2009) (http://www.uhero.hawaii.edu/eis/eis_forecastarchive.html)
4
Hawaii DBEDT, "Outlook for the Economy: 2nd Quarter 2009," (May 18, 2009) (DBEDT visitor estimates include cruise ship arrivals)
http://hawaii.gov/dbedt/info/economic/data_reports/info/economic/data_reports/qser/outlook-economy
5
Carl Bonham (UHERO) and Paul Brewbaker, "UHERO Hawai'i Construction Forecast: Global Downturn Hammers Construction" (March 6, 2009)
(http://www.uhero.hawaii.edu/eis/eis_forecastarchive.html)
6
Professor Leroy Laney, Hawaii Pacific University (https://www.fhb.com/hm_econ.htm)

Data were compiled by TZ Economics but users are encouraged to refer to orginal sources for updated information.

4 Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009)

 Hawaii Economic Indicators
Seasonally-adjusted, real data
(home prices nominal)
2006:3 2006:4 2007:1 2007:2 2007:3 2007:4 2008:1 2008:2 2008:3 2008:4 2009:1
Real personal income billion 2008$ 51.992 52.065 52.345 52.547 52.468 52.483 52.362 52.784 52.222 51.810 52.210
Growth rate % y-o-y 2.0 1.0 1.2 0.8 0.9 0.8 0.0 0.5 -0.5 -1.3 -0.3
Honolulu CPI inflation* % y-o-y 5.84 5.83 5.24 4.95 4.82 4.75 4.9 4.9 4.0 3.6 2.1*

Civilian labor force thousands 644.62 647.46 648.04 645.13 644.18 646.44 651.23 655.03 655.71 655.05 647.07
Civilians employed thousands 628.93 633.00 632.08 629.52 626.57 627.42 631.43 632.25 627.87 622.18 603.94
Civilian unemployment rate percent 2.5 2.2 2.4 2.5 2.7 3.0 3.0 3.5 4.1 5.2 6.9
Total wage and salary jobs thousands 626.96 628.43 630.06 630.70 631.98 632.93 633.39 628.00 622.20 617.97 613.70
pre-benchmarked jobs thousands 624.69 629.34 632.18 634.31 636.15 638.11
Nonagricultural jobs thousands 619.96 621.50 623.31 624.12 625.59 626.54 627.02 621.70 616.104 612.122 607.956

Private building permits million 2008$ 976.3 1002.0 814.5 930.2 819.7 839.3 859.7 909.2 659.3 444.4 681.5
Residential million 2008$ 443.9 411.6 435.6 557.6 398.1 357.9 385.9 439.0 350.6 174.9 326.0
Commercial and industrial million 2008$ 165.8 259.8 97.6 195.9 113.1 232.4 167.8 139.7 109.9 40.4 75.2
Additions and alterations million 2008$ 363.6 331.5 245.5 180.3 318.6 233.7 275.0 369.1 206.2 235.5 226.6
Government contracts million 2008$ 156.6 238.1 157.7 327.5 184.9 160.8 180.1 140.8 269.5 384.7 169.6

Oahu home sales units 2,431 2,373 2,500 2,453 2,157 2,031 1,913 1,715 1,604 1,457 1,124
Single family: Honolulu units 984 964 1,000 979 881 776 776 697 652 629 505
Condominium: Honolulu units 1,447 1,409 1,500 1,474 1,276 1,256 1,137 1,018 951 828 620
SF median price: Honolulu thousand $ 627.7 627.7 633.4 650.0 642.9 634.0 633.1 621.0 608.7 618.7 581.9
Condo median price: HNL thousand $ 317.2 313.5 321.9 325.0 327.6 323.8 331.4 327.1 319.7 319.5 300.9

Visitor arrivals thousand 1,887.3 1,881.3 1,833.3 1,908.7 1,904.3 1,845.5 1,830.2 1,734.7 1,589.8 1,551.5 1,561.8
Domestic arrivals thousand 1,409.9 1,403.1 1,351.6 1,433.5 1,412.2 1,380.1 1,367.9 1,261.1 1,139.7 1137.2 1124.2
International arrivals thousand 477.4 478.1 481.7 475.1 492.1 465.3 462.3 473.6 450.2 414.3 437.5
Hotel occupancy percent 79.3 78.1 74.1 74.6 75.7 75.8 75.2 71.4 68.0 66.9 66.0
Average daily room rate 2007$ 197.51 196.16 198.59 200.26 200.07 200.74 201.83 192.68 189.20 185.34 171.18
*interpolation; 2009:1 forecast

Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009)

5
Dimensions of the Great Recession
Not as severe as the Great Depression of the 1930s, the
U.S. recession that started at the end of 2007 has proven
to be more severe than almost every other one since then.
Late in November 2008 the National Bureau of Economic
Research (NBER) confirmed December 2007 as the peak
of the last U.S. economic expansion. Shortly before that, in
September 2008, a financial panic ensuing from the
collapse of Lehman Brothers precipitated a more intense
phase of the recession, until then more moderate in many
dimensions. Hawaii data illlustrate much of what happened
pre- and post-Lehman. The slowdown in Hawaii’s eco-
nomic expansion had emerged some years earlier. Sales
of existing homes peaked at the end of 2004, in seasonally-
adjusted terms. Homebuilding peaked in 2005, and
constant-dollar total visitor expenditure also peaked that
year. The subsequent erosion in residential investment
and in real tourism receipts during 2006 and 2007 began a
process that ultimately dragged Hawaii into recession after
the financial crisis began in August 2007 and intensified in
September 2008. Accompanied by loss of lift following the
shutdown of Aloha Airlines and ATA in the spring of 2008,
the tourism contraction deepened. The corresponding
downward trend in Hawaii real retail sales in 2006 and
2007 steepened sharply in fourth quarter 2008 after the
post-Lehman financial panic (see graph below). Hawaii’s
recession was exacerbated in mid-2008 by the rise in
global petroleum prices that peaked that summer, but
subsequent declines also eased somewhat those pres-
sures on Hawaii’s highly-petroleum dependent economy.
The commodity price rebound that has raised oil prices to
about half year-earlier levels in 2009 is a complcation for
the stabilization that is starting to show sustainability in
domestic tourism (facing page). The starting date picked
by the NBER for the current recession corresponds with the
start of job loss in Hawaii, which proceeded throughout
most of 2008 and into 2009.

Hawaii real visitor expenditure Hawaii real retail sales

(annual, billion 2008 dollars ) (quarterly, billion 2008 dollars at annual rates, s.a.)

16 32

15 30

14 28

13 26

12 Gulf 24
9/11
2008 2008Q4
11 22
NBER recessions shaded

Jul90 Mar91 Mar01 Nov01 Dec07

10 20
85 90 95 00 05 10 98 00 02 04 06 08 10

Crude petroleum prices Hawaii payroll employment

(monthly, U.S. dollars per barrel) (monthly, thousands, seasonally-adjusted)

160 640

630

80 620

610

40 600

590
NBER recessions shaded NBER recession shaded
20 580
00 01 02 03 04 05 06 07 08 09 2004 2005 2006 2007 2008 2009

6 Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009)

Tourism recovery interrupted by H1N1-A virus Monthly domestic visitor arrivals
Despite some weakness in March 2009--an unseasonably (thousands, seasonally-adjusted, log scale)
low volume of “Spring Break” domestic travel to Hawaii 600
NBER recession shaded Passengers
following two recent years with early Easters (2005; 2008)-- Visitors
domestic tourism had already begun to establish recession 550
lows when the collapse of Lehman Brother was occurring
back in September 2009. To be sure, it would have been
hard for the average person to know what was going on. 500
June*
Monthly visitor arrivals are not seasonally-adjusted in the
official statistics, nor was the stabilization in seasonally-
adjusted domestic arrivals even clear until well into the 450
winter of 2009. At the very moment in March 2009 that
stock prices reached their low after the peak of October May
2007, Hawaii domestic visitor arrivals were dropping out of 400
the seasonally-adjusted plateau to which numbers had Aloha Airlines/
ATA shut down Jul
settled in the July 2008-February 2009 period, with the
Sep
notable exception of September 2008. As April and May March
350
2009 domestic visitor counts confirmed, however, season-
2004 2005 2006 2007 2008 2009
ally-adjusted domestic volumes have been bouncing along
a flat and volatile trajectory since second quarter 2008. *based on daily data through June 25, 2009
Importantly, they are not declining. In the international
segment, things are more complicated. As this report
Monthly international visitor arrivals
originally would have “gone to press” at the end of April
(thousands, seasonally-adjusted, log scale)
2009, the global H1N1-A viral pandemic emerged, casting
doubt on fresh tourism forecast revisions. Now, with two 190
months’ daily data on international passenger arrivals 180
available, a “mini-SARS” pattern is emerging. International
170
arrivals, after recovering from the Lehman event, are now
falling because of this new biological event. The decrease 160
appears to be less profound than SARS in 2003, but
meaningful quantitatively. The hotel industry, which 150
cannibalized its own utilization rate by raising hotel room
rates more than 25 percent before the recession, has now 140
been further unsettled by a small increase in the transient Lehman
accommodation tax rate intended to help fill the State’s 130
balanced-budget gap. Deep discounting has yet to H1N1*
stabilize hotel occupancy, although arrivals may finally have 120
SARS
found a bottom.
110
03 04 05 06 07 08 09
Hawaii real hotel performance indicators *includes June estimate based on daily passenger arrivals
(quarterly, percent of capacity (right scale), 2008$ per data through June 25, 2009
night (left scale), all seasonally-adjusted)

Occupancy (right) 85
Domestic and international visitor arrivals back
Real room rate (left) to the late-1990s
80
(thousands, seasonally-adjusted, log scales)
75 500
NBER recessions shaded
450
70
210
400
200 65
190 350
60
300
180 300
Domestic (right scale)
250 9/11
170 International (left)
200 Asian 250
160
NBER recessions shaded crisis Y2K
150 150
96 98 00 02 04 06 08
Lehman
H1N1*
SARS
Data sources: Hawaii DBEDT for visitor counts (not seasonally- 100
adjusted); hotel data from UHERO, as produced by Hospitality 96 98 00 02 04 06 08 10
Advisors LLC; all seasonal adjustment and deflation by TZE

Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009) 7

No lags this time
Historically it has not been uncommon for Hawaii macro- U.S. and Hawaii unemployment rates: cyclical
economic performance, by a variety of aggregate indica- movement aligned in the current recession
tors’ experiences, to lag the mainland by months or (percent of labor force through May 2009)
quarters, and even years. During the S&L mortgage
9
lending crisis of the 1980s, and the ensuing formation of
the Resolution Trust Corporation (RTC), the cyclical trough U.S.
8
in homebuilding nationwide coincided with the peak of the Hawaii
“Japan bubble” in Hawaii’s housing cycle around 1990.
(Graph below; in the aggregate, statewide homebuilding 7
peaked in Hawaii in 1990, but earlier on the neighbor
islands than on Oahu.) The peak of the residential 6
investment cycle coincided, this time, in the year 2005.
Similarly, Hawaii’s unemployment rate moved widely “out of 5 9/11
synch” with the national average during the early-1990s
recession. While U.S. unemployment rates began rising 4
almost immediately at the time of Iraq’s invasion of Kuwait
3
NBER recessions shaded
2
U.S. and Hawaii residential construction cycles:
90 92 94 96 98 00 02 04 06 08
peaks aligned in the current recession
(U.S. in million housing starts at annual rates, right scale;
Hawaii in units authorized by building permit, left scale; both
scales logarithmic) and the commencement of Operation Desert Shield in mid-
1990, Hawaii’s unemployment rate was actually at its
U.S. starts (right scale) cyclical low point in the middle of Operation Desert Storm
Oahu units (left scale) 3.2
during winter 1991. Hawaii unemployment peaked years
Neighbor islands (left)
after U.S. unemployment peaked in 1992. (Hawaii unem-
1.6 ployment rates did not even rise during the “dot.com”
recession of 2001 except for the increase associated with
the 9/11 event in September 2001.) In the 2008-09
0.8 recession, however, not only have unemployment rate
movements been highly synchronized between Hawaii and
1000 the mainland, home price movements that were a precur-
0.4 sor to the broader economic downturn were equally
synchronous around their peak in early-2006. As recently
as the 1990s, home price movements had been highly
unsynchronized between Hawaii and the mainland, with
Hawaii lagging by years.
NBER recessions shaded
100
75 80 85 90 95 00 05 10
Comparison of median home price movements
and Case-Shiller index movement
Median single-family home prices (thousand dollars, s.a., and
2000Q1 = 100; log scale)
Peak:
(thousand dollars, s.a., log scale)
Synchronous
800
240
NBER
recessions
Orange Co., CA shaded
200
Maui Oahu
Oahu Maui
160
Peak:
400 Case-Shiller
Synchronous
Oahu
120 Oahu (median)
Maui Maui (median)
S&P Case
C Shiller 20
Troughs:
O.C.
Asynchronous
200
96 98 00 02 04 06 08 00 01 02 03 04 05 06 07 08 09

8 Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009)

Hawaii’s low mortgage risk experience
As has been true historically, but is especially distinctive in
the current recession, Hawaii’s low mortgage delinquency
rates set apart its economic performance from the national
average. Broadly defined as 30 days or more past due,
Hawaii’s mortgage delinquency rate is in the lowest quintile
nationwide. Hawaii’s four counties ranks among the lowest
nationwide as well in terms of serious delinquency, defined
as 90days or more past due. Notably, these data include
all residential mortgages with Hawaii collateral including
those properties held by offshore investors. In many
cases, particularly in Neighbor Island resort communities,
the latter comprise second-home purchases by mainland
investors enabled by the same slackening of underwriting
requirements that contributed to mortgage lending prob-
lems and the financial crisis generally. Correlated default
risk, exacerbated by the simultaneity of the increase in
mortgage delinquencies nationwide, contributed to the
depreciation of mortgage-based CDOs (collateralized debt
obligation) and related derivates such as credit default
swaps (CDS) that precipitated the liquidity crisis.

Mortgage delinquency rates by state at end-2008 (30 days or more past due)
Ranked by delinquency rate

Mortgage delinquency rates 1 Mississippi 13.11

continue to run lower in Hawaii 2 Nevada 11.12
than elsewhere, serious 3 Florida 11.09
delinquency (90+ days) on Oahu 4 Michigan 11.08
is 1.6% compared to 12% in 5 Georgia 10.73
Dade Co. FL, 10% in Riverside
6 Indiana 10.59
Co. CA, and 8% in Clark Co. NV.
7 Louisiana 10.13
8 Tennessee 9.92
9 Alabama 9.69
10 Ohio 9.49
11 Arizona 9.46
12 West Virginia 9.40
13 California 9.13
Hawaii 5.29% (90+ days 1.75%) 14 Texas 9.01
15 Rhode Island 8.75

0 2 4 6 8 10 12
Percent 30 days or more past due
Source: Mortgage Bankers Association

Mortgage delinquency rates by county at end-2008 (90 days or more past due)
Darker shading indicates higher delinquency rate

Selected Counties:
(percent of loans)
_________________

Dade, FL 12.26
Merced, CA 10.57
Clark, NV 8.24
Maui, HI 3.15
Hawaii, HI 3.08
Honolulu, HI 1.64
_________________

Resilient Oahu home

prices reflect
underlying economic
fundamentals, not
imminent collapse

Source: Federal Reserve Bank of New York (image not geographically accurate)

Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009) 9

Real Estate still receding
Total sales of existing single-family homes and condomini- Oahu sales of existing homes
ums in Hawaii have declined from an annual pace around (Monthly units at annual rates, seasonally adjusted,
21,000 statewide at the peak of the last cycle in 2005 to an logarithmic scales)
annualized pace around 10,000 trades in the first several
800
months of 2009. Low interest rates during winter 2009
helped surge a huge wave of refinancings as a deliberate
outcome of Federal Reserve policy of “credit easing” or Condominium
“quantitiative easing.” This was an explicit strategy of
extraordinary purchases of long-dated U.S. Treasury
Lehman
securities designed to maintain low interest rates, com- 400
bined with outright purchases of mortgage-backed
securities and agency debt designed to reduce the risk
premium in mortgage financing costs. By enabling large
numbers of households to reset the terms of their mort- Single-family
gage liabilities, the hope was to help partially ofset much of
the wealth loss associated with falling stock and housing 200
prices by reducing debt burdens. Higher bank mortgage
underwriting standards may have limited somewhat the NBER recession shaded
efficacy of this strategy. At the same time, sales volumes
2005 2006 2007 2008 2009
in Hawaii--a “non-recourse” state with low mortgage
delinquency and foreclosure volumes--did seem to
respond positively to the low rate environment. Season- Months of inventory remaining on Oahu
ally-adjusted sales volumes on Oahu rebounded through (at existing sales rates and last month’s inventory)
mid-2009 (graph at upper right). Greater absorption in the
first few months of 2009 drew down months of inventory 14
remaining on Oahu (graph at rigth). A sudden rise in long-
term interest rates caused mortgage interest rates to rise 12
beginning mid May 2009. Home prices on Oahu began
fading more quickly in the early months of 2009, on a 10
seasonally-adjusted basis. Oahu condominium prices
looked somewhat more steady through mid-year. The 8
drop in sales and rise in inventories that followed the post- Single-family
Lehman financial panic did reverse itself in first half 2009, 6 Lehman
but whether sales have indeed found the bottom of the
home sales recession that began at the end of 2004 4
remains an open question. Condominium
2
NBER recession shaded
0
2005 2006 2007 2008 2009

Oahu existing single-family home median sales

prices Oahu existing condominium median sales prices
(thousand dollars, seasonally-adjusted, level scale) (thousand dollars, seasonally-adjusted, level scale)

700 350

600 300

500 250

400 200

300 150

NBER recessions shaded NBER recessions shaded

200 100
00 01 02 03 04 05 06 07 08 09 00 01 02 03 04 05 06 07 08 09

10 Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009)

Residential investment: at root
At the roots of the financial crisis, and even undelrying the
explosion of sub-prime lending in the years preceeding the
crisis that has left such a legacy of toxic mortgage-banking
related assets, is a “garden variety” housing cycle. Resi-
dential investment is one of the components of gross
domestic product that, though small, vary widely in a cycle
in which the range from peak to trough is larger than
virtually every other component of GDP. A tremendous
amount of credit creation is associated with this residential
investment cycle, because wealth in the form of home
equity comprises the dominant form of household wealth,
larger even than stock market exposure through household
portfolio investment and retirement programs such as IRA
and 401k plans. Financial innovation during the last
decade extended the reach of securitization to a broader
class of mortgage assets than those traditionally supported
by conforming fixed-rate, 30 year mortgages sponsored by
agencies like Fannie Mae and Freddie Mac. Sub-prime
and Alt-A mortgages that had lower underwriting standards
were securitized by private packagers, which increased the
Hawaii housing authorizations by building permit
(quarterly, units, seasonally-adjusted)
4000
2000
1000
NBER recessions shaded
500
75 80 85 90 95 00 05 10
Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009)
financial system’s exposure to default risk as the housing
cycle turned after 2005. As illustrated below, unlike the
cycle in the 1980s and 1990s that preceded the post-2005
housing recession, the recent cycle was one in which U.S.
and Hawaii homebuilding cycles were in phase. Both
residential investment cycles peaked at around the same
time in 2005, whereas in the 1980s/90s cycle the trough of
the U.S cycle in 1990 coincided with the peak in the Hawaii
cycle. At that time, the so-called Japan Bubble was having
an unusually influential effect on Hawaii housing invest-
ment, while the U.S. mainland was working its way through
the down years that followed the S&L crisis of the 1980s.
Equally striking as the synchronous downturn in Hawaii in
U.S. housing investment since 2005 is the difference
between the extent to which U.S. homebuilding has fallen
well below the lower bound of the range over which it has
varied cyclically during the last half century. In Hawaii,
where complete data aren’t available for as long, the
current homebuilding downturn remains within the lower
bounds of housing decreases from the last few cycles.
U.S. housing starts
(monthly, million units at seasonally-adjusted annual rates)
3200
1600
800
U.S. residential investment decline has
broken out of the lower bound of the
cyclical range of the last half century
400
60 65 70 75 80 85 90 95 00 05 10
11
Notoriously cyclical, construction is problematic
While the dominant view among economic forecasters is Hawaii private construction commitments:
that a broad-based reversal of private U.S. real investment monthly totals and cyclical (trend) component
expenditure should mark the shift from negative real GDP (monthly, million 2008 dollars, s.a., log scale)
growth in first half 2009 to positive and accelerating real
GDP growth in second half 2009, that pattern of invest-
ment-led recovery may be uneven across segments.
Gains in equipment and software investment, and even 400
consumer durables purchases, seem likely. Residential
investment has overshot volumes consistent with mere
maintenance of the per capita housing stock in the U.S.,
but here as well as in nonresidential investment the 200
constraints imposed on the overall economy by the credit
crunch in U.S. commercial banking will be slow to recede.
Moreover, an overhang of commercial mortgage
refinancings expected to surge in the next two to seven
years poses additional uncertainties in spite of efforts by 100
the Federal Reserve to directly restore channels of
securitization for commercial mortgages. In Hawaii these NBER recessions shaded
issues also weigh on the construction outlook. The most
65 70 75 80 85 90 95 00 05 10
recent forecast of the University of Hawaii Economic
Research Organization (UHERO), published in March
2009, anticipated overall construction recovery in Hawaii no
earlier than 2011, partly as a result of implementation lags Hawaii public construction commitments
associated with federal fiscal stimulus. A quarterly forecast (annual, million 2008 dollars, s.a., log scale)
prepared by the author for the January 2009 meeting of the 3200 “Burns” “Waihee”
Hawaii Council on Revenues, before passage of the Includes county,
American Recovery and Reinvestment Act of 2009 (ARRA: state and federal
government
federal fiscal stimulus) envisioned a similar timetable for
contracts
construction recovery, with less rapid recovery for real
construction spending. Somewhat surprisingly, at least 1600
some observers appear to have expected that federal fiscal
stimulus would have strong near-term impacts, even
though it is virtual textbook doctrine that implementation
lags for fiscal policy are long and variable. Material positive
800
impacts of the 2009 federal stimulus initiative, comprising
at three percentage points of GDP an injection twice the DBEDT data
size of the New Deal in the 1930s, should be largest in Old BOH data
second half 2009 and first half 2010, gradually tapering off UHERO 3/09 forecast
over the four quarters ending in mid-2011. 400
65 70 75 80 85 90 95 00 05 10 15

Brewbaker construction forecast for January

UHERO Hawaii construction forecasts
2009 meeting of Hawaii Council on Revenues
(annual, billion 2008 dollars, log scale)
(quarterly, million 2008 dollars, s.a., log scale)
8
2000
7

5
1000
Mar 2007
Actual real contracting 4 Sep 2008
H-P trend Mar 2009
Forecast
NBER recessions shaded
Strikes NBER recessions shaded
500 3
80 85 90 95 00 05 10 15 80 85 90 95 00 05 10 15

12 Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009)

What a long, strange trip it has been
When the Chair of the National Bureau of Economic
Research (NBER), Stanford University Professor Robert
Hall, opined to a conference of the National Association
for Business Economics (NABE) in October 2008 that the
jury was still out whether recession should officially be
declared (conceding its likelihood), U.S. real GDP still
hadn’t experience a sustained and broad pattern of
decrease that would be consistent with economy-wide
recession. The intensity of the financial panic in the fall of
2008 that followed the collapse of Lehman Brother in
September, despite extraordinary, and globally coordi-
nated, monetary policy interventions in the following
months, helps explain why only one month after the NABE
meetings the NBER officially dated the peak of the last
U.S. expansion as December 2007. Clearly, the implosion
of U.S. consumer spending in second half 2008, much of
which accompanied the stock market collapse in the fall’s
financial panic, served as the decisive accelerant. After
December 2007, widespread job loss averaging 150,000 to
200,000 per month through September 2008 contributed to
a creeping deterioration in consumer sentiment. A collapse
of real consumption expenditure in third and fourth quarter
2008, marked by an unprecedented jump in the U.S.
personal savings rate, dragged real GDP into the vortex.
By end-2009 it appears increasingly likely that the U.S.
personal savings rate will return to its historic range of 8-10
percent (from the 1960s-90s). As of mid-2009, total
nominal U.S. personal savings had in one year reversed
two decades of decline to exceed personal savings almost
a quarter century ago. While investment is beginning to
mobilize in anticipation of a consumption recovery, and
massive inventory reductions now presage a production
recovery, it seems quite plausible that a significant, secular
shift in consumer behavior may have been initiated in 2008.

U.S. personal savings rate

U.S. real disposable income and consumption
(percent of disposable income, through May 2009)
(monthly, trillion 2008$ at annual rates, s.a., log scales)
10
9.2

Disposable income (right) 9.0 8

Personal consumption (left)
8.8 6
8.4
8.6 4
8.3
8.4
8.2 2
8.2
8.1 0

8.0 NBER recession shaded -2

NBER recessions shaded
7.9 -4
2006 2007 2008 2009
92 94 96 98 00 02 04 06 08

Quarterly U.S. real aggregate consumption Quarterly U.S. real GDP growth through first
expenditure growth through first quarter 2009 quarter 2009
(quarterly percent change at annual rates) (quarterly percent change at annual rates)

6 6

4 4

2
2
0
0
-2
-2
NBER recession start date -4
2007.4 and presumed
-4 2009.3 end shaded -6

-6 -8
05 06 07 08 09 05 06 07 08 09

Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009) 13

Unwinding the monetary intervention
Combined with an historically unprecedented fiscal policy
intervention, the extension of monetary policy intervention
beyond traditional use of interest rate targeting is one of the
hallmarks of the current recession. When the federal funds
rate, reached zero at the end of 2008 a new policy ap-
proach was needed. Implemented gradually at first in
fourth quarter 2008 and then expansively in early-2009, this
was executed especially through securities acquisition,
while other channels of intervention actually diminished
(graph at right). The Fed’s move to what Chairman
Bernanke has called “credit easing,” or quantitative easing
in the theoretical literature, is exhibited in the massive
increase in the Fed’s balance sheet as depicted. Because
this injection coincided with what the Depression-era
economist J.M. Keynes called an increase in “liquidity
preference” by households and businesses following the
collapse of Lehman Brothers, the Fed was essentially
acting to prevent the collapse of the money supply that
NABE real GDP forecasts: 2nd half recovery
(quarterly percent change in real GDP at annual rates)
6
would otherwise have accompanied the flight towards the
save haven of bank deposits and cash equivalents. This
increase in the demand for money required a countervailing
increase in its supply. In the short-run, such behaviors are
rational responses to perceptions of increased risk. In the
long-run, as behavior returns to normal and households
and businesses go back to minimize holdings of liquidity
that forego higher interest earnings and other returns
(including utility from consumption) the Fed will gradually
have to reverse its massive monetary injection to avoid
becoming a source of future price inflation.
Federal Reserve assets
(billion dollars, weekly through mid-June 2009)
2500
Securities
Other assets
2000 Term Auction credit
Commercial Paper funding
Central bank swaps
1500

4 1000
02/08
2
05/08 500
0
10/08
NABE 0
-2
05/09 Aug-07 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09
11/08
Actual
-4
May 09 forecast
02/09
-6
Federal Funds rates under the Taylor Rule
NBER recession shaded (percent, actual and under NABE forecast assumptions)
-8
06 07 08 09 10 8
NBER recessions shaded

6
U.S consumer price inflation rates show no sign of
future inflation risk, but only time will tell
(percent changes, year-over-year)
4

5 Headline
Core
2
4

3 0
Fed funds rate
2 Taylor Rule
-2
98 00 02 04 06 08 10 12
1

Target Fed Funds as f[inflation gap, output (growth) gap]:

0
r* = [4.5 + (0.5)(p - p*) + (0.5)(y - y*)]

-1 r = Fed Funds rate

p = increase in the core CPI [p* =2 (target)]
03 04 05 06 07 08 09
y = real GDP growth rate [y* = potential GDP growth]

14 Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009)

Monetary policy and beyond: fiscal policy
An intensification of the global financial crisis in September
2008 abated in winter 2009 with a stabilization of equity Nominal U.S. Treasury yields
valuations, enactment of federal fiscal policy stimulus, and (percent, adjusted to constant maturities)
signs going into the spring that economic indicators might
exhibit a transition from recession to stabilization during the Jul 06
course of the year. Indeed, much talk of “green shoots” of 5
spring accompanied a rebound in stock prices during the Jul 07
latter two-thirds of March through April and May, before
running into the “lawn mower” of summer by June 2009. At 4
Jul 08
the end of second quarter 2009 long-term yields on U.S. June
Treasury notes and bonds had moved up sharply at the tail 2009 Apr 09
end of the stock price recovery. Concern about the 3
persistence of federal budget deficits implied by the fiscal
stimulus plan and other ambitious initiatives including Dec 08
health care systemic reform began to raise two kinds of
2
concerns both unfavorable for bond prices. First, under a
scenario in which long-term inflation expectations remained
“well-anchored,” real long term interest rates might have to
rise to induce the necessary global savings required to 1
finance persistent deficits. Second, any erosion of mon-
etary policy credibility might lead to higher future inflation
than such deficits might imply if the central bank’s commit- 0
ment to restraining future inflation was not called into

r
r
3- r
yr

yr
FF

2- r

yr

-y

-y
-y
y
y

7-
1-

5-
question. Neither of these outcomes is necessary in the

10

30
20
sense that a stable inflation environment and higher real
interest rates could exist in a formation that doesn’t unduly
crowd out private investment under a sufficiently robust
economic recovery. At the end of second quarter 2009,
long-term inflation expectations remained contained. Real U.S. Treasury (TIPS) yields
(percent, adjusted to constant maturities)

3
Long-term inflation expectation implied by the
Jul 2007
difference between nominal and real yields
(percent, includes a latent (unobservable) inflation risk Jul 2006
premium and liquidity risk premium)
2
3
Jul 06, 07, 08
Jun 2009
2 Mar 2008
1
Jun 2009 Jul 2008
1
Feb 2009 Mar 2008
0 0
2- r
yr
yr

yr

yr

r
FF

-y

-y

-y
1-

3-

5-

7-

10

20

30

-1
Nov 2008

-2
FF

2- r
yr
yr

yr

yr

yr

r
y

-y

-y
1-

3-

5-

7-

-
10

20

30

Bank of Hawaii Economic Research Center https://www.boh.com/econ/512_539.asp (June 30, 2009) 15