Federal Reserve Bank, Boston

While a recession has not been officially announced, the latest reports, from consumer confidence levels spiraling down and unemployment rates spiraling up to the Federal Reserve Bank’s Beige Book, indicate the country is in for at least a few more months of rough times economically.

The Beige Book, a summary of comments on the current economic conditions in the 12 districts of the Federal Reserve Bank, is released quarterly. The latest edition, released in September, was completed with information gathered before Sept. 11 – any market effects stemming from the tragedies were not reflected.

In Boston, the current economic reality differs little than other areas of the country, especially in lending, where the Fed observed that the residential mortgage industry remains strong while business lending is flat.

Wayne Ayers, chief economist at FleetBoston Financial, said if banks haven’t already seen a drop-off in small business lending, they probably will. I think they probably already have, again, because in a bona fide recession, just about every sector takes its lumps, he said.

But while banks have tightened their credit standards – not an unexpected move during recessionary times – the outlook is far from bleak.

The banks, I assure you, are still open for business, unlike the situation a dozen years ago in New England and in the country where we had a credit crunch where banks had an enormous amount of bad loans and were very much undercapitalized. That’s not the situation today. The banks are still open for business, he said.

Although economic activity in New England continues to be slow, the retail sales outlook was described by one person contacted by the Fed as grim. Most retailers don’t expect the situation to improve until the third quarter of 2002.

Ayers said he agrees with that description, but I wouldn’t say that Boston is an outlier, however. The outlook for retail sales in general and holiday sales in particular are not good, given the fact that we’re in a bona fide recession, he said.

While the poor retail sales environment doesn’t affect banks directly, said Ayers, it is a contributing factor to bank performance. The low rates that the poor economy has brought about, if you will – that does produce some problems for banks. The problem not being that they have to pay low rates; there’s a limit to how low those rates can go and therefore they risk deposits moving to other places such as money market funds, said Ayers.

While most economists are now using the term recession, it won’t be official until the National Bureau of Economic Research announces it. Ayers said that announcement probably will not be forthcoming for some months, however.

In Ayers’ estimation, the peak of the recession occurred during the spring or early summer of this year. Ayers said the numerous interest rate cuts by the Fed – nine since the beginning in January – are working and are different than past easing cycles, so criticism of the rapidly changing rates is not valid. They [the Fed] had to react a lot more quickly, a lot more aggressively. I think they have done so and I think it will pay off next year when we see the beginnings of a recovery, probably by the second half, he said.

Other sectors also are not performing well at present, according to the Fed’s findings. Among those listed is the commercial real estate industry in New England. The Beige Book cites the drop-off in high-tech firms, both large and small, as one of the major contributing reasons for rising vacancy rates in the office market. The hubs of Boston and Portland, Maine, continue to fare well but suburban markets such as Cambridge have seen vacancy rates increase dramatically.

We’re not looking for the commercial real estate side to take the same kind of hits they did a dozen years ago, said Ayers, because unlike the last recession, there isn’t massive overbuilding, for example.

Pleasant Surprises
Additionally, Daniel J. Forte, president of the Massachusetts Bankers Association, said that banks are also much better capitalized this time around.

But Ayers said one sector that banks have to watch is their own brokerage and investment banking arms. We’ve already seen substantial layoffs in those areas because of what the market has done or, in this case, has not done, he said, noting that it’s cutting into bank profitability. The equity and venture capital markets are lackluster as well, he said.

Still, banks are in a good position. Forte said anecdotal evidence at a recent conference suggested bankers are pleasantly surprised that they haven’t really seen a rise in consumer delinquencies for equity credit lines and home mortgages. Granted, those types of delinquencies have a lag factor, but we’ve all been pretty surprised that delinquencies have not increased, he said.

Clearly the economy is softening, particularly on the commercial real estate side – commercial rents, you’ve definitely seen a decline – but the residential side of the business continues to be very strong right now, he said.

Although the economy is expected to decline through the first quarter of next year, according to economists from the New England Economic Project, it’s the best time, in essence, for it to happen in the Bay State.

The state economy is increasingly based on industries that are not cyclically sensitive and therefore will not contract as much during a recession as more cyclical industries, said Robert A. Nakosteen of the School of Management at the University of Massachusetts at Amherst.