1. © 2008 Northern Trust Corporation northerntrust.com The Northern Trust Experience A C C E S S. E X P E R T I S E. S E R V I C E. Paul L. Kasriel Director of Economic Research PH: 312.444.4145 plk1@ntrs.com © 2006 Northern Trust Corporation northerntrust.com How Housing Has Affected the Economic Ecology

2. The Northern Trust Experience How Housing Has Affected the Economic Ecology This past cycle was accompanied by one of the biggest housing booms in the post-WWII era.

3. © 2008 Northern Trust Corporation northerntrust.com Three factors were responsible for the strength of the recent housing boom

4. The Northern Trust Experience How Housing Has Affected the Economic Ecology Low mortgage rates in absolute terms as well as relative to house price appreciation.

5. The Northern Trust Experience How Housing Has Affected the Economic Ecology The increased popularity of affordability mortgage products this past cycle.

6. © 2008 Northern Trust Corporation northerntrust.com Rating Agency Errors

7. The Northern Trust Experience How Housing Has Affected the Economic Ecology The housing boom played a major role in increasing employment. The housing bust is now responsible for contracting employment.

8. The Northern Trust Experience How Housing Has Affected the Economic Ecology The recent housing boom created an enormous amount of paper household wealth …

9. The Northern Trust Experience How Housing Has Affected the Economic Ecology …which, in this cycle, households could more easily and cheaply borrow against.

10. The Northern Trust Experience How Housing Has Affected the Economic Ecology This increased home-equity borrowing activity, along with corporate stock buybacks …

11. The Northern Trust Experience How Housing Has Affected the Economic Ecology … enabled households to increase their consumption to a record high in relation to their after-tax income.

12. The Northern Trust Experience How Housing Has Affected the Economic Ecology Households and corporations have reversed roles in recent years with households having become net demanders of funds and corporations net suppliers

13. The Northern Trust Experience How Housing Has Affected the Economic Ecology But now with home equity falling …

14. The Northern Trust Experience How Housing Has Affected the Economic Ecology … with mortgage lending terms tightening …

15. The Northern Trust Experience How Housing Has Affected the Economic Ecology … and with the unemployment rate rising …

16. The Northern Trust Experience How Housing Has Affected the Economic Ecology … growth in real consumer spending is the slowest since 1991.

17. The Northern Trust Experience How Housing Has Affected the Economic Ecology Household balance sheets are in the worst shape in the post-WWII era with household leverage at record highs …

18. The Northern Trust Experience How Housing Has Affected the Economic Ecology … and household liquidity at near-record lows.

19. The Northern Trust Experience How Housing Has Affected the Economic Ecology With the housing sector still contracting and the consumer sector weakening, economic activity in other sectors also will slow.

20. The Northern Trust Experience How Housing Has Affected the Economic Ecology Large and small business sentiment has soured …

21. The Northern Trust Experience How Housing Has Affected the Economic Ecology … which is reining in capital spending.

22. The Northern Trust Experience How Housing Has Affected the Economic Ecology With unemployment increasing and retail spending slowing, commercial real estate vacancy rates are beginning to rise.

23. The Northern Trust Experience How Housing Has Affected the Economic Ecology This augurs poorly for private nonresidential construction activity going forward.

24. The Northern Trust Experience How Housing Has Affected the Economic Ecology The next domino to fall will be state and local government spending, which accounts for about 11% of real GDP.

25. The Northern Trust Experience How Housing Has Affected the Economic Ecology The relative strong performing sector will be exports. With economic growth in the rest of the world slowing, however, our exports will face some headwinds.

26. The Northern Trust Experience How Housing Has Affected the Economic Ecology Consumer price inflation has resurged in recent months, primarily because of sharp advances in energy and food prices.

27. The Northern Trust Experience How Housing Has Affected the Economic Ecology The rate of increase in energy prices is likely to abate as the demand for energy moderates because of the global economic slowdown.

28. The Northern Trust Experience How Housing Has Affected the Economic Ecology increased demand from developing economies such as China and India competition from biofuels low inventories of grains, in part due to droughts and now, floods Food price increases are less likely to moderate much because of …

29. The Northern Trust Experience How Housing Has Affected the Economic Ecology Businesses are not able to pass on completely to consumers their higher input costs.

30. The Northern Trust Experience How Housing Has Affected the Economic Ecology With the unemployment rising and growth in employee compensation already slowing, there is little danger of a 1970s-style wage-price spiral.

31. The Northern Trust Experience How Housing Has Affected the Economic Ecology In addition to food price increases, the biggest threat to higher inflation would be a renewed weakening in the dollar.

32. The Northern Trust Experience How Housing Has Affected the Economic Ecology It is important to recall, however, that inflation is a lagging economic process.

33. The Northern Trust Experience How Housing Has Affected the Economic Ecology Not surprisingly, the housing boom resulted in a mortgage debt boom, with home mortgage debt rising to a record high percentage of total U.S. nonfinancial debt.

34. The Northern Trust Experience How Housing Has Affected the Economic Ecology Home mortgage debt is now twice as large as U.S. Treasury debt held by the public.

35. The Northern Trust Experience How Housing Has Affected the Economic Ecology Herein lies the problem – the collateral of the single largest debt class in the U.S. is experiencing perhaps its most severe decline in value in the post-WWII era.

36. The Northern Trust Experience How Housing Has Affected the Economic Ecology And with still large excess inventories of homes, there is no relief in sight for home prices.

37. The Northern Trust Experience How Housing Has Affected the Economic Ecology Contrary to conventional wisdom, commercial banks have a record amount of mortgage-related debt on their balance sheets.

38. The Northern Trust Experience How Housing Has Affected the Economic Ecology Although the largest credit problems are in the home mortgage market, distress is beginning to be signaled in the consumer loan and commercial real estate markets, too.

39. The Northern Trust Experience How Housing Has Affected the Economic Ecology With nonfinancial corporate profits contracting and interest rates on high-yield corporate bonds rising, increased corporate bond defaults are likely.

40. The Northern Trust Experience How Housing Has Affected the Economic Ecology Current and expected credit losses are constraining financial institutions ability to create new credit.

41. The Northern Trust Experience How Housing Has Affected the Economic Ecology The U.S. economy likely entered a recession early in 2008. Because financial institutions will experience large losses across a wide spectrum of debt classes and because there is the likelihood of increased regulation, the financial system will be capital impaired through 2009. Even though the Federal Reserve is offering cheap credit to the financial system, financial institutions will have diminished demand for the Feds offer because they will not have the capital to support lending to the private sector. Thus, U.S. economic performance will be substandard through 2009 due to the relative lack of credit creation from financial institutions. Conclusions and implications:

42. The Northern Trust Experience How Housing Has Affected the Economic Ecology In the words of Mel Brooks: Hope for the best, expect the worst!

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