A Good Step, But There's a Long Way to Go

While the Fannie-Freddie takeover will help bring borrowers and lenders back together, rising unemployment is the newest roadblock to any recovery

The historic action by the U.S. government to effectively nationalize the mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) is the biggest step yet in righting the housing sector and restoring confidence in the credit markets, but it's no miracle cure for this ailing economy. That's clear from the Labor Dept.'s report showing August's jobless rate surged to a five-year high of 6.1%. Even if the takeover succeeds in its key goals of bringing down mortgage rates and easing borrowing conditions, rising unemployment will prevent a growing number of households from taking advantage of the benefits.

The unemployment rate is now up 1.4 percentage points from a year ago. That's comparable with its upward moves in the two previous recessions, and it is sure to rise even higher in coming months, depressing income growth and cutting further into demand for homes, cars, and other items. Job losses will also push more mortgages into delinquency, creating more foreclosures and more downward pressure on home prices. In the second quarter, when the jobless rate had risen to only 5.5%, the share of mortgages beginning the foreclosure process posted the largest jump on record, rising to a high of 1.19%, from 0.99% in the first quarter (chart).

The economy is not growing fast enough to generate the monthly job gains of 100,000 or so required to hold the jobless rate steady. Through August, payroll losses have averaged 76,000 per month, and the number of people working part-time because of poor economic conditions hit a 15-year high of 5.7 million. Many analysts now expect joblessness to top out between 6.5% and 7% next year, well above the 6.3% peak in the 2001 recession.

The sharp rise in unemployment suggests the job markets are even weaker than recent payroll losses imply. Declines so far have been about half those in similar periods in the past two recessions. But at the beginning of recessions and recoveries, the Labor Dept. has a hard time counting business shutdowns and startups, so recent job declines might be understated. For example, after revisions, Labor ultimately said payroll losses early in the 2001 recession were about double the original numbers.

It's starting to look like the same story this time. In the past, an increase in the jobless rate of 1.4 points has always been accompanied by much larger declines in payrolls than the data now show. First-time filers for unemployment insurance are also at levels historically consistent with bigger job losses. August claims averaged 438,000 per week, a reading elevated partly by the government's special efforts to reach new claimants in early July. Those temporary effects should be fading by now, yet claims jumped in late August and remain at levels typical of past recessions.

The growing problem is flagging income growth at a time when the lift to buying power from the tax rebates has run its course. As the jobless rate has turned up, hourly pay has already slowed sharply, and overall income from wages and salaries is growing only 2.9% annually so far this year, down from 4.5% all last year. The pain of energy inflation will ebb, but income growth will slide further, too.

One plus from the weak labor ­market: Slower wage growth—along with lower oil prices and a stronger dollar—has greatly improved the inflation outlook. That means the Federal Reserve will not feel obligated to lift interest rates for a long time, and recent calls for a rate hike by some Fed policymakers are starting to look out of touch with the economic realities of rising unemployment. In early September a key market measure of expected inflation had dropped to a five-year low.

The takeover of Fannie and Freddie may eventually accomplish what the Fed's rate cuts have been unable to do: loosen financial conditions and bring lenders and borrowers back together. Plus, it lessens the chances things could go seriously wrong. Still, the job markets are signaling that it will take a long time before things start going seriously right.

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