Commentrary: Shrinking Bottom Line

Lost in the kerfluffle over the ""unexpected downward revision"":http://dsnews.comarticles/1q-gdp-growth-dips-corporate-profits-fall-2013-05-30 of first quarter GDP growth--2.4 percent annualized compared with the originally reported 2.5 percent--was the companion release of first quarter corporate profits, a disappointing drop from the fourth quarter.

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First quarter pre-tax profits, as reported by the Bureau of Economic Analysis (BEA), came in at $1.969 trillion, down 2.2 percent from the fourth quarter (but up 3.6 percent from the first quarter a year ago). After-tax first quarter profits were off 2.0 percent. Along with the drop in profits, dividends fell, although the decline from the fourth quarter was exaggerated because of special dividends paid before year-end, when businesses were uncertain whether endâ€"of-year fiscal cliff negotiations would result in higher taxes on dividends.

While BEA's method of calculating and reporting corporate profits differs from reports found, say, in corporate annual reports or on tax returns, that the methodology is consistent from year to year speaks to trends if not to actual results. And the trend was clearly not a good one.

According to BEA, profits fell for both financial and non-financial corporations in the first quarter. For financial corporations, it was the fourth quarterly decline in profits in the last five quarters; for non-financial firms, it was the second decline in the last five quarters.

The slip in financial corporation profits comes at a particularly critical time for the financial sector, as housing-so heavily dependent on lending institutions--is in the midst of a nascent recovery, and that recovery is causing concerns that we may be on the cusp of yet a new housing bubble.

Recent data shows home prices rising at the fastest pace since the housing bubble burst. At the national level, though, the relatively rapid increase in prices doesn't automatically suggest a new ""bubble"" since prices (adjusted for inflation) are down from their peak.

There are, according to Dean Baker of the Center for Economic Policy Research, ""serious grounds for concern in many local markets."" Baker, who gained credibility as one of the first economists to spot the bubble said prices in some markets are ""rising at an extraordinary pace.""

Indeed, the ""Case-Shiller Home Price Index"":http://dsnews.comarticles/case-shiller-indices-show-strongest-gain-since-2006-2013-05-28 report for March showed a sustained year-over-year price gain of 20 percent or more in Phoenix--for the last seven months--while five other cities have had double-digit annual percent increases for at least the last five months in a row. The Case-Shiller data for March showed, in addition to Phoenix, two cities with a year-over-year price gain of more than 20 percent: Las Vegas (20.6 percent) and San Francisco (22.2 percent).

To be sure, there is nothing magic about a 20 percent annual price increase that automatically suggests a bubble. Prices in Phoenix peaked in June 2006 following 18 straight months of yearly price gains of 20 percent or more and nine straight months in which the Case-Shiller data showed three-year price gains of over 80 percent.

Prices peaked in Las Vegas in August 2006 after 24 straight months of three-year price gains of more than 80 percent. In San Francisco, prices peaked after 15 straight months in which prices grew 50 percent or more over three years.

According to Baker, ""the most rapid price increases are occurring at the lower end of the market. In Las Vegas the price of homes in the bottom third of the market have risen by more than 40 percent over the last year. In the last three months they have increased at almost a 70 percent annual rate."" And, he said, the pattern is similar in Phoenix, ""where prices for homes in the bottom third of the market rose by just under 40 percent over the last year and have risen at just under a 50 percent annual rate over the last three months.""

Adding to the concern is that economic fundamentals are not tracking the higher prices. In all three cities--Phoenix, Las Vegas and San Francisco--household employment is falling, not rising.

Many low- and moderate-income people saw their dreams destroyed when the last bubble collapsed. It would be too cruel to see the same mistake repeated just a few years later.

While the increase in house prices might not track economic fundamentals, there is one economic truth that will continue: Businesses base hiring--and firing--decisions on a simple calculation of revenue or profit per employee. As profits become losses, employment will decline; put another way, the decline in employment in Phoenix, Las Vegas and San Francisco suggests business challenges in those cities with the prospect housing could follow.

_Hear Mark Lieberman on P.O.T.U.S. Radio (Sirius-XM 124) next Friday at 8:45 a.m. and again at 1 p.m. Eastern._

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