The distress index: Where does it hurt?

The economy has not been a source of comfort and joy this year. The collapse of the housing market, the accompanying sub prime debacle and the credit crises has produced pain, for individuals and institutions. But how much does it hurt? Lee McPheters, professor of economics and director of the JPMorgan Chase Economic Outlook Center has developed the "Distress Index By State," which utilizes unemployment rates and home loan troubles to quantify economic grief, and those numbers say that Ohio and Michigan are feeling the greatest amount of economic stress.

Distress - noun; great pain, anxiety or sorrow; acute physical or mental suffering; affliction; trouble. Antonym — comfort. The economy has not been a source of comfort and joy this year. The collapse of the housing market, the accompanying sub prime debacle and the credit crisis has produced pain, for individuals and institutions. But how much does it hurt?

Lee McPheters, professor of economics and director of the JPMorgan Chase Economic Outlook Center has developed the Distress Index By State, which utilizes unemployment rates and home loan troubles to quantify economic grief. The numbers for third quarter 2007 were released today. Knowledge@W. P. Carey asked McPheters to explain how the index works, and what it says about the nation.

K@WPC: What components did you use to create the Distress Index?

McPheters: Our methodology combines the unemployment rate and the percent of home loans Seriously Delinquent (either 90 days delinquent or in foreclosure as reported by the Mortgage Bankers Association). The sum of these two measures is the Distress Score. The national Distress Score for the nation was 7.58 in the third quarter (4.63 quarterly unemployment rate + 2.95 percent of loans Seriously Delinquent). The Distress Index for a state is the ratio of the Distress Score for that state compared to the national Distress Score.

K@WPC: Why did you select these two data sets to create the index?

McPheters: When the economy weakens, the unemployment rate soon begins to rise, and shortly after that, home loan problems begin. The cause and effect typically runs from job losses to foreclosure. When unemployment and foreclosures are both increasing we know the effects of an economic downturn are being felt by workers and home owners and we can see this numerically as the Distress Score goes up.

What is interesting about the current upward trend in the Distress Scores is that labor markets are strong in many states but loan problems exist due to subprime issues, so the Distress Index for those states is on the rise while unemployment rates may be low.

K@WPC: A low number indicates relative economic comfort. What state logged the lowest score in third quarter?

McPheters: Idaho recorded the lowest value on the Distress Index, with a Distress Score of 47.3, less than one half the size of the national figure. Idaho had the lowest unemployment rate in the country during the third quarter, and Serious Delinquencies were well below the national average.

K@WPC: How many other states joined Idaho at the comfortable end of the index?

McPheters: In all, 16 states recorded Distress Scores that were 80 percent or less of the score for the nation as a whole. At the opposite extreme, five states (Kentucky, Indiana, Mississippi, Ohio, and Michigan) had scores 120 percent or more of the U.S. figure. Ohio and Michigan have the greatest percent of Seriously Delinquent home loans and Michigan had the nation s highest unemployment rate in the third quarter.

K@WPC: Were there any surprises in the numbers — states that, viewed objectively, did better or worse than perception?

McPheters: Arizona, California, Florida and Nevada are often mentioned as suffering the most from current problems with home loans and the weakening economy. However, Arizona ranks 12th on the Distress Index, ahead of 38 other states, and Florida s Distress Index is 98.8, just below the national average.

K@WPC: Let's look at Arizona. With the collapse of a red hot real estate market, the state is experiencing dropping revenues, and some neighborhoods are being thinned out by foreclosures. What is the reality behind the impression?

McPheters: Arizona s unemployment rate in the third quarter averaged only 3.57 percent and September s value of 3.3 percent was the lowest in three decades. Arizona s percent of Seriously Delinquent loans is likewise below the national average, at 2.02 percent. Florida s Seriously Delinquent loans are at 3.52 percent, but the state has still has an unemployment rate one half percentage point below the national figure.

K@WPC: What about California and Nevada?

McPheters: California and Nevada both had unemployment rates above five percent in the third quarter. But Nevada s percent of Seriously Delinquent loans was 3.48, compared to 2.66 in California.

K@WPC: Looking at your map (see Distress Index link below), a large percentage of the nation is experiencing average or lower levels of distress. How would you characterize the average, though? Is the nation on average more distressed than a year ago?

McPheters: Although Seriously Delinquent loans are up, the national level of distress is below last year because the unemployment rate has stayed low. The U. S. Distress Score hit a peak of 8.27 in 2002 due to the recession that started in 2001. If unemployment goes over 5 percent in the next few quarters we will probably surpass that peak, because it appears that Serious Delinquencies are going to continue to rise into 2008.

Lee R. McPheters is professor of economics and senior associate dean of the W. P. Carey School of Business. In addition, Dr. McPheters is director of the JPMorgan Chase Economic Outlook Center. The center specializes in economic development studies and forecasts for Arizona and the Western United States. He is a frequent contributor of articles on the regional economy to the Western Blue Chip and Arizona Blue Chip economic forecasting newsletters published by the W. P. Carey School.