FF: Housing Elephant
How many of you homeowners have received ads urging you to refinance and take cash out? Gotta love a sweet deal on leverage.
It’s funny how financial articles refer to housing as the "elephant" in the room. By this they are referring to the latest trends in housing that seemingly have had little impact on the economy. An increase in housing sales and building permits in December might have some whistling dixie. Don't ignore those unadjusted figures, though.
There are 10 main leading indicators of future economic activity, but none of them have anywhere near the lead time as building permits. Residential construction from permit to completion takes anywhere from 8-15 months. What we see in the data is that building permits have fallen -27.3% since their peak, with the first increase in a year coming last month. Perhaps it's because of unseasonably warm weather as some have claimed.
Completions of projects have remained high which correspond to building permits authorized in late 2005 and early 2006. A slowdown in building activity will arrive in the next month or two and continue for a year based upon mid to late 2006 permits. So far, the economy has only been impacted from a decrease on the transaction side as home sales have declined. But we are only now about to see the impact from a slowdown in building activity as well.
Even as the economy stands strong, we are witnessing signs of stress. The Center for Responsible Lending on page 53 & 54 of this PDF estimates the foreclosure rates for subprime loans taken out between 1998 and 2006 for Oregonians. Because of high refinancing, the vast majority of loans have been reformulated into this time period. ACORN conducts regular studies on minority homeowners. Their latest Oregon study reports how minorities share a greater percentage of the subprime market than prime rate market as well as other factual tidbits. These organizations estimate high foreclosure rates among subprime lenders in Oregon even with a standard economy. What happens if the economy slows here?
Household mortgage debt doubled from $4.5 trillion in Q1 of 2000 to $9.5 trillion in Q3 2006. If we add credit cards, automobiles, etc. into the equation, total household debt to personal income rose from 79% to 115% over that same time period. This is from data pulled from the Bureau of Economic Analysis and the Federal Reserves’ Flow of Funds. What I find outrageous is how home prices, which should be included in inflation measurements and which should be part of the Consumer Price Index, completely stripped free of all inflation metrics. This graph, which I apologize for forgetting the website that generated it, illustrates what I'm talking about. (Click to zoom.)
As with my initial article, The Recession Cometh, I was concerned that the Fed would have to continue to raise interest rates because of inflation growth in housing. In 2006, the shelter component rose 4.2%, but it shows signs of accelerating. What’s interesting is how the most sensitive areas increased the most. Education costs increased 6.3% in 2006. Medical care increased 3.6%, while hospital care rose 6.1%. The official Consumer Price Data distorts housing inflation, shows monster increases to price-sensitive areas, but still manages to keep the money party alive. Well, you can thank the oil speculators for some of that.
These next several months are the most critical for our economy. Housing is a slow moving freight train that's only now leaving the station. Wait! Foreclosures are increasing. Revolving debt is balooning. The trade deficit is beyond compare. The nice thing about a housing-led recession is you can see it coming way in advance. The bad thing is that it tends to last the longest. Save!
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January 26, 2007 |
Jenson Hagen | Comments (14 so far)
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Posted by: jim karlock | Jan 27, 2007 2:47:36 AM
check out:
The Planning Penalty
How Smart Growth Makes Housing Unaffordable
http://americandreamcoalition.org/penalty.html
Thanks
JK
Posted by: Steve | Jan 27, 2007 8:36:27 AM
Mr Hagen - You always write good articles and I agree with you most of the time. THe only thing I can say is thank god the builders are not over-building (if you discount expensive condos in Portland) so we don't have a dual-edged sword of new construction and inventory.
I agree, the next 6 months are home-buying season. If everyone freezes and waits, a lot of mortgage brokers may have to break their Mercedes leases also which will be excess inventory at Rasmussens.
The other fortunate thing is that interest rates and inflation seem to be holding low which helps. The exception being the people "smart" enough to take out interest-only loans who really need house-price inflation to pull themselves out of a jam.
Posted by: Russell | Jan 27, 2007 7:07:06 PM
It isn't just that mortgage debt has doubled. It's the type of loans being offered. Subprime mortgages are the devil; there are so many people who "own" a house who shouldn't have ever had the opportunity to sign a loan agreement. I can't wait to see what happens when the foreclosure rate really spikes (it hasn't yet). The flood of single family homes will decimate the already distraught housing market. On a slightly different note, I've read articles within the last week in which the CEO of DR Horton and the CEO of Beazer homes have said that they see no end in sight to the bear market. It makes sense. Compared to the equity market, the housing market is very illiquid. What this means is that the cycle is a lot more drawn out. What would take 12-18 months in the stock market takes 2-5 years in the real estate industry. Great analysis Jenson - I wish more people understood the magnitude of the looming crisis.
Posted by: Realtor Tee | Jan 27, 2007 11:40:16 PM
Foreclosures in process increased by 42% in 2006, and are currently running at just over 1% of all households. For those who had to buy mortgage insurance, it is closer to 2%. That's high for non-recessionary times, historically speaking. The headline "1% of all households" is a bit understated, because not all homeowners have a mortgage. Oregon ranked 23 (1st being worst: Colorado).
11% of the value of all sub-prime mortgages were technically "in default" as of November 2006 (30-60 days past due on a mortgage payment). If real estate prices stabilize going forward, we would expect at least half of that 11% would cure their default.
I believe we still have as much as 15% downside price volatility nationally, but it will be worse in the highest unemployment and most overvalued markets. Portland's prices will simply stagnate without a recession: the UGB helps prop up the bubble, especially for high-end housing. Ironically, it may also prop up the 'burbs, especially for price sensitive growing families who want a BIG BACKYARD.
Posted by: Russell | Jan 28, 2007 12:35:25 AM
Foreclosures in process increased by 42% in 2006, and are currently running at just over 1% of all households. For those who had to buy mortgage insurance, it is closer to 2%. That's high for non-recessionary times, historically speaking. The headline "1% of all households" is a bit understated, because not all homeowners have a mortgage. Oregon ranked 23 (1st being worst: Colorado).
11% of the value of all sub-prime mortgages were technically "in default" as of November 2006 (30-60 days past due on a mortgage payment). If real estate prices stabilize going forward, we would expect at least half of that 11% would cure their default.
I believe we still have as much as 15% downside price volatility nationally, but it will be worse in the highest unemployment and most overvalued markets. Portland's prices will simply stagnate without a recession: the UGB helps prop up the bubble, especially for high-end housing. Ironically, it may also prop up the 'burbs, especially for price sensitive growing families who want a BIG BACKYARD.
This sounds like an advertisement for the National Association of Realtors, NAR
What's that??? Portland's prices will simply stagnate without a recession??? Um no...It just means that the Portland real estate market is behind the national market. If anyone still believes what the realtors say, I have a bridge I'd like to sell you...How can anyone not realize the massive vested interest for realtors...inflated prices = inflated commissions...no?
Posted by: MISTERRealtorTEE | Jan 28, 2007 9:03:51 AM
Russell:
My "worst-case" scenario (a 15% nationwide housing price decline) is about 14% worse than the National Association of Realtors is predicting. While I have great respect for their chief economist, they tend to fall on the more optimistic side of the "correction" spectrum. I do remember a few of their shills saying that we've "never" had a national year-on-year price decline. That's simply not true. I am not a realtor or a mortgage banker.
You might be interested in this little Propaganda Piece from the Mortgage Bankers Association. Warning: there aren't any pictures, just a bunch of economics and charts!
I think Oregon benefits by proximity to more expensive real estate markets in Washington and California, as well as quality of life benefits. Portland housing prices also benefit from the constrained supply of (UGB) land.
Posted by: lin qiao | Jan 28, 2007 9:35:36 AM
Let's propose building a chemical factory in Jim Karlock's neighborhood and then see how quickly he decides that planning is the greatest thing since sliced bread.
Posted by: Pat Ryan | Jan 28, 2007 12:22:43 PM
The elephant in the room here is that money supply, and hence interest rates are ultimately based on how much money the government chooses to print.
Government chooses to print more money every time that they spend more than they have.
Currently this Alice in Wonderland system works because of the interdependence of national economies worldwide, i.e. as long as our principle creditors, the Saudis and the Chinese need us to consume the products that they manufacture/extract, the house of cards keeps churning along and interest rates are determined by overt manipulation rather than adhering to "free market" principles.
The most likely way to crash the entire US economy, which currently depends way too much on real estate "wealth", would be for oil producers like Iran and Venezuela to start demand payment in a more reality based currency, like say, the Euro.
If that happens, there'll be buttloads of 'Muricans living in Chinese refrigerator boxes under the Burnside Bridge.
Posted by: Robert Ted Hinds | Jan 28, 2007 5:25:40 PM
Good article, Jenson. As the aphorism goes, it's better safe than sorry. So much for the chicken little criticisms.
The recession of '90-92 was a rare case of recession in that it was immediately followed by extraordinary gains in productivity via affordable, powerful personal computers and software. The recent blip of recession caused by the tech-stock bubble's burst was quickly ended by unprecedented monetary policy by the FRB. One really needs to look back to the early 80s for the last real economic hangover the US has had to endure. The best book, to my mind, on the subject is "Secrets of the Temple" by Will Greider. That recession was caused by (1) war costs from Vietnam, and (2) the energy shocks from the mid 70s. It's a painful read, but ultimately worth it.
Going back to the mother of all American recessions, the Great Depression, that was caused by exuberant claims-to-wealth (vs real wealth) through leveraged holding companies, and misguided attempts by the International banking trifecta of London, New York, and Paris (along with other central banks) to return the world to the pre-WWI gold standard (something that never actually happened, contrary to popular belief). In the U.S. that took the form of commodity price deflation and currency devaluation (the latter of which is currently taking place). The best resources on the great depression are John Kenneth Galbraith's "The Great Crash" and Carrol Quigley's "Tragedy and Hope."
Any blue-blooded, interested observer would be well advised to study the aforementioned texts, rather than trust the tea leaves of the mainstream financial press. The potential exists for a "perfect storm" of economic calamities--war debts, energy shocks, interest rate shocks--that could trigger a serious recession. Recent financial innovations have made it possible for anybody with high-five or low-six figure portfolios to diversify into foreign currency holdings. Yes, save, but I recommend 20-25% in a pot that includes Euros, Norwegian kroner, British pounds, yen, CAD, etc. It's strange as a 20th century American, who can remember when US dollars were accepted anywhere you went in the world, to say that, but we can all blame Bush admin fiscal policy for this mess. Don't see the mess yet? Just wait. You will. (Now I sound like Hunter Thompson...)
Posted by: Bambi's Mother | Jan 28, 2007 6:54:14 PM
Just like Hunter...Igualito...Two peas in podcast.
Posted by: Jenson | Jan 28, 2007 9:51:01 PM
Kuwaiti Finance Minister Bader al-Humaidhi said on Jan. 24 that the third-largest Arab oil producer may abandon the dinar's peg against the dollar in favor of a basket.
A quote from this article.
As for the first questions posed to me, the sky is not falling. I remember a war movie where they needed to explode a damn. Two guys set off a charge and nothing happened. They felt like trying again before they started to see cracks emerge. The damn slowly broke apart from the initial charge, but it took time. Patience.
The inflation scare back in May was that charge. It took the speculative winds out of housing. We are reaching a point that is in line with long-term trends. The problem is that we still have to correct for all the excesses. And a correction of excesses is better known as a recession.
But I'm not worried about a recession. They happen with frequency. I'm worried about the leverage. Too much debt. Or as Russell has pointed out, too much high-risk debt. We've been able to binge on credit without inflation problems because of productivity gains, which have been a combination of technology and outsourcing labor intensive production. But we should not be leveraging ourselves to the hilt simply because our average productive hours per output have fallen.
It's the debt. Only the debt. Get away from it. Far, far away.
Posted by: Bambi's Mother | Jan 29, 2007 7:23:18 AM
The global balance of payments imbalance has been marginalized by the market for so long, it's difficult to imagine what sort of event would drive the dollar over a cliff. I'm not saying it can't happen, I simply can't imagine what could provide the impetus (a first volley by Iran that sinks a carrier?...Chinese invastion of Taiwan?...A big dirty bomb on U.S. soil?).
It is not in our trading partners' interest to start dumping the dollar with great fanfare: (generally) the dollars is still their largest foreign currency holdings.
As for the domestic housing correction, the banks and CMO investors have largely insulated themselves from the credit risks which led to previous banking crisis. If the foreclosure rate continues to drift slowly higher, that will result in many personal bankruptcies, net worth dimunition, and declining real estate prices in the most (previously) bubbly markets.
But that is unlikely translate into recession without fear inducing bank failures or large reductions in consumer spending (unlikely so long as employment holds up). A housing correction can take years to fully play out, and the resultant financial losses are mostly absorbed by the investor/speculator class. People who need a place to live will continue to make their mortgage payments until they can't afford to, if they can sell it for more than the mortgage payoff, they will. If they can't, then the bank forecloses and their personal credit rating will suffer. A few hundred thousand wealth destroying foreclosure auctions on the courthouse steps doesn't translate into recession, unless it become even more
widespread and leads to panic selling.
If new homebuilding activity completely dries up (which nobody is predicting), it might shave a 1.5% off of GDP (worst case), but that would likely be the end of it. And surviving homebuilders would be back in the catch-up business by 2008 or 2009.
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Posted by: Hmm | Jan 26, 2007 11:06:33 PM
Jenson,
In general I like your posts and the energy you put behind them...but going back over time you are starting to sound like Chicken Little. Is the sky falling, or not? Or is the sky just always falling for you? Do you see anything positive in the economy?