Are Economists Too Optimistic on Housing's Soft Landing?

Tuesday, August 08, 2006 | 06:13 AM

A large part of our Slow-Motion Slow-Down thesis has been based on Real Estate -- the prime engine of economic growth the past few years -- grinding towards a much weaker posture.

This is notably different from what most economists see, as they are expecting a "soft landing" in the Housing market.

As previously mentioned, I do not see a Housing Bubble; rather, we have an extended asset class based on ultra low rates, and as those rates tick higher, the biggest housing boom in U.S. history will end and then retrace.

The key question for the economy is "how bad will the aftermath be?" Most economists expect a "soft landing," a gradual decline that won't derail the the 5 year stimulus driven economic expansion.

A few data points to consider when contemplating Housing:

  1. Inventory is now at 9 year highs, having increased in many areas 75-150% over last year; That inventory issue is why the Home Builder's Index is down 50% from recent highs;
  2. Home affordibility index is at 15 year lows, as rates AND price have moved higher during the past 36 months;
  3. Real Income gains have been negative or the past 5 quarters, challenging middle income buyers to afford new homes;
  4. Home ownership ticked up to record levels after Mortgage Rates dropped to 5.25%; There simply aren't many new buyers coming into the market;
  5. Residential construction accounted for about 6.1% of the economy -- close to a 50-year high; When that reverts tot he mean, it will take 0.75-1% off of GDP; If (as I suspect) it swings past the mean, as these thngs tend to do, 1-3% of GDP can get lost;
  6. The NAHB Home Builders Index -- a sentiment reading of builders -- fell to a 15 year low last month;
  7. Mortgage Apps for new purchases are down 24% year over year; Refis are off 37% y/y; ARMS are still 42% of dollar volume;

Despite all of these facts, the Dismal set remains optimistic about a gradual slowing and a soft landing. What if they are wrong?

click for larger graphic

courtesy of WSJ

Here's an excerpt from a columninm yesterday's WSJ, As Data Point to Slowdown, Housing Market May Land Harder Than Economists Predict:

"But there is a good chance [Economists] are being too optimistic. The boom has depended heavily on the upbeat psychology of consumers, builders and lenders. As moods swing, the landing could be very hard indeed.

"We could be underestimating the dark side," says Mark Zandi, chief U.S. economist at Moody's and among the first to seek to quantify the housing boom's broader effects. "Euphoria could turn into abject pessimism very quickly."

With each passing data point, signs of the housing slowdown grow stronger. In June, total single-family-home sales fell 8.7% from a year earlier, to an annualized rate of 6.9 million -- the sharpest year-to-year drop since April 1995.

The government's report on second-quarter real gross domestic product, the inflation-adjusted value of the nation's output, showed that fixed investment in housing by companies and individuals declined at an annual rate of 6.3% in the quarter. That was a sharp change from a year earlier, when it was increasing at an annual rate of 20%. As of Friday, futures markets were predicting about a 5% drop in house prices by May 2007.

Still, judging by most economists' forecasts, the fallout from a slowing housing market doesn't look all that unpleasant. Typically, they expect the decline in housing -- and housing-related activity -- to shave about a percentage point off inflation-adjusted GDP growth in 2007, compared with the estimated one percentage point the sector contributed to growth in 2005. If business investment and exports accelerate as expected, that would bring inflation-adjusted GDP growth to about 2.8% in 2007, down from a forecast 3.5% this year.

Economists, however, have few clues on which to base their predictions. Today's housing boom differs radically from its predecessors. For one, it has been bigger and longer-lived. House prices are still more than twice the level of 1991, when the boom began. Even after the recent decline, June's rate of home sales is 40% above the 20-year average."

How does this impact the rest of the economy? Consider how much the housing slowdown will affect consumers:

"If house prices plateau or fall, homeowners will feel poorer, and thus less willing to go out and buy more cars, boats and refrigerators. Typically, this "negative wealth effect" would be only about three to five cents of spending for each dollar of wealth lost.

But modern mortgage finance has magnified the effect of home values on spending, says Jan Hatzius, chief U.S. economist at Goldman Sachs in New York. He estimates that when people take cash out of their homes through home-equity loans and refinancings -- which they were doing at an annualized rate of $558 billion in the first quarter -- they tend to spend about 50 cents of every dollar. If house prices merely stabilize, people's diminished ability to use their houses like automated-teller machines would subtract about 0.75 percentage point from annualized GDP growth in 2007, Mr. Hatzius says."

Ian Shepherdson, chief U.S. economist at consulting firm High Frequency Economics estimates that the decline in residential construction could subtract about 1.5 percentage points from annual GDP growth in each of the next two years. He thinks Real Estate is "a 15-year bubble unwinding in two years."  Net result? "It's going to hurt."

See also the Sunday NYT article, titled: "The Houses That Wouldn’t Move."


As Data Point to Slowdown, Housing Market May Land Harder Than Economists Predict
WSJ, August 7, 2006; Page A2

The Houses That Wouldn’t Move
NYTimes, August 5, 2006

Ohio foreclosures on the rise
JIM SABIN, Aug. 3, 2006

California Mortgage Default Notices Soar 67%
20,752 homeowners in the state were warned last quarter. That's still below the average.
David Streitfeld,
L.A. Times, August 3, 2006,1,824432.story

Tuesday, August 08, 2006 | 06:13 AM | Permalink | Comments (28) | TrackBack (0) add to | digg digg this! | technorati add to technorati | email email this post



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It is Kahn's banana all over again. There is no bubble, bubbles are scary. People panic during bubbles. Instead, we'll replace bubble and crash with all manner of nonsensical analogy. Ships turning, soufles deflating, beautiful hot air balloons slowly gliding back down to Earth. Breath in, breath out. Ahh, that's it, don't you feel calmer already?

Posted by: James Bednar | Aug 8, 2006 7:35:14 AM

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