Wednesday, October 19, 2011

Are home prices behind consumer gloom?

I'd say they are; and CNBC appears to agree.

The United States has a confidence problem: a nation long defined by irrational exuberance has turned gloomy about tomorrow. Consumers are holding back, businesses are suffering and the economy is barely growing.

There are good reasons for gloom — incomes have declined, many people cannot find jobs, few trust the government to make things better — but as Federal Reserve chairman, Ben Bernanke, noted earlier this year, those problems are not sufficient to explain the depth of the funk.

That has led a growing number of economists to argue that the collapse of housing prices, a defining feature of this downturn, is also a critical and underappreciated impediment to recovery. Americans have lost a vast amount of wealth, and they have lost faith in housing as an investment. They lack money, and they lack the confidence that they will have more money tomorrow.

Many say they believe that the bust has permanently changed their financial trajectory.

“People don’t expect their home to regain value, and that’s really led to a change in consumer attitudes about the economy that we’ve just never seen before,” said Richard Curtin, a professor of economics at the University of Michigan who directs its Survey of Consumers. The latest data from the survey, released Friday by Thomson Reuters, shows that expectations for economic growth have fallen to the lowest level since May 1980.

. . .

Economists have only recently devoted serious study to how a decline in housing prices affects consumer spending, not least because this is the first decline in the average price of an American home since the Great Depression. A 2007 review of existing research by the Congressional Budget Office reported that people reduce spending by $20 to $70 a year for every $1,000 decline in the value of their home.

This “wealth effect” is significantly larger for changes in home equity than in the value of other investments, such as stocks, apparently because people regard changes in housing prices as more likely to endure.

A recent paper by Karl Case, an economics professor at Wellesley College, and two co-authors estimated the decline in home prices from 2005 to 2009 caused consumer spending to be $240 billion lower in 2010 than it otherwise would have been.

That figure is equal to about 1.7 percent of annual economic activity, enough to be the difference between the mediocre recent growth and healthy growth. And it does not include all the other effects of the housing crash, including the low level of new home construction, that are also weighing on the economy.

There's more at the link.

This bears out something I've pondered ever since coming to this country in the late 1990's. I was never able to figure out the almost manic obsession with housing prices, buying bigger and better homes when the family could have remained very comfortably in the one they had, buying second properties as investments, and so on. It defied economic logic; but it was being promoted throughout the land as the path to prosperity and financial security. There were even those who tried to argue that the housing market could never go down! Nor was this hysteria confined to the USA. It had its effect all over the world.

On the other hand, the warning signs were there for those who had eyes to see them. In 2005 the Economist warned:

NEVER before have real house prices risen so fast, for so long, in so many countries. Property markets have been frothing from America, Britain and Australia to France, Spain and China. Rising property prices helped to prop up the world economy after the stock market bubble burst in 2000. What if the housing boom now turns to bust?

According to estimates by The Economist, the total value of residential property in developed economies rose by more than $30 trillion over the past five years, to over $70 trillion, an increase equivalent to 100% of those countries' combined GDPs. Not only does this dwarf any previous house-price boom, it is larger than the global stockmarket bubble in the late 1990s (an increase over five years of 80% of GDP) or America's stockmarket bubble in the late 1920s (55% of GDP). In other words, it looks like the biggest bubble in history.

Again, more at the link. The following year, as the housing bubble began to collapse, the Weekly Standard pointed out:

Roughly a quarter of the jobs created since the 2001 recession have been in construction, real estate, and mortgage finance. Even more important, consumers have withdrawn $2.5 trillion in equity from their homes during this time, spending as much as half of it and thus making a huge contribution to the growth the U.S. economy has enjoyed in recent years (consumer spending accounts for two-thirds of GDP).

But consumers cannot keep spending more than they make. Eventually, home prices will flatten, the flood of "cash out" refinancings will become a trickle, and consumer spending will slow, as will job creation in housing-related industries. The big question is this: Will the housing sector experience a soft landing and slow the economy or a hard landing that pushes us into recession?

. . .

A weakening housing market could transform what has been a virtuous cycle into a vicious one, substantially reducing economic growth during the next couple of years (and going into the 2008 election). If economic analysts on the right ignore this risk, they may be blindsided by a weaker economy. They will also be unprepared to answer those on the left who will blame tax cuts for what could be a painful unwinding of a credit bubble that, in fact, was fueled by a loose monetary policy from 2002 to 2004.

If the inflated prices are justified by economic fundamentals and sustainable, then the 82 percent increase in mortgage debt since 2000 will probably turn out to be innocuous and the risks to the economy minimal. If, on the other hand, prices are out of whack, painful adjustments lie ahead.

More at the link.

That puts it in a nutshell. That's how US consumers financed the boom years of the early 2000's.

"According to US Federal Reserve estimates, in 2005 homeowners extracted $750 billion of equity from their homes (up from $106 billion in 1996), spending two thirds of it on personal consumption, home improvements, and credit card debt."

They had 'paper wealth', not real wealth. They drew money against that 'paper wealth' and used it to buy other things - 'personal consumption, home improvements, and credit card debt' - and then, when the bill came due, didn't have the real wealth to pay it, thanks to the decline in the value of their homes. What's worse, many families sank all their retirement savings into the property market, because during the bubble years it was outperforming stocks and bonds. When the property bubble burst, it took their retirement savings with it. I know more than a few Americans who are in their sixties, but now can't afford to retire. Some have told me they're going to have to work until they die, just to make ends meet - if they can find a job, that is. As for leaving an inheritance for their children, that's a bad joke.

I have no doubt whatsoever that housing prices are squarely at the root of many of the economic woes of consumers today. Unfortunately, I see no hope whatsoever for an improvement in the property market for the next five to ten years. I hope I'm wrong . . . but I'm darned if I can find evidence to persuade me otherwise. That being the case, is it any wonder that consumer confidence isn't rebounding?

I'm just grateful I managed to sell my house a few years ago, and use the profit to pay off other debts. It wasn't a lot of profit (I didn't own an expensive house), but it's helped me to stay afloat during these lean years.



Anonymous said...

Heck, after the dot-com-bomb of 2001, A. Greenspan said that real estate would be the next bubble.

Peter, I suspect the fixation so many Americans have with owning a house goes back to the late 1800s, combined with the Homestead Act. North America was the place with lots of land for people to come and get their own farm. The ideal of the middle class owning a home "in the country" grew stronger and stronger in the 1880s through the 1910s, then really took off after WWII with Levitton and other developments. You might look for the book "Crabgrass Frontier." The author does not like suburbs but he wrote a good history of them pre-WWII.


TheAxe said...


As a young professional I've started looking around and I'm shocked at how much people are still asking. Wildly unrealistic figures for the area and economy, and I'm in a pretty nice area. I don't know how much of it is psychological but people and banks need to accept the reality that how much they paid for it or feel they deserve has no bearing on how much it's worth now. Once the prices are more reasonable we'll start buying again. I have plenty of friends in the same place I am. The next generation's ready to buy.

trailbee said...

I think I was lucky that we put our house up for sale right at the start of the bust. It would not move! Our children suddenly were in dire straits and needed us here; but in addition, in my hurry to move I lost sight of the real reason we bought our land in the first place in '92. I love this land. If I could move our 20 acres, house, the deer and turkeys, etc., and leave CA it would be great. A pipe dream. So glad we stayed for our kids.