Monday, August 2, 2010

Housing Poses Long Term Problems For Economy

The Census Bureau released home ownership statistics last week. For the 2nd Quarter 2010, it showed a continued decline to 66.9% from a peak of 69.4% in 2004. This rate hasn’t been below 67% since 1999, an incredible round trip in just over a decade.

Everyone has spoken about what a horrible decade the last one was. I was "googling" this and was able to find these stats.

-Annualized nominal increase in household net worth since mid 1999: 3.25%
-Annualized inflation since mid 1999:  2.7%
-Real increase in household net worth: Annualized 0.55%

The last stat is clearly disturbing when you factor in roughly 8% annual growth in nominal household net worth from 1952 through 1999.  So what meteor hit us?

Firstly, you have to point to what the theme today is: JOBS!

There has been no job growth. Job creation (non farm payrolls) since mid 1999: 1.6 million jobs, or an increase of 1.25% in 10 years (not annualized, just 1.25% total).

Secondly, little income growth. Real personal income less transfer receipts rose at only 1.4% annually since 1999.

Its hard to build net worth when there are no jobs or income growth. What made the crisis more painful was the fact that housing was ramping thru out the decade with these headwinds.

OK, the two most important metrics for household net worth are jobs and income, but what is also sobering is the two most volatile asset classes have been housing and the stock market. Thru out the last decade the Case-Shiller 20 city index was rising 3.7% annually before inflation, but mortgage debt was running 8.5% higher. Clearly Americans were paying too much for their biggest asset class. Since we have seen a 30% decline nationwide in housing, but the debt remains. Now a correction was needed and we got one, 30% brings us back somewhat in line historically, but housing was a bubble before and bubbles tend to over correct. Coupled with foreclosures still a problem, shadow inventory, and an over supply of homes, we can see another 10-15% down spike.

The simple idea that the Fed and Treasury want to a return to business as usual is absurd.  How can we get back to BAU when 1 out 4 mortgages have negative equity. There are roughly some 15MM underwater mortgages in the country at the moment. There is some $4 trillion in access mortgage debt that needs to be either paid off, restructured, or defaulted on. This is some 30% of GDP..

For years, total mortgage debt consistently equalled about 0.4 times the value of the US housing market. This average of 0.4 makes sense as every property usually has a mortgage ranging from 0 to 0.9X its value. So in 1990, $6T of housing collateral could support $2.5T of mortgages, and by 2006, $23T of housing collateral could support about $10 trillion of mortgages. But since then, the US housing stock’s value has slumped to $16 trillion which means the amount of mortgage lending supportable by the collateral should have declined to $6T However, actual mortgage debt has remained at $10T, which is $4 trillion too high. Mortgage debt has barely declined. Even if the face of defaults and foreclosures, homeowners have not defaulted or paid off debt fast enough enough to support current prices. How can they?

This is the reason why we have seen all of these home owner subsidies, without them the economy would collapse. There is simply too many homes that are empty. The logical reasoning would then be to stop building, but currently there is excess supply of new homes, REO, and shadow homes that have yet to hit the market.

We have to couple these headwinds with homeowners who also strategically default on their properties. Again, 25% of homes have negative equity, if homeowners didn't just walk away this figure would be exponentially higher.

Net. Net. We built too many homes. The economy came back after the 2000-2001 recession on the backs of residential construction. Between 2002 and 2006, US home builders went on a construction orgy, building 12 M new homes while the number of households went up by just 7M, from this we have a massive oversupply of homes relative to the number of households. A major demographic nightmare. This is also a huge problem (Simply Speaking) when talking about the political atmosphere surrounding immigration. Bottom line, we need immigration to sustain the economy.

We had a fake economy during the last decade. We had two wars that were unfunded. Medicare Part B that was unfunded. Tax Cuts for the uber wealthy that were unfunded. Phony GDP growth based on a credit bubble. It will take more than a few years to get thru this dark period.

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