January 26, 2006
HOUSING'S FALLING BLOOMS
The general assumption regarding the current Fed policy is that the central bank's intent on cooling the housing boom. Until and if the real estate market cries "uncle," the central bank will continue raising interest rates. At least that's the theory, and as theories go it's as good as any, which is to say it's in play until proven irrelevant.
As for facts, the housing market in particular has been on a tear in the 21st century, the fuel being the easy credit that became standard of recent years. Meanwhile, the Fed's Alan Greenspan has been stung by criticism that the world's most powerful central bank has been asleep at the switch while two of the greatest speculative booms in history have unfurled beneath its monetary nose.
The first, an extraordinary stock market run in the late-1990s, ended with a bursting of the bubble that for a time looked like it might drag the economy down with it. The Fed barely lifted a finger to slow the rise of excess in the latter half of the nineties, despite the maestro's infamous recognition of the clear and present danger brewing a la his "irrational exuberance" speech of 1996.
Arguably, there is now another bubble in our presence, this time in residential real estate. But compared to its predecessor, the signs of irrational exuberance are fuzzier, the implications for the economy less distinct. History is clear on what the stock market crashes can do. The deflating of national housing bubbles isn't nearly as common, nor as deeply studied.
That said, there are signs of late that the housing bubble, if in fact that's what we're in, is losing air. Whether the future will bring a slow leak or a crash remains to be seen. For the Fed's part, it seems fixed on encouraging the former. Yet central banking is a blunt tool, as we're so often told, and so the best laid plans may yet produce surprises.
In any case, it's clear that the next five years aren't likely to look like the past five years when it comes to housing trends. Yesterday's report on December's existing home sales is the latest bit of evidence suggesting that cooling is now the operative trend in residential real estate. Last month's sales fell to the lowest rate since March 2004, dropping a sharp 5.7% in December from the previous month.
Adding to the anxiety is the news that the normally booming housing market in the South suffered its first dramatic monthly setback in some time, with existing sales falling more than 7% last month.
In addition, sales prices of existing homes nationally fell for the second month in a row in December, dropping 1.9% after a 1.4% setback in November.
Perhaps we're getting overly concerned over nothing. It's winter, after all, and real estate tends toward the sluggish when the air turns cold. What's more, any bullish run invariably corrects at some point, thought not necessarily leading to a crash.
Nonetheless, some dismal scientists warn that economic growth of late has been overly dependent on rising home values, which in turn drives consumer spending. To that extent there's a reversal in the real estate boom, the fallout threatens the economy, or so this line of thinking goes.
BCA Research subscribes to that line. In a note published January 20, the venerable consultancy advises that a "cooling in U.S. housing activity is underway and should coincide with a consumer spending slowdown." Among the data points that BCA cites:
* Failure in the January U.S. home builders’ survey to rebound after steep losses in late 2005.
* Sharp declines in both housing starts and new permits in December
"Housing affordability has eroded significantly due to sky-high house prices and, to a lesser extent, higher mortgage rates," BCA concludes. "Real consumption growth tends to weaken after affordability has significantly declined."
So far, talk of an expected housing slowdown as a catalyst for something dramatically negative in the economy has remained just that--talk. But if the Fed's intent on cooling the housing market, there's reason to sleep with one eye open.
"The bloom is definitely off the housing rose," Mark Zandi, chief economist at Economy.com, tells AP via The Mercury News. If so, what does that imply for the economy and the stock market?
Posted by jp at January 26, 2006 10:00 AM
It's true that the Fed can only directly adjust short rates, but the goal is usually to affect long ones as well. Obviously, that's not happening of late, although historically a rise in short rates tends to do no less on the long end of the curve eventually. The fact that the lever isn't working suggests the market expects a recession, or perhaps the culprit keeping long rates low is, as Bernanke opines, a "global savings glut."
As for the Fed's reported intent on slowing the real estate market, many economists and money managers I talk to make this case. That said, the Fed is loath to officially confirm or deny its intent, a cloud that keeps a cottage industry bubbling for dissecting Fed actions.
To be fair, it's clear that in the past the Fed was reluctant to prick asset bubbles. Perhaps that's now changing. Reasons to consider the possibility include:
Greenspan recently said the housing market looks "frothy." Also, the maestro took the unusual step of putting his name to a Fed research paper last September that raises concerns that a drop in housing prices might negatively impact consumer spending (http://federalreserve.gov/pubs/feds/2005/200541/200541abs.html). The implication being that it may be better to slow, if not reverse the housing boom before it does damage to the wider economy via a sharp real estate correction.
Reading Fed tea leaves is always a subjective task, but one could argue the clues are mounting for expecting the central bank to prick the housing bubble. We'll see.
Posted by: James Picerno at January 27, 2006 9:23 AM
I am talking about nominal prices in saying that I don't expect housing to crash. However, nominal and real only become markedly different in a high inflation environment. High inflation really would not be bad for housing as it would drive up wages and housing values would not have to drop that much to become affordable. Also, inflation would decrease the real value of the mortgage money most homeowners owe to their banks, so it might not be such a bad thing for them.
Posted by: quintsquarry at January 27, 2006 9:18 AM
I have not heard anywhere that the Fed's "intent" is to cool the housing boom, as you suggest. After all, the Fed controls the money supply and very short-term rates, not rates that mortgages are tied to.
Posted by: thc at January 26, 2006 11:34 PM
Holcher, the question is who will be able to buy those houses the boomers are selling? If all those boomers are planning on selling to the Gen X and Gen Y folks, they may be in for a rude surprise. People who don't have property already can not afford to get in right now. Housing affordability is low, debt is high, and wages are stagnating. If the cost to enter the market is too high, prices will adjust until they are in line with historical norms.
Quintsquarry, are you talking real price drops, or nominal price drops?
Posted by: d_rumsfeld at January 26, 2006 8:01 PM
Key is relationship of median income to median house prices in their respective markets. Even as we approach end of Feds interest raising steps, residential housing mortgage money is reasonably priced and more so when you deduct one's cost of living from today's mortgage rate and the tax benefits. 5,7 & 10 year interest only loans are available and can carry one out a long time past cycles in the economy. Typically real estate is a hard asset that is good in inflationary environment. Historically inflation is driven by wage increases and now we see what techonology and globalization do to change the old sage formula.
In addition to affordability, supply and demand coupled with cost of mortage money -- watch out for the largest percentage of the population. Boomers are indicating in surevy after survey their plans which include "likely" and "very likely" to sell over next 60 months, willing to downsize, willing to relocate and looking for view and security and perception of tranquility. This is the same group that will benefit from the largest transfer of wealth from their parents that US has experienced.
Don't count on Boomers to go quitely to "Sun City" waiting ground, not after a facelift.
Posted by: Holcher at January 26, 2006 12:27 PM
I think the fed is trying to manage this by raising interest rates, but the long rates are not moving as they would wish. However, I don't think housing will crash. A house is a tangible asset, like a commodity. The fed is increasing the money supply greater than 7% per year, so all tangible assets, including housing should be supported from dramatic price drops based on the additional money supply.
Posted by: quintsquarry at January 26, 2006 11:44 AM