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Max Fraad Wolff

Max Fraad Wolff

Posted: September 28, 2007 03:58 PM

Let's Be Honest, It Doesn't Look Good


The hard times we banished have returned. The economic weakness that the Federal Reserve was going to head off, and that the tax cuts assure against, just pulled into your driveway. Just in time for the Christmas season, too! Housing markets have provided us with easy credit, rising wealth and a share of the growing prosperity that everyone loves to talk about. Not anymore. I will go through some of the recent news and numbers below. The real story you already know. Tougher times have arrived for America. Housing will be costing people their jobs. Before, inflating homes got folks employed. Retailers will suffer as shoppers can't cash out the equity in their homes. That wealthy feeling people get when their assets increase in price will run in reverse. We have been through it before and we will survive. Honestly, it looks just plan lousy over the next 12-18 months. There will be bright spots and advance warning is always valuable.

A Few Flogs of the Dead Housing Horse

On Tuesday, September 25, 2007 the National Association of Realtors (NAR) released its latest numbers on the median price, sales rate and inventory of homes for the month of August 2007. I will refer to these numbers below which can be accessed here. The news is not good! Prices, as measured by NAR, were ever so slightly up. Existing home sales rates fell dramatically and inventories of unsold homes hit multi-decade highs. Existing home sales were down four percent since July 2007 and 13 percent since August 2006. Co-op and condo sales fell further with an eight percent decline since July and a 12 percent decline since August 2006. There was an inventory of 4.6 million unsold homes at the end of August. This is a 10 month supply of homes and is a level at or above the record. The widely tracked 20-city S&P/Case-Shiller(R) Home Price Index declined four percent between July 2006 and July 2007. This is the largest home price decline in more than 15 years. At the same time leading retailers and home builders reported disappointing numbers with larger than expected declines. Target and Lowes both indicated that they have experienced difficult Septembers. Even Toyota Motors is not looking for September sales growth. These are well-run, popular, leading firms. Consumer sentiment also fell to a two-year low. Oil is stubbornly expensive, food prices are rising and the U.S. dollar is in free-fall. All this just says what we covered above in different language.

On Friday, September 28, 2007, we learned that personal income continued its very modest growth and spending continued rather immodest growth in August. Current dollar personal income grew at a very modest .3 percent and spending increased by .6 percent. Spending growth outran personal income growth by $14.6 billion in August. In the month of August, personal receipts on asset income increased by $15.7 billion. The total month over month increase in wage and salary disbursements to all private sector employees was $12.8 billion. It was a better month to be living on dividends and interest than labor income. There have been many such months across recent years. It was another very weak month for savings. Officially, the personal savings was .7 percent of personal income in August 2007. This offers some clues as to how we got here.

How did we get here? Where do we go from here?

Let's start with the how we got here. This is America so the official blame game distraction will start as soon as the powers that be acknowledge that trouble exists. This generally happens a few weeks after everyone already knows. We got here trying to borrow and speculate our way out of a recession. After the tech bubble burst and the late 1990s growth spurt hit a wall, the economy careened toward trouble. Fearing an angry and indebted public, Congress, the Fed and the president decided to fib, speculate and induce America to borrow out. It worked, sort of and in the sort run. In the period from 2002-2006 we borrowed at cheap rates from the ocean of available credit. This was concentrated in housing.

The housing debt explosion is breathtaking. In 2001 there was $5.5 trillion in outstanding mortgage debt in the U.S.. Halfway through 2007 there is $11.6 trillion. It turns out that borrowing and spending on housing and all things housing led an employment, spending and recovery boom. The problem this created was a dependence on housing and debt. More and more debt was required to generate less and less growth and employment.

The Harvard Joint Center for Housing Studies, The State of the Nation's Housing 2007, reveals that mortgage payments as a portion of income in the average household have increased 25 percent to 25.4 percent of owner's income. From 1995-2006 Americans withdrew $1.343 trillion in home equity. In 2006, $1.5 trillion in non-prime mortgage origination took place, 51 percent of the market. There was 600 billion in subprime and $400 billion in Alt-A loans issued. Thirty-seven million Americans spent more than a third of the income on housing. In 2006, the ratio of old to new loans on refinanced homes was .94. That means that the old loans were either on better terms and/or for significantly less money. The last time this was true was 2000. We have borrowed every dollar we could get. We have extracted equity like there was no tomorrow. This has tided people through but, left them with mountains of debt. Borrowing and spending today assures earning more and spending less tomorrow. It looks like tomorrow is coming.

So far official response and wisdom is to deny trouble and attempt to make cheaper, easier credit available to solve the problem. This is exactly what created the problem. People can't afford the spending they are doing or the debt they have accumulated. Thus, making more debt available, at lower prices, will only help so many and so much. Many folks need to make more and spend less. This means that take home pay needs to rise and spending needs to fall. If left to market discipline, this will be a painful process for many. If we attempt another quick fix we run a risk of failing or buying time by creating a larger future downturn. I have no doubt the later course is now being attempted. I have little faith it will work. It is far from clear that putting off the correction and creating greater future difficulty is wise.

We have used housing as crutch. The weak and upward-skewed "recovery" since 2003 can not absorb the blow of a housing downturn. It is now being asked to absorb one of the largest and most significant housing corrections in decades. Thus, we are likely to be at or near official recession economic conditions by the start of 2008. Ironically, in 2008 as in 1992, it's going to be about the economy.