Housing and the Economy: Bottoming Out?

Submitted by
CalculatedRisk on Sun, 10/22/2006 - 7:17pm (39 comments)
Shtarbucks wrote on Sun, 10/22/2006 - 10:23 pm

Is it possible that the purpose of Goldman's newsletter is to attract new clients and capital rather than portray an accurate picture/forcast for the economy?

BB wrote on Sun, 10/22/2006 - 11:09 pm

Better than yesterday's graphs (as far as detail).
The short-term trend is right up front, in your face.

Bill wrote on Mon, 10/23/2006 - 1:55 am

Recently, the Wells Fargo CEO stated that housing should recover next year, now that the speculators are out of the picture. The postive buying of speculators is now gone, but many speculators have yet to sell their positions. Thus, the negative effects of speculative buying are going to get worse. As indicated by this post, economists, analysts, realators and others seem to misunderstand the time lags involved in the adverse effects of the housing bust on the economy.

Bruce Webb wrote on Mon, 10/23/2006 - 2:00 am

Explosive decompression (pop) or decompression (leak), I don't think anyone is seriously quarelling that there isn't some swelling in the housing limb but some people are suggesting lancing the wound while others insist on total amputation.

The noise of the bone saw may be outweighing the notice that the fever has peaked and the patient, while still ill, has been moved from critical to serious. Ironically because surgeons Baker and CR told us months ago that if we didn't take some preventive steps we would lose that leg.

I can't put it into numbers, but just by following the narrative it seems that there has been some unwinding, recent weakness in the Las Vegas and Phoenix markets being a positive thing overall.

I saw the Tech Bubble close up. I saw friends taking their sweat equity out of their houses in the way of a second mortgage and puttting it in tech stocks, I had a good friend who was worth an easy seven figures on paper who refused to take even 20-30% out of the market, no Cisco had nowhere to go but up.

Were there really serious websites and consensus reporting that tech was overinvested to match current reporting on the housing bubble?

It will be one of the ironies of history if Baker and CR get no credit for foresight because people ended up listening to them. "Sure everyone knew housing was too hot". Except those that didn't. But how many people are still leveraging themselves to the max to throw money at housing?

I know it was happening 18 months ago, I saw (and posted about) an ad for a luxury condo here in Seattle that said there was a strict two unit per buyer limit. Which when analyized meant the developer was worried about internal compeition, if the market suddenly softened he didn't want to be stuck with an inventory of a dozen units and competing against a guy with a block of six for resale. If the sky was really the limit then there would have been no reason to restrict the supply.

"Pop'? or 'Hiss'? Landing hard or landing soft? A lot of rhetoric has built in crash when we may just be experiencing a downdraft.

jmf wrote on Mon, 10/23/2006 - 3:22 am

hello from germany,

ca renter on bens blog has found something rella good from bloomberg.

The ABX index, which measures the risk of owning bonds backed by home-loans to people with poor credit, rose 30 percent since Aug. 9 to the highest since January. There are more than $500 billion of such notes outstanding.

quite a jump......
summary immobilienblasen: Housing Slump in U.S. Poised to Worsen, Derivatives Trades Show

DaveL wrote on Mon, 10/23/2006 - 4:31 am

Fascinating, and startling. If you're right, which I believe, then the usually reliable and insightful GS economists are missing the entire lag structure of housing construction's cycles. Which implies that so is a large swath of the investment community. I wonder what other indicators we could check and what the implications for taking advantage of this investment-wise might be ?

Notice that arguing about lag structure and economic impact comes before asking our recurring question about starts vs over-hangs - which we've collectively guestimatted at 800K-1.2M houses. Or almost an entire year's activity ?

MEW would seem to be another matter as long as rates stay low, unless and until the proportion of the population with the riskiest finances gets caught up in rate resets and other adjustments. From the chart one has to ask though have we reached a new world where MEW is a permanent part of the landscape ? Or will it return to something closer to historical characteristics ?

Bob_in_MA wrote on Mon, 10/23/2006 - 4:41 am

There is a Bloomberg article on the subprime backed bonds falling. The credit default swaps on these jumped 30% in two months. That's what I would have liked to invest in, but you can't trade those at Scottrade. Wink

OkieLawyer wrote on Mon, 10/23/2006 - 4:58 am

Are there any charts that show the effect on construction-related industries from the California real estate bust in the 1990s?

Bob_in_MA wrote on Mon, 10/23/2006 - 4:59 am

The GS piece clearly fails to see a distinction between starts and completions. We won't know the effect of the inventory bubble until it's done expanding and that won't occur until completions equal current demand.

But if you believe the over-all economy will suffer from the loss of construction, real estate and lending jobs, and a decrease in MEW-generated consumer spending, demand for housing becaomes a moving target.

They could be right that we will miraculously have a soft landing, but we won't know that for six months or so. At this point, it's just an optimistic guess.

However recent data from the Mortgage Bankers Association (MBA) shows a rise in refinancing activity in Q3 2006, so MEW might have increased again in Q3.

Actually, I don't think that's necessarily true. Remember, the MBA only represents the more reputable half of home lending. There are a lot of people who took option or I/O ARMs who are getting out of them and moving to more traditional loans, and that probably involves some movement back to local banks.

edhopper wrote on Mon, 10/23/2006 - 5:42 am

I find this laughable. Have these guys ever study Economics?
We have the biggest Housing Bubble in history. Followed by a slow down with prices stayinf flat or declining about 10%. And after less than a year the downturn is over. That has to be the shortest housing cycle ever. Do prices return to the mean? No. Does the affordability index correct? No. Does housing, perhaps the biggest growth factor in GDP the last 5 years impact the economy? No.
Idiots.

Jim a wrote on Mon, 10/23/2006 - 6:08 am

A cursory look at the chart would seem to indicate that MEW would be even further down if seasonally adjusted. It lookse like it usually bottoms out in Q4 or Q1 and is generally higher in Q2 or Q3. But it is a noisy enough series that seasonal adjustment is minimally helpful.

ac wrote on Mon, 10/23/2006 - 7:40 am

I think the real key question here is whether the MEW effect on consumption is immediate or delayed (or altogether non-existent). Certain anecdotal evidence suggests that it may be delayed (e.g. consumers use MEW to pay down credit card debt allowing them to load up more in the future).

Also I think the more generalized wealth effect (especially with regard to retirement expectations) may be delayed - Americans in general seem to think the value of their homes will continue to increase over the next few years.

Having talked to some people about recent events the responses I get are along the lines of: "Well maybe home values will go down, but not my house!"

dc1000 wrote on Mon, 10/23/2006 - 7:51 am

yet the market continues to diverge from the expectations laid out here...

and by market i mean the stock market.

Skip Savage wrote on Mon, 10/23/2006 - 7:57 am

I call the unfailingly bullish readings "stockbroker economics". If you have a vested interest in rising markets, it's not surprising when you report that trouble is behind us and the market looks inviting.

skytrekker wrote on Mon, 10/23/2006 - 8:13 am

I would heartliy agree with the above poster who said 'this has been the shortest housing cycle ever' and after record price rises in the most important geographic regions of the country and rampant speculation- this is the tiny little 'correction' we get?

Affordability has reached an all time low- debt levels are at an all time high, and savings at an all time low. And we have vast demographic changes looming around the corner.

Seems to be there is going to have to be a major correction 'to the mean' and with stocks being 'eerliy' pushed higher on weak fundamentals- the perfect storm is looming.

Greed will bring more people into stocks- perhaps taking equity out again to buy into the markets.

Hopefully they will be smart enough to know when to get out- but from all indications from the past- that seems very unlikely.

Paul wrote on Mon, 10/23/2006 - 8:19 am

My nerdy question for the day:

We hear so much about productivity in other businesses, and how it is allowing the US economy to expand with out a lot of additional wage expense. My question is, does anyone know how productivity has changed over the last 20 years for the home-construction industry? I'm no builder, but it seems like new houses go up with alarming speed these days (alarming as in, I'd be worried about living inside it). I'd be interested in some sort of comparison between housing completions and overall residential construction-related employment. In otherwords did it take 35 FTE workers to build your average tract home in 1990 but only 26 FTEs now?

If there is a difference, I suppose that it could either magnify or reduce the effect of any housing slow-down, depending upon, naturally, just how overbuilt the home builders are.

Anyone have any ideas?

k harris wrote on Mon, 10/23/2006 - 8:27 am

Paul,

Depending on how much you want to read, this could be a place to start:

eLCOSH - Electronic Library of Construction Occupational Safety and Health

Atlanta_Renter wrote on Mon, 10/23/2006 - 8:36 am

Here's an interesting article that attempts to estimate "Existing Homes Sales and Employment Growth Cycles" and "Peak to Trough Lags for Existing Homes Sales and Employment Growth".

"Housing and Retail Trends Likely to Weigh on Future Employment
Growth" Market WrapUp by Chris Puplava - Financial Sense

Paul wrote on Mon, 10/23/2006 - 8:36 am

Thanks K! Good stuff -- I'll have to go over this one at length.

foo wrote on Mon, 10/23/2006 - 8:37 am

Don't forget there's an election around the corner, and many people have a vested interest in making things look brighter (or dimmer, for that matter) than they really are.

Don't expect honest, realistic analysis until after Nov 7

Jose Padilla wrote on Mon, 10/23/2006 - 8:57 am

Since '03, completions seem to have been less than starts, even taking into accound the six-month lag. Why? Are there a lot of half-built houses around? Is there any reason to believe completions will outpace starts as the market cools down (seems to me it would be the opposite as builders go out of business)and this will sustain employment?

realist wrote on Mon, 10/23/2006 - 9:13 am

home prices should continue to fall until there is some semblance of parity between rents and 30 year mortgage payments. without the speculator, or cap rate driven investor, who, aside from the owner-occupant, is home buyer. if the owner-occupant can't afford to buy a home, then there are no home buyers.

saleries have been stagnant for 35 years. so, if saleries don't go up, then home prices must continue to come down until they are affordable.

Troy wrote on Mon, 10/23/2006 - 9:31 am

then home prices must continue to come down until they are affordable.

or financial products make them affordable. Hello 50 year mortgage.

Kett82 wrote on Mon, 10/23/2006 - 9:50 am

To foo:

I’m no conspiracy theorist, but interesting to note that the current Treasury Secretary was Chairman and Chief Executive Officer of Goldman Sachs.

To jmf and Bob_in_MA on ABX Index:

I wonder where Goldman is placing its bets. In the ABX Index, perhaps? One interesting thing in that article was this:

“Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co. in Newport Beach, California, forecasts the housing slump will cause the economy to slow and force the Fed to lower interest rates to 4.5 percent next year.”

But with creeping inflation, how does Behanke manage to do that?

A fine conundrum indeed!

charts wrote on Mon, 10/23/2006 - 10:10 am

"Recently, the Wells Fargo CEO stated that housing should recover next year, now that the speculators are out of the picture. The postive buying of speculators is now gone, but many speculators have yet to sell their positions. Thus, the negative effects of speculative buying are going to get worse. As indicated by this post, economists, analysts, realators and others seem to misunderstand the time lags involved in the adverse effects of the housing bust on the economy."

Wells Fargo is a huge HUGE originator of mortgages. It's a huge part of their business, and possibly accounts for most of their revenue growth over the past couple years. What do you think they're going say?

My girlfriend interviews chinese manufacturers for a living. She tells me when a manufacturer is presented with evidence that its industry might slow a year ahead, nearly every manufacturer acknowledges the oncoming slowdown but says it won't really effect their business.

Paul wrote on Mon, 10/23/2006 - 10:31 am

Jose-

I think completions always are lower than starts (even in "normal" markets) simply because something is counted as a "start" as soon as the building permit is approved. Lots of builders get permits approved for entire developments, but as we have seen recently may only do the first few phases, or even sell the land to avoid having to carry it on their books.

Dirk van Dijk wrote on Mon, 10/23/2006 - 10:42 am

CR,
What is the economic significance of those periods like the mid 90's when MEW goes negitive. Is that just the normal amortization of the mortgage or is that people sending in extra with their mortgage check to prepay principal?

CalculatedRisk wrote on Mon, 10/23/2006 - 12:01 pm

Dirk, based on my method for calculating MEW, the negative periods can have several possible causes: Homeowners in aggregate are 1) putting more moeny down when buying a house, 2) they're paying down their mortgages, 3) paying for improvements (new kitchen, etc.) with savings and not new debt.

Also, because of the simple method I use, more apartment construction makes MEW look lower (a problem with my approach). Unfortunately there is no easy approach based on available data.

Best Wishes.

wstephens wrote on Mon, 10/23/2006 - 1:22 pm

Is there a number somewhere for how much total outstanding MEW has accumulated over the past, say, 5 years?

winjr wrote on Mon, 10/23/2006 - 2:31 pm

"yet the market continues to diverge from the expectations laid out here...

and by market i mean the stock market."

DC, does it really matter?

We could just as well have been blogging about the huge internet inventory buildout in the late 1990's, and looking to the 1999 stock market for confirmation that our fears were unfounded.

Even when the internet companies blew up in March, 2000, the common bull argument was "don't worry, the internets are such a small part of our economy". Then the big boys (CSCO, LU, Etc.) blew up a few months later, recession followed and the stock market took a massive hit.

What precisely led to this mess was an inventory buildup in the tech sector. An even more massive buildup of housing inventory, impacting a much greater swath of the economy than tech could even dream about, doesn't lead me to put much faith in the notion that "The Stock Market Has Got It Right".

dc1000 wrote on Mon, 10/23/2006 - 5:19 pm

yeah but the SP500 is trading at 17x last year's earnings and we are having yet another double digit increase....

the firms are making money and the market is trading within reason with respect to P/E.

its not enough to just disregard whats happening b/c at some point in the past the market traded like 20 to 30 times and some stocks traded at infinity vis a vis earnings....

sharkbait wrote on Mon, 10/23/2006 - 5:52 pm

The prevaling view on wall street now is that housing has bottomed out. The GS analyst is in line with concensus. Thats what Alan toll us after all. Alan knows best.

winjr wrote on Mon, 10/23/2006 - 6:33 pm

DC, I disagree that the market is trading within reason with respect to it's P/E. The current multiple is historically high. Corporate earnings are at record highs, and are now at the top of their historical 6% growth trend line. Profit margins are at record highs.

Is it reasonable to expect corporate earnings to continue these streaks? At a time when the economy is clearly slowing and may even contract?

Because the market traded at 20-30x earnings in the past, is no statistical justification for the market to trade at 18. The historical average is around 10.6, and this includes even the go-go years of the late 1990's.

I do not disregard what's happening with the markets. I just feel it's irrelevant when analyzing where economic growth may be headed. The stock market reflects the past and present. It's never been a very reliable indicator of what is to come. And I would never allow my opinion to be swayed just because it differs from the majority opinion.

Anonymous wrote on Mon, 10/23/2006 - 7:02 pm

In dec 2000 s&p500 earnings was 50.00, in dec 2001 it was 24.69, p/e's wont look so good anymore if e gets cut in half and it will happen again sometime

todays p/e of 17 would be 34 asuming the market didn't move while earnings went down 50%

dryfly wrote on Mon, 10/23/2006 - 7:09 pm

dc1000 the stock market never predicts the future - never has. If it did no one would have been sucked-in in 1929.

It's similar to SPC charts - they work great as predictors as long as everything behaves like it did in the past - once something 'changes' the records of the past have no relevance to the future.

The market is exactly the same.

The billion dollar questions are (1) 'Do you think there is a major housing decline?' (2) 'Do you think a housing decline will have an impact on the economy & then as a result the markets as a whole?'

If you answer 'No-No' or 'Yes-No' or even 'No-Yes' (as in 'No, there is no decline but if there was there would be an effect')... If you sign up for any of those then there is no reason to question the run up in the market. Heck then you should borrow against all your other assets & pour them in to the market too.

But if you answer 'Yes-Yes' as in 'yes there is a decline and it will have a measurable effect'... then you have reason to be cautious. I'm cautious.

BTW - I'm heavily in the market too right now, have been since the early 90s. Didn't panic in 2000 - let it ride & glad I did. Though I wasn't into 'tech'.

But I'm older now & have less time to 'catch up'. I'm seriously rethinking my asset allocation right now. I can't imagine I'm alone.

I wouldn't put much faith in this run up as a predictor.

dryfly wrote on Mon, 10/23/2006 - 7:16 pm

I guess to sum up what I was thinking - I wouldn't get too giddy about the market run up.

Instead I'd be looking for a safe hiddy hole to put my winnings when I take them off the table.

I'm doing that thinking now but slowly, I hope I have time. But everytime you post one of these 'Whooopie! S&P 500 ROCKS!!!' makes me want to move a little faster.

vicjim wrote on Mon, 10/23/2006 - 8:04 pm

Dryfly I agree with you. As an experienced investor my opinion is large company stock prices are about average in relation to economic variables and better value than many investment alternatives. However, the market looks a little overbought (high) in the short term (next month?) and is also risky because of potential fallout from weaker housing. It's a good time to focus on the highest quality companies or keep stock market exposure relatively low.

dc1000 wrote on Tue, 10/24/2006 - 4:47 am

dry -

my main point is that i'm confused and i think a lot of people are. i could be a yes-yes guy i dont know. i'm one of those manufacturing companies that knows a slow down is either here or coming but it wont impact MY business (ha). my personal prospects are very good, i'm in this housing business, AND the market is smoking hot.

but yet i read this blog every day because clearly something is afoot -

i bring up the markets to point out another dichotomy i see.

as i've said all along - i'm confused.

has it always been this confusing?

PS Puts on the market are starting to sound better and better every day

Jim a wrote on Tue, 10/24/2006 - 9:36 am

Judging by the unsettled market in RE that we have now, many speculators still expecting the moon. Even if the front seats are dipping, the roller coaster isn't bottoming out if the people in the rearmost seats are still looking at the sky.

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