More Real Estate Problems

When you build your economy primarily on the basis of finance and real estate, as the US appears to have done during the past two decades, you are relying on economic sectors renowned for their fickle and unreliable properties. When you then combine them via unscrupulous lending and tricky derivative activity, you are definitively playing with fire. You had better have a back up plan.

Now we all know the US, and many other places had no such plan, and thus much of the GDP growth generated by relying on those chimeric sectors was a total illusion. On the upside the “wealth effect” unleashed a whole lot of consumption as households strutted about in the glow of the inflationary gains they accrued simply by sitting on a home bought years ago. Such folks supplemented their spending by borrowing gleefully as the equity in their homes shot out of sensible limits and into fantasy orbit.

But what the bubble sows the bubble reaps.

So here we are languishing in the worst real estate market in recent memory. Deservedly so. Today’s data shows just how much trouble we are in.

Here we are supposedly enjoying an economic recovery, with many of the top level statistics now well above the terrible floors they all reached a few quarters back. But real estate is still slipping. Sales of existing homes fell 9.6% in February, back down to an annual rate of 4.88 million. That’s down 2.8% on the same month last year. And don’t forget: 2010 saw the lowest level of sales since 1997.

Worse for those wealth effect fans – Alan Greenspan I am looking at you – average home prices continue to tick downwards. They fell to $156,100 last month which is off 5.2% over the past year. So just as all that goodwill supplied extra energy on the upside, now all the price declines are supplying boatloads of negativity on the downside. People feel more poor because their home price is dropping rather than rising. That forces them to re-evaluate the way in which they spend and consume. If a home is no longer the safe nest egg it seemed before, then something else has to provide for retirement. And since we were so dependent on real estate, the depressing shock of realizing it is not safe, is causing a massive shift in habits. All those safe guaranteed retirement plans – the defined benefits or yore – have been replaced by the volatility of defined contributions. Who really knows what they will have when they retire. The house was supposed to offset that instability. Now it compounds it. People are exposed to more risk than ever before. So they retrench. And the economy stalls.

Whether that shift is temporary or longer term will depend on the success or failure of households ability to reconfigure their balance sheets and cash flows.

Right now the evidence suggests that the reconfiguration is going to be longer and more difficult than many analysts first imagined.

The problem is that when we remove the house price inflation from the equation we suddenly find that other sources of wealth, for the average household, have failed completely to provide growth. They have added risk, but no return. Wages are in terrible shape. Most people have insufficient funds to save for much other than a house. And then with wages falling behind over the past three decades, even housing became a risky financial bet requiring marginal risks unheard of thirty years ago.

Not only this but we are now learning that returns on the cost of education no longer cover the cost of that education. The middle class value proposition: go to school and by your own home and you will emerge stable and secure, is being undermined by the economy’s failure to distribute the spoils of growth widely enough. Throw in out of control health care costs and the fabric from which the post-war increase in the middle class was cut is in tatters.

We are going backwards, not forwards. Or at least most of us are. The lucky few are immune to this, which is why today’s real estate numbers reveal that a full 33% of all sales last month were for cash. That’s much higher than usual and tells me that investors are speculating on housing. Those with the cash will make out well. The average household will struggle.

That’s a consequence of building an unequal economy.

It’s going to be a long road back.

What a waste.