Bleak Housing; Brighter Debt

Today’s slightly upbeat report does nothing to mask real estate’s rotten 2010. For the record: sales of existing homes rose 5% in December hitting an annual rate of 4.61 million homes. Part of the increase is accounted for by the revision down of November’s numbers and the rest by the extraordinarily low mortgage rates and continued depressed prices that haunt the market.

The numbers speak for themselves. At the height of the lunacy, in 2005, 7.08 million existing homes changed hands. Obviously we are a very long way from that peak and are highly unlikely to get back there any time soon.

Meanwhile the median sales price edged down agin – to $164,500 in December – bringing prices all the way back to where they were in 2002. An entire decade of stupidity and irrational pricing has come and gone, yet we are not done. Prices look set to decline some more: the average for 2010 was $166,100, so December’s lower figure suggests we are still on the downward slope.

The mix of sales was also revealing. Distressed sales still account for about one third of all sales, while first time buyers accounted for about 30%, well below the usual 40%. Evidently the market is still disgorging the errors made during the bubble and looks set to continue that way through 2012 and into next year. The backlog of foreclosures is still sufficiently large that it will cast a long shadow across the market for a couple more years.

Finally, credit conditions continue to hamper recovery. Nearly one third of all homes bought in December were cash transactions as buyers picked up distressed homes for a song. The banks, the epicenter of the crisis, are still nursing their self inflicted wounds and thus being overly parsimonious with new credit extensions. So having caused the slide they now are working furiously to prevent a full recovery. Minsky must be smiling somewhere at this total vindication of his theories.

Amid this gloom there is good news: US debt ratios and levels are improving. One consequence of the foreclosure mess and the retreat of households from high levels of consumption, is that the process of de-leveraging has begun to have noticeable effect. The US private sector is now far less indebted than it was at the outbreak of crisis. While this improvement has been masked by the rapid run up in public sector debt, the improvement in private sector balance sheets is getting close to the point that we can expect a shift back towards spending.

As you know, I have argued all along that the most important factor triggering a stronger recovery – as opposed to the stagnation we are now lumbering through – is the indebtedness of business and, more importantly, households. The enormous shock to private sector balance sheets caused by the sudden exposure of the asset price illusion built up during the early 2000’s, the consequent collapse in confidence and expectations regarding wage security, and then the realization of the extent of over indebtedness within the private sector, all combined to create a sudden and sharp retrenchment. This sent us into recession and prevented us bouncing back. The retrenchment lingers on because wages are depressed, unemployment still is high, and asset prices have not recovered – notably home prices as I mentioned above. To the extent that this process is now winding its way towards a conclusion, and indebtedness arrives back at more comfortable and sustainable levels, we can expect consumption to accelerate.

It is this acceleration that will, finally, push us back to more rapid growth and allow unemployment to fall.

When will this be?

Sometime in 2014. That’s when, at current rates, debt levels look as if they will finally return to earth from the orbit they have been in for far too long. Until then the economy is at risk from further shocks, and cannot be expected to grow more than fitfully.

One last thing: people often speak as if the run up in public sector debt will hamper this outlook. Not at all. For two reasons.

First: the ability of the US government to issue debt throughout the crisis buffered the economy from the full impact of the private sector retrenchment. The key during a crisis such as ours is to allow those who need to cut debt do so without crippling the entire economy. This implies that someone else, whether in the private or public sectors, needs to keep borrowing. Indeed they need to increase borrowing to mitigate the sudden reversal elsewhere. The alternative is the old fashioned depression advocated by libertarians and classical economists. They have no fear of the social disaster that rapid retrenchment brings, seeing it, instead, as a necessary purging of bad decisions. They are correct to think we need to eliminate the consequences of this bad decisions, through bankruptcy etc, but they fail to account for the downward draft an unbuffered retrenchment can create. It is quite possible, in real world economies rather than in idealized ones, that the private sector will overcompensate for its prior mistakes. If that happens unnecessary harm is done with often irreversible consequences. So using the government’s balance sheet to limit the speed and depth of the adjustment helps prevent this overcompensation and allows for society to heal itself sooner rather than later.

Second: and consequent to the first, the more rapid healing in the private sector then allows growth to resume more speedily also and at at more rapid rates. This sharpening of the recovery then allows government income statements to return to normal – tax revenues recover and expenditures decline – thus limiting and then reversing the run up in public debt.

And don’t forget: most of the debt the government issues, especially here in the US, goes into the hands of local citizens. So the interest paid, often called a burden on the taxpayer, is also an income to those self same taxpayers. In aggregate in nets out – except for the small amount that leaks into foreign hands – and is thus not a burden at all. US taxpayers are lending to themselves, paying themselves interest, and then paying themselves back. At no point is this a burden. Indeed if the proceeds of the loan are used wisely and invested in socially beneficial projects, not only do taxpayers benefit from the umbrella of public sector debt preventing total economic collapse, but they benefit from long term infrastructure construction and other pay-offs from the utilization of the debt.

So even with US public sector debt ratios very high, the outlook for US balance sheets has improved markedly. There is no debt crisis. Not now anyway.