home prices

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Double Dip Recession?

I realize that this is a lower than 50/50 probability, but the data this week has me thinking that, unless something ‘turns up’ we could be in for a nasty surprise sometime next spring. We may get a couple more quarters of contraction. And as we all now know two quarters of GDP contraction is a recession. So are we in for a ‘double dip’?

Here’s the data:

  1. All the signs now point to a recovery in manufacturing. The ISM index on Monday rose close to the mythic 50% level that indicates expansion in manufacturing. Today we learn that inventories are still declining slightly – after ten straight months of decline – so there has to be a turn around in inventory levels soon else the stores and factories will be entirely empty.
  2. This inventory recovery is a very typical factor in driving an economy out of recession because as businesses crank up production to restock they need to re-hire workers. that sets in motion a ripple effect – the newly re-hired workers can now buy stuff, that boosts demand, that depletes inventories, which requires even more restocking. And so it goes.
  3. But. The big point to remember is that ‘re-hiring’. Without it the engine sputters to a halt once more, and after the initial euphoria of recovery the economy gets that sinking feeling. You know: the kind of feeling you get when you miss a step and you realize there’s no firm ground right where you imagined a solid footing.
  4. Which brings us to the employment news: ADP reports today that payrolls are still shrinking at over 300,000 a month. the good news is that this rate of job loss is nowhere near as catastrophic as it was last summer. The bad news is that the backlog of people needing a job is now enormous – long term unemployment, defined as people looking for a job for more than twenty-six weeks, is now at a level unseen since the Great Depression. This, to be blunt, is not good.
  5. Why? Because consumers are so battered they are not spending. They are saving. And without consumption coming back any hope of sustaining a recovery gets really remote. Yes we need consumers to repair their balance sheets so they feel financially secure – rotten home values have knocked the stuffing out of household wealth, and the stock market has rubbed salt in the wound – but we need them to spend enough to get the engine running smoothly. So all eyes are on consumption.
  6. Meanwhile, lower mortgage rates, and those ‘rotten’ home values, seem to have enticed some buyers back into the housing market. Mortgage applications are rising slightly. That tells me the bottom of the housing market may be in sight. Unless this turns out to be a false dawn: to keep the market humming we need plenty of nicely employed buyers.
  7. Which brings us back to jobs. Without a turn in the jobs market we run the risk of our incipient recovery running out of gas early next year.
  8. Ergo ‘double dip’.

It’s an easy story to piece together based upon current data. All the joy at the recovery in manufacturing means nothing unless it produces jobs. The manufacturing sector is much smaller than it used to be and its ability to be a driver is diminished – we may simply end up re-hiring in our ‘off-shored’ facilities. Which is great for profits but not for the economy at large. Non-manufacturing is where the action needs to be, and with banking in a self-inflicted stupor – except for the traders making millions – getting much action there may be too big a task.

Oh, and by the way, don’t go around saying it’s up to small business either: a recent report shows that the mythological power of American small business – as the true all-American centerpiece of capitalism – is just that. A myth. Apparently we have less of a small business sector than most other industrial countries. We rely on big employers. And they’re all to busy cutting costs and off-shoring.

Whoops.

So is this double dip scenario likely? Less than 50/50. But we had better see a uptick in hiring this year or else those odds shorten dramatically early next.

Addendum:

One more thing: with approximately 15 million households having their mortgage ‘under water’ – the value of the mortgage is more than the value of the house – the chilling effect of the drop in home prices will roll on for a long time. Think about that: there are millions of people who cannot relocate to get a better job, or who cannot move to a larger home to accommodate a growing family, because in order to make such a move they’d have to take a loss on their home. Not just a ‘paper loss’ such as that taken by a long term home owner who bought a home years ago at pre-bubble prices, but an actual cash loss.

This is the kind of problem that works behind the scenes to corrode the outlook. It chips away at confidence and fuels the need to switch from consumption to savings.

From an aggregate point of view we have to locate a factor that will offset something like this. Will it be a boom in manufacturing? I don’t see that. Construction? Nope: we still have an overhang of unsold homes. Exports? No again: to whom will we export – they are all in the same boat we are. Business investment? Unlikely if they see that consumption isn’t coming back strongly. What then?

Government spending. Another stimulus. Think about it.

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Today’s News: Home Prices and [Lack of] Confidence

Two pieces of news were released today: the Case Schiller Index of home prices, and the Conference Board’s consumer confidence survey. The message: very mixed.

The good news is that for the first time since 2006 there was a slight increase in home prices across the country. Prices in the twenty city index rose 0.5% in May, the latest month covered, compared with a 0.6% drop in April. This slight pick up had the effect of slowing the annual decline: for the year ending in May the same index shows a decline of 17.1%, whereas the decline for the year ending in April was 18.1%.

The message here seems to be that the bottom of the housing price cycle may not be too far away. Whether there are one-time effects at work distorting the figures we will have to wait and see next month: for instance, the activity created by recent tax credit for first time home buyers may have produced a slight firming in prices. Nonetheless when we add this data point to the decent new home sales figures yesterday the overall tone of the real estate sector does seem to be improving. This is a long way from a recovery – and there are plenty of reasons to hope we don’t get back to the way we were a few years back – but at least the dizzying descent appears to be drawing to a close.

That is not the message we get from consumer confidence which dropped unexpectedly last month. The index now stands at 46.6, whereas it had been 49.3 in June and 54.8 in May. So clearly there has been a significant souring in the public’s mood over the past two months. The importance of this is clearly linked to consumption: as long as consumers feel less confident they will tend to spend less. That will undermine any incipient recovery.

In all likelihood we will see the end of the recession later this year for the simple reason that inventories will need replenishing and that drives GDP upwards – just as any investment does. Whether there is enough activity to maintain growth into next year is now the question. The optimists are still calling for overall GDP growth in the 2% range during 2010, a series offadingconsumer confidence figures and we have to question that optimism. With real estate investment unlikely to recover much strength, and with businesses still waiting for stronger signs of consumer activity before the commit to re-hiring the best guess for GDP next year is slow – perhaps closer to 1% than to 2%. That will have all the hallmarks of stagnation: a poor employment market along with very low growth.

We really need the employment picture to change quickly if we are to avoid such a stagnation. It is very hard to see why consumers would suddenly start to spend much again without a decent job outlook.

Anecdotally the stimulus is now kicking in by stemming job losses, and we are getting the first proper analyses supporting that view. If that turns out to be a true trend then the hope is for the rising tide of job loses to taper off later tis year. Unemployment will still keep rising, but the damage to consumers will abate as they realize they have weathered the storm. Once the tide turns in the job market the rest of the economy can fall into place.

We will get a better handle on that later this week with the weekly initial claims data. Then on Friday we will get our first look at second quarter GDP, which should come in around at a decline of 1.5% – the first quarter saw a decline of 5.5%. If that is the case then this will be a rare four quarters in a row of decline, but it will also give us hope that the third or fourth quarter will see a return to growth.

Stay tuned.

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Green Shoots Watch: House Prices

This has been a fairly quiet week for news. Everyone seems to be headed for a break earlier than usual, maybe hoping that the entire recession has been a bad pre-summer dream. Undaunted I continue to scour the data for signs of those green shoots promised us by Ben Bernanke three months ago.

This morning’s home price release definitely falls into the category of a very small green shoot – green sprout may be a better description.

Standard and Poors puts together and index called the Case Schiller Index which measures the prices of homes as they are sold and compares that price with previous sales of the same home. It thus tracks very carefully the price history of housing. The index is compiled for large areas and cities across the country and has become the most reliable indicator of home prices in the US.

This morning’s news relates back to prices in April and compares them with both March of this year and April 2008.

It seems as if the price of homes is still falling, but that the rate of decline is slowing quickly. That indicates that the bottom of the market may be approaching later this year.

The ‘Twenty City Index’, which unsurprisingly covers that top cities in America, fell 18.1% over the year ending in April. That’s a very slight improvement from March when the equivalent annual decline was 18.7%.

The worst declines were in the usual suspects: Phoenix prices fell 35.3%, Las Vegas 32.2% and San Francisco 28.0%. Cities such as Charlotte and new York both experienced record declines this last year.

So the declines continue, but there is just a hint of a slowing effect. The regional differences are significant with the sun belt suffering almost calamitous declines: for example, since they reached a peak three years ago prices have fallen over 50% in Phoenix. Las Vegas is just as bad and had the worst decline last month as well.

For the country as a whole prices are back roughly in line with where they were in 2003, and have fallen about a third from the peak in early 2006.

The implied elimination of wealth has had a massive dampening impact on the economy. As wages or salaries failed to grow significantly over the past ten years, consumers increasingly turned to the equity in their homes for cash. They also felt comfortable spending a much higher percentage of their incomes, rather than saving, because they saw the value of their homes rise quickly. The collapse of home prices has thus cut off a major cash source and eliminated savings for millions of households. While the savings were always illusory – they don’t exist until the home is actually sold – the cash effect is very real. We now have a middle class that feels much poorer and is less secure than at any time in several decades. At the same time certain costs such as health care and college tuition are rising at unprecedented rates. The consequent pinch on consumption was a major contributory factor in the economy’s implosion at the end of 2007.

So getting a firm price footing for housing is essential to a rebound. But we should be careful about lauding a turn about in housing: the lost wealth will have a lasting impact and will tend to drag down spending for years. Anyone unfortunate enough to be retiring this past year is facing a massively impoverished life compared with what they imagined even two years ago. And anyone approaching retirement has to face the possibility of working longer in order to recoup their loss: if they were relying on the value of their home as a ‘nest egg’ the shock and disappointment must be immense.

So is this a green shoot?

I think so. As I joked: a very slight one. The housing market remains very sick and is likely to stay that way for a while. Prices are not about to rebound. There is simply no earnings strength to justify price increases much above the inflation rate for a few years. Couple that with much tighter credit conditions and higher mortgage rates – no more sub-prime loans – and the housing market won’t witness the frothy conditions of the mid 2000’s for a long while, if ever.

Having said that: housing is still heavily subsidized: mortgage interest and property taxes are still tax deductible. Even in our deficit riddled times I can’t see the political willpower to eliminate this welfare for the middle class, so the lost revenue to the government – about $40 billion a year – will continue. As will the skewing that the subsidy makes in the economy overall: we spend too much on housing because its cost is artificially lowered by the government. Were the tax deductions eliminated home prices would fall to an unsubsidized level. Conversely: the continued subsidy keeps home prices higher than they otherwise would be.

To sum up: the outlook for housing is improving very slightly: prices are still declining, but less quickly than before. This summer should be a great time for bargain hunting. By this time next year prices should have fallen as far as they are likely to go. But there will be no huge rebound, and there will still be bargains as people are finally forced to acknowledge the reality of the new price levels.

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Housing Woes Continue

We all know the housing bubble, and the policies that enabled it, are a prime cause of the current crisis. So watching every bit of housing data has become something of an obsession. The problem with this, of course, is that month-to-month changes are notoriously inaccurate guides as to the underlying direction of any economic statistic. Housing is no exception.

But clusters of data can provide more insight.

So if we take today’s reports on the housing market, mix in yesterday’s home price data and then look at broader indicators such as unemployment and incomes we are better positioned to discern what’s going on.

The short answer is that housing continues to wallow in very bad shape. I just don’t see a healthy housing market for years to come. If, on the other hand, your concern is bargain hunting, then 2010 is beginning to look good.

First the news:

Today’s data shows that home sales rose 2.9% last month. That’s not a very significant change and should be ignored as a sign of the market having hit bottom. Let’s see a few more months of steady gains before we break our the champagne. Especially since almost 45% of all sales included in the data were distressed properties, and overall sales were down 35% from their peak three plus years ago. Bargain hunting is the theme of the moth..

Some of the details are astonishing: the unsold inventory of homes priced over $750,000 is now a gargantuan forty months. Such is this overhang that the realtors are calling for more government aid to help this part of the market. I say no. Cut prices. Our problem is that we massively over-built homes at the higher price points as every developer piled in to exploit the bubble. Affordability issues were thrown aside as long as exotic forms of credit were made available to enable enough people to buy these expensive properties. In other words it was not basic income strength that provided the flow of buyers, it was the collapse of credit standards. So we have an inventory of high end properties far in excess of the number of properly qualified buyers.

Throw in the fact that incomes are stagnant, and have been for years, and that most consumers are trying to reduce rather than increase debt loads, and the only conclusion I can come to is that the high end property market has a very long way to go before it reaches stability. And that must include much more aggressive price cutting than we have seen so far.

The low end of the market seems to be adjusting more quickly, largely because the flood of foreclosures has forced a downward shift in pricing, and the government’s new home owner credit is encouraging first time buyers to take the plunge.

Given the impact that distressed properties and government credits are having, and the fact that even the lower priced homes have an unsold inventory almost twice ‘normal’, there is no way the housing market can be viewed as functioning remotely well. The very weak outlook for unemployment over the next year only adds to this conclusion: the huge over supply of homes is weighing so heavily on the market that, without outside help, the market just seems frozen.

So when will it recover?

Who knows?

The imbalances remain huge. Price stickiness – they come down slowly and erratically rather than smoothly and quickly – prevails, especially in markets like New York. Yet the signs of adjustment are there: New York saw its largest ever price reduction just last month, so reality is creeping in. Finally.

At this rate 2010 or even 2011 seems the best bet for housing to arrive at its new balance. Hopefully one stripped of its obscene price inflation and destructive support, both from the government and from the banks. Perhaps then we can rid ourselves of the folly of biasing our economy towards real estate. Home ownership should be viewed as any other transaction and not privileged with excessive government assistance. It is time to abolish the tax deduction afforded mortgages. It is expensive and skews household savings away from more productive uses. It drives up home prices by creating excessive demand. In the new era of Federal budget austerity that should follow our current malaise, I hope to see this welfare for home owners ended.

Addendum, May 28th, 11:30 a.m.:

This morning’s data on new home sales, as opposed to existing home sales, confirms the housing slump is far from over. Prices are down about 15% from this time last year; and the volume of sales has dropped a whopping 34%. The latest release was an estimate of 352,000 sales at an annual rate, which is the preliminary number for April. The previous estimate for March was revised down slightly to 351,000. Unsold inventory is stuck above ten months. Clearly the housing sector has a very long way to go!

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Mixed News

This morning brings more data to support the notion that the worst is behind us. But along with it is evidence of the long road ahead. In other words a typical day for this point in a recession.

  1. First the good news: consumer confidence, as measured by the Conference Board,jumped quite strongly last month and is now back roughly where it was in September last year. So the glum despondency of the winter months has been lifted. Maybe it’s the prospect of summer? The rise in the confidence index, from 40.8 in April to 54.9 in May, caught most people by surprise and is the fourth largest one month jump in the index’s thirty-two year history. Notably respondents told the survey compilers that they thought jobs were easier to come by than last month. That seems to be more aspirational than factual, nonetheless sentiment will play a key role in resolving our economic ills, so even this will help if it causes people to spend more freely. Still, we should remember that, at 54.9, the index is still very low by normal standards. Readings in the 70’s are more healthy, so we obviously have a very long way to go in order to find consumers truly breathing easily.
  2. Second: today’s release of the Case-Schiller home price index confirms that house prices are still falling across the country. The index measures home prices throughout the nation and particularly in the top twenty metropolitan districts. All of those twenty districts saw price declines in March, which is the latest available data, with Minneapolis showing a 6.1% drop, the largest ever in any area. The month-to-month price decline was 2.2% nationally, more than anyone expected and shows just how difficult unwinding the housing bubble is proving to be. In fact the year-on-year decline was 19.1%, a record. Sellers are still hoping that the vast inflationary windfall profits the bubble brought them are not going to evaporate entirely, so there remains substantial downward ‘stickiness’ in pricing. It seems difficult for property owners to realize that their gains were on paper and a product of inflation only: selling for ‘less than the home is worth’ is still a common mantra amongst disgruntled sellers. Cities like New York are still experiencing rapid declines – last month’s decline was the largest ever for New York and Detroit – and the backlog of unsold homes will only contribute to the continuance of that trend. Even with mortgage rates at historic lows activity is very poor, with most of that action on distressed properties.

So the news is very mixed. The consumer confidence data points to a possible uptick in spending later in the year. But the housing data is miserable and will cast a long shadow for a while yet. Couple this with the facts that unemployment is still rising, albeit less rapidly, and that foreclosures are still rising as more and more people experience difficulties after a job loss, and the prognosis is still guarded.

All the evidence suggests that the recession will end later this year, but the outlook for next is very weak. The optimists look for things to snap back to normal levels of growth – somewhere between 2.5% to 3% for 2010 as a whole. I think that is too high. The combination of stubborn unemployment levels above 9% next year, and the continued need by most families to reduce their debt levels, doesn’t leave much room for a strong recovery in spending. Add in the weak outlook for business investment and exports and a more likely prospect is for to grow only a little over 1.5%. Given that the population will grow more than that, the implication is that wealth per person will actually fall next year.

That’s not a strong recovery by any means.

We will have to wait until 2011 for strength to re-appear across the board.

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