Housing Crisis Is Key to Economic Recovery

The weakness in the housing sector remains a significant drag on the macroeconomy and is reinforcing the strains in the financial system. - Federal Reserve Governor Elizabeth A. Duke 16 Feb 2009

With a smile I read about the adventures of Robin Hood who robs from the rich to give to the poor.

In today’s adventure Robin is strongly suggesting that the wicked banksters refinance loans that are under water and in foreclosure.

Robin believes that if he can stop the wicked banksters from taking back the houses from the poor people – the housing crisis will be diminished and we will live happily ever after. After all, if there were no foreclosures – this housing crisis would almost be over.

Can this be true?

What effect are foreclosures having on the housing crisis? It surely is creating a situation of involuntary sales. Foreclosures are a symptom of the problem – but not the problem. The housing crisis is a housing price bubble caused by:

• Demographic Shifts (generational differences in home requirements)
• Poor past lending practices
• Housing pricing increasing significantly faster than income

To put it more simply, it was the absence of qualified buyers which started this crisis. Once the crisis began and home values began falling, different dynamics set in. Why buy today when tomorrow it is very probable that house prices will be cheaper? Sellers simply do not want to sell at the prices buyers are willing to pay.

Now it has become more than a housing crisis – it is intertwined in a full scale worldwide major recession. During the Great Depression, many people – even the rich – lived simply, saved every penny, invested conservatively, many avoiding the purchase of a home, in expectation of a renewal of depression.

Concentrating on foreclosures is missing the forest for the trees. Economic recovery will be restrained until buyers return to the market.

The objective is to get the housing market to demonstrably bottom out – not linger in limbo. Foreclosures help this price discovery process – especially when auction methods are used to dispose of the foreclosed properties. Non-liquid assets such as real estate tend to be slow to react to market pressures as buyers and sellers have considerable differences in their price expectations. The normal reaction is a slow down of the market until price expectations are reconciled.

Both foreclosures and their pre-foreclosure cousin – the short sell - allow real estate appraisals to adjust to new realities. Armed with lower appraisals, sellers are more comfortable selling at lower prices.

Currently sellers are withdrawing from the market thinking that Robin will somehow make the problem go away. And buyers are waiting for Robin to produce enticement legislation – including anticipated lower mortgage rates.

Robin, do not interfere with the market forces finding correct prices. Stop getting involved in foreclosures. Stop screwing with mortgage rates or sound lending practices. Robin, please help foreclosed families by funding relocation at government expense especially those who were renting the house which was foreclosed. It will be much cheaper than your current solutions.

The National Association of Realtors (NAR) continues to spin data to try to show we are near a bottom. This is a ludicrous policy. Once the housing market bottoms and the economy stops its freefall, the buyers will emerge from hiding. It would be in the NAR’s best interests to have the market collapse overshooting the bottom. The recovery would be demonstrated by recovery of housing prices confirming for homebuyers it is time to buy. The current policy is death by a thousand cuts where the decline is being slowed and the bottom is illusive. The NAR members make money on sales volumes. It is not in their best interests to have this crisis linger. We need to get this crisis behind us.

Update of Economic News

Bad economic news was pervasive this week – but I honestly do not see how it was not expected unless you walk around with rose colored glasses. The markets, which are supposed to be a forward looking indicator, fell 6% this week on all the news. This only points out that the equities market is not a forward indicator – and the market does what the market does. Conditions are going to continue to be bad through the middle of 2009 – and most likely longer based on current data. There is absolutely no driver for any sort of recovery apparent today.

The biggest economic news last week was the signing of the American Recovery and Reinvestment Act – otherwise known as Obama’s Stimulus V1.0. This act will add $787 billion dollars to the deficit according the Congressional Budget Office. It is not really a stimulus package, but a series of tax reductions, some funding for education and infrastructure rehab, and reinforcing the social safety nets. This program will have little effect on economic recovery as the downward economic momentum will easily evaporate the relatively small stimulus effect.

The nitty-gritty of the effort to stop foreclosures was unveiled as “Homeowner Affordability and Stability Plan”. No one seems to know how much this new plan will cost (range between $80 to $300 billion), but in fairness it will depend on how many homeowners want to take the government up on this plan. It is focused on homeowners who are underwater AND whose mortgage is more than 38% of the gross monthly income. There has been some good analysis of this program.

The New York Fed has continued purchasing fixed-rate mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. Selected private investment managers are acting as agents of the New York Fed in these purchases. They have already purchased $114.7 billion prior to this week, and $19.9 billion this week. By mid-year, the Fed wants to purchase $500 billion worth of these securities.

The Federal Reserve stated that economy is even worse than thought and now forecasts it will continue contracting throughout 2009, with:

• no sign that the housing market will stabilize.
• unemployment climbing as high as 8.8% this year
• GDP contracting this year between 0.5% and 1.3%. The last full year contraction was in 1991 were it contracted by 0.2%. There was a 1.9% GDP drop in 1982.

My economic prediction remains a 5% GDP drop this year with the recession ending in the fourth quarter. To put the Fed’s predictions into perspective, the economy contracted almost 1% in the fourth quarter of 2008. What they are saying is that the total economic contraction in 2009 will be equal to 4Q – 2008. The Fed’s prediction appears understated.

In the category of weirder and weirder, the Federal Reserve Open Market Committee has released economic growth projections for the period after 2012 (three years away).

• 2.5 to 2.7 percent growth in real gross domestic output
• 4.8 to 5.0 percent unemployment
• 1.7 to 2.0 percent inflation, as measured by the price index for personal consumption expenditures (PCE).

The interesting statistic is the unemployment rate which I consider marginally recessionary. A good rule is about 3% unemployment being full non-inflationary employment. I am beginning to question whether the economists are using unemployment to fight inflation.

Real average weekly earnings fell by 0.1 percent from December to January after seasonal adjustment according to the BLS. Average weekly earnings rose by 2.7 percent, seasonally adjusted, from January 2008 to January 2009. Holding wages in check is positive news economically as it keeps America competitive. Wage increases, have been blamed by some, for deepening and elongating the Great Depression. The BLS Consumer Price Index for All Urban Consumers (CPI-U) increased 0.4 percent in January, before seasonal adjustment. The January level of 211.143 (1982-84=100) was virtually unchanged from January 2008. So far, deflationary fears in this Great Recession have not manifested except for non-liquid assets. I would be concerned that as the supply chains continue to adjust for demand and inventories fall to normal levels, that a burst of price rises will occur later this year.

The Federal Reserve issued their report on industrial capacity and utilization which confirms the obvious that industrial production is going downhill. You can draw two conclusions from this report: 1) the rate of increase in industrial capacity and production changed dramatically in 2000; and 2) industrial plant utilization is lower than in any other modern day recession. We simply do not have the drivers for a robust economic recovery.

As clear as the nose on your face, the Producer Price Index is indicating deflation has evaporated in manufactured goods. The finished goods price index actually rose slightly in January with only the price of food decreasing. Even though intermediate products and raw materials declined in January, the rate of decline has significantly eased over past months. This is the expected effect as the producers adjust for changing demand. Unless we get another cascade of falling demand, this is a positive sign of stability in goods pricing. This does not indicate recovery is near, only that industry is well along on the painful path to the new normal.

Filing for Bankruptcy: Trump Entertainment Resorts, Inc., Saab AB (GM)

Economic Indicators Published this Past Week

We all know that economic conditions are bad. I try not to dwell much on data that supports this, but I try to cover indicators which are windows into the future. There does not yet appear to be any leading indicator which points to an end to our Great Recession. My primary indicator I use is ECRI’s Weekly Leading Index (WLI). The WLI continues to demonstrate deteriorating market conditions six months from now.

Another leading indicator to watch is the LEI from The Conference Board. The LEI increased for the second consecutive month in January, but November and December values were revised down as new data for manufacturers' new orders became available. Between July 2008 and January 2009, the LEI decreased 1.9 percent (a -3.7 percent annual rate), faster than the decline of 1.1 percent (a -2.1 percent annual rate) during the previous six months. In addition, the weaknesses among the leading indicators have remained widespread in recent months. Here is a cautionary statement from The Conference Board:

Although the LEI has risen during the past two months, it is too soon to say the contraction in the LEI that began in July 2007 is coming to an end. The LEI has continued to decline over a six-month period in the second half of 2008, with continued widespread weakness among its components. The primary sources of strength in the LEI in recent months have been the consistent and large contributions from inflation-adjusted money supply and the interest rate spread, and consumer expectations have only provided a weak positive contribution.

The bottom line is that this index is positive because of the massive money supply expansion. This expansion was caused because of the Great Recession itself. To use it as a determinant of economic conditions is similar to saying a drowning man is okay because he has enough water to drink.

There have been reports of positive economic fundamentals due to the rise of the Baltic Dry Index. This index tracks the rates being paid for bulk material (spelled commodities) in certain classes of ships. At various points in my past life, I was responsible for chartering these vessels. I will tell you that increased shipments using this type of vessel very definitely signals recovery. However, this index always tends to rise in February. This index is based only indirectly on volumes – and is simply the price being paid for transport. Annual haulouts of ships reduces shipping capacity and affects this index. Unless you are tracking volumes, the usefulness of this index as a standalone economic indicator is limited. I would use it only to confirm trends I was seeing on other indicators.

After a long weekend, investors on Tuesday last week were welcomed by the Empire State Manufacturing Survey. It indicated that conditions for New York manufacturers deteriorated significantly in February. The general business conditions index fell to a new low of -34.7. The new orders index also fell to a new low, the unfilled orders index stayed close to its recent record low, and the shipments index—despite a slight improvement—remained negative. The indexes for both prices paid and prices received held below zero, with the latter dropping sharply. Employment indexes remained deep in negative territory; the average workweek index slipped to a record low. The future general business conditions index was negative for a second consecutive month as many of the forward-looking indexes remained close to recent lows. The future index for number of employees fell particularly sharply, eclipsing last month’s record low. I hate these surveys because the future forecasts are subjective.

The Philadelphia Fed’s Manufacturing Survey was also issued this week showing bad current conditions but an optimistic future. As I have pointed out particularly concerning this survey, this is subjective data where the participants have no basis to make these predictions.

In the week ending Feb. 14, the advance figure for seasonally adjusted initial claims was 627,000 unchanged from the previous week. The 4-week moving average was 619,000, an increase of 10,500. Do not expect unemployment to improve until we are into recovery.

If you would like a summary of all government financial indicators, click here.

Wrap Up for the Week

There is not a single blade of grass that is demonstrating this economic disaster is about to end. If you want to believe any of the fictional economic spin being produced which is telling you to invest because the sun is about to rise – there are several bridges I can sell you.

Disclosures: None.

Comments

[billp37:]

We're concerned that new construction may have to be limited in the future for electricity [energy in general] shortages and environmental concerns [pollution] reasons.

www.prosefights.org/co...

But this could be delayed because of recession/depression?

Feb 22 09:53 AM

[bebido:]

Once again you have provided useful information relative to economic issues. Keep up the good work.

Feb 22 10:40 AM

[Bundee:]

"Economic recovery will be restrained until buyers return to the market."

Not exactly.

"Economic recovery will be restrained until" the job market improves and people can afford to buy houses.
If a person is in fear of losing their job they are Not going to buy a house and take on all that debt.
You can use all the charts and figures and calculations in the world to show that housing must improve so the economy can improve, but if potential buyers are scared of losing their jobs they are not going to buy a house. A fact that experts seem to ignore or can't wrap their brains around.

Mr. Hansen, the author of this article, probably was not informed of all of the crazy housing loans that were made for the past eight years or so. There were "fog the mirror" loans where anyone with a pulse could get the loan as long as they could sign their name on the loan documents. Alt-A and subprime loans were made to people who couldn't afford to make rent payments but were deemed 'creditworthy' to take out loans for homes. The absolute worst instance was when a strawberry picker who made $17,000 a year was able to get a loan for a $200,000 house.
Do the housing experts expect buyers like these to come back to the housing market now that the banks only want to make loans to people who can pay back what they borrowed?
(Pay back what you borrowed, what an interesting new concept!)

Flippers were using leverage to buy 2, 3, 5, 10 houses and then flipping them for a profit and instead of paying off the loans used the money to buy more houses (a technique known as doubling down, as in doubling down to nothing if you bet wrong.)

The banks and lenders didn't care at the time if the loans went bad or not since they were rolling up the loans into CDSs and selling them as investments. So much for prudent lending practices.

While all this was going on, prudent potential homebuyers went on strike choosing to rent rather than take out crazy loans or buy overpriced McMansions. The old maximum amount that a person could reasonably borrow and pay back was 3 times their income for a house. A person made $60,000 a year, the maximum amount they could borrow was $180,000 (under the old loan method.) In the new market, loans of five times annual salary, 8 times salary, even 10 times salary were considered acceptable.

"You can always refinance" and "take out the HELOC money for trips and cars, you deserve it" were some of the mantras peing pushed by the housing 'experts', and the masses fell for it. Now the US has home owners (homedebtors) walking away from their houses that have declined in value, flippers are few and far between, banks will only make loans to those who can actually pay back the debt (again, new concept) and there are still pndits who insist that housing is needed to turn the economy around.
Its jobs people, jobs. Jobs and paychecks turn an economy around, not houses.

Feb 22 10:52 AM

[Bundee:]

Sorry if I typed a few words wrong, my keyboard acts up from time to time.

Feb 22 11:00 AM

[1234987:]

We need a housing solution, stop all the commentary!!

Until we address 2.5 million homes (& growing) held by Banks there will be no bottom.

Housing solution!

I, Remove 2 million homes from the MLS (for Sale) that financial institutions currently have
for Sale. Any Institution that received TARP funds will be required to first offer the home
to the RTC for purchase. RTC will not purchase any home above $417,000. No Jumbos.

2, Government Resolution Trust will purchase these homes from these institutions for 20%
less than original first Mortgage amount. No negotiating.

3, 600 billion dollars to buy these homes (app $300,000 each average) will come from the sale
of long term 30 year bonds. (Currently app 3-5%) issued by Government.

4. RTC will send these homes to the local HUD offices for disposition thru voucher program
(rentals). $5000 will accompany each home for repairs & upkeep. eventually as the MLS
system reaches certain inventory levels (i.e. 30-60 days) HUD will be allowed to place these
homes on the sale market. If the inventory increases HUD will remove homes accordingly.
This will be a local HUD market decision, differing from region to region. Rental Income will
help cover expenses such as maintenance, insurance and property taxes.


Pro's:


Supply/demand economics will create a bottom in the housing market once 2 million homes
for sale are removed. Prices will start to increase.

Local governments will see a bottom in declining values and revenue will increase as values
slowly stabilize and slowly increase.

Individual homeowners as well as other sellers will find a housing market ready and able
to absorb the inventory.

Banks will now have a fresh source of funds to lend on homes that are not declining in value.

Banks will be able to clean balance sheets of hard to liquidate assets.

Lending/leverage/credi... markets will slowly begin to return to normal. Applications will
increase, appraisals, home inspections, title work, all types of stimulating activity for business.

As home prices stabilize and increase the local HUD agency selling homes over a 3-7 year time
frame will see prices rise for properties purchased by the RTC. HUD will only be required to
return to RTC the original amount of the purchase price plus the 20%. Or the original amount of the
selling banks first mortgage.

Once the RTC is closed and all homes sold, all losses (if any) will be covered proportionately
by the selling institutions. All financial Institutions selling homes to the RTC will share the loss
at the RTC as a percentage of total homes purchased and homes sold to the RTC. That percentage
will be the Banks percentage for covered losses. These losses will be paid by the banks over a 30 year period liquidating the original bonds sold to finance the purchase.

Other agenda items:

Mark to Market accounting will only apply to non performing assets.

Spend 50 billion each year for the next 3 years rebuilding infrastructure. Bridges, Roads, tunnels,
water plants, dams, levies anything to create jobs.
Stimulus checks for $300 only help pay a credit card bill once.

Feb 22 11:36 AM

[Steve in Gr...:]

Thanks, Mr. Hansen, the usual great commentary.

There will be no bottom either real estate or financials until the government gets out of the way and lets the market find the bottom. More banks need to go bankrupt. More houses need to be foreclosed upon.

Until this happens, no sane person would buy into either market.

Feb 22 12:22 PM

[gotnochips:]

Outstanding presentation. Pithy, bottom-line, readable, objective. Best of breed.

Feb 22 12:27 PM

[Mad Hedge F...:]

In case you missed the business section of the San Francisco Chronicle today, there is a fabulous graphic illustrating the hard times for the city’s commercial real estate market. The epicenter of the melt down is Tishman Speyer’s 556,000 sq. ft. 555 Mission Street, which opened in late 2008 during the worst possible market conditions, and remains 70% empty. What is really impressive is how bad the implosion of the legal profession is hitting landlords. The dissolution of Heller Ehrman has emptied 350,000 sq. ft. 333 Bush Street, while 388,000 sq. ft. 101 Second Street has been vacated by the dissolution of Thelen LLP. Conditions will worsen as more new buildings started during better times come on the market.

Feb 22 01:02 PM

[John Lounsbury:]

Bundee - - -

You wrote: "Mr. Hansen, the author of this article, probably was not informed of all of the crazy housing loans that were made for the past eight years or so. There were "fog the mirror" loans where anyone with a pulse could get the loan as long as they could sign their name on the loan documents."

I can assure you that your guess about Mr. Hansen is completely off base. He has a well documented history of understanding of the abuses in lending and borrowing practices. The rest of your comment is appropriate, but you made a mistake in speculating about what the author knows and dosn't know without reviewing what he has written in the past.

Feb 22 01:23 PM

[scotty1560:]

Steve:
I favor three things..

expedite the foreclosures and short sales.. auctions or whatever process necessary for liquidation value.

if a borrower is working.. re-write the mortgage at current appraised value..
saves the owner, avoids unnecessary flooding of the market with more properties, and really helps the banks from carrying more distressed homes.
What's the difference if they write down for the current owner or sell it in
the current market?

go back to traditional lending standards.. I prefer 20%+ equity and 15 year notes.... creates more stability.. prefer fixed rate expenses... eliminate HELOC's. Leveraging has proved to be a time bomb and the average lower, middle, and even lower upper class can not handle this kind of attack on income, equities, and real estate.. it's overwhelming for most of us.. at least in the boom areas. On second homes or investment.. more equity..30+%..

Leverage is the curse of the working class and in most ways the worst
mistake the average guy will make in his life.. the deck is marked and
the odds are against you.

Feb 22 02:04 PM

[ArnoldCountry:]

Great article! Best I have seen in some time. Thanks for the reality check!

Feb 22 02:33 PM

[silverfox:]

i wouls like to know why the US Government did not give a $500,000
bailout to each howmowner rather than giving it to the Banks.
much of this money would go back to the banks anyway and people would have a house free & clear (a condition to the bailout).
there would be no housing crisis and liquidity would be expediated to the Banks.
consumers have more expendable income without a mortgages &
the economy would rebound much sooner.
my question: does this sound like a pipe dream or is their some valisity to this idea?

Feb 22 05:01 PM

[Lok Sang Ho:]

Since late September last year I had been advocating a buy-back offer from existing homeowners for homes below the median price at a market price as of a designated date. This will freeze the housing price for 50% of American homes and will greatly improve market sentiments and will ease credit. The government will hold any acquired homes till it can sell at a price at or above the snapshot price. Cost is only the interest cost borne by the government minus any capital gains eventually realized and rents collected. Even if a total of 5 million homes had to be acquired, at a net cost of 20,000 dollars the total cost to the government will be only 100 billion dollars. While this is still a big amount you can be sure that banks' balance sheets will not further deteriorate. Note that this does not even mean subsidizing people for their realized losses through the date of the snapshot. I have outlined some of these ideas in my articles in Seeking Alpha.

Feb 22 06:07 PM

[Gre:]

Steven, first time reader. I am amazed you are putting this together from Malaysia or maybe Thailand. Is that right? Nice work and meaningful comments.

Feb 22 07:03 PM

[PainfullyAware:]

The Hand (Steven) Rocks !!!

Give Me The Truth - It makes it easier to navigate.

Most of reality is perception. However, Reality Will Be Reality Whether Believed In Or Not.

Safety Is A Function Of Awareness.

Heroic Hansen - Great Effort !!!

Feb 22 08:13 PM

[Aristophanes:]

Steve Hansen wrote:

"To put it more simply, it was the absence of qualified buyers which started this crisis"

That's coming into the problem mid-stream. You are basically stating that there was over-supply of housing stock. That can also be attributed to the financial wizards who saw the building boom as a low risk process because of securitization. Float a bond to fund a development. Get it graded 3A. Now sell the bonds OTC. First risk gone. Build houses. Sell mortgages. Market survey indicates there's not enough prime borrowers on the outskirts of Las Vegas? (funny that). Create different mortgage vehicles with clever names like LIAR loans, Alt-A, Jumbo, etc. Loan like crazy. Securitize those mortgages. Tranche. Sell. Risk gone.

The stagnant wages of Americans also is a contributing factor. With wages in relative decline compared to inflation (remember last summer's gas prices?) the outlet for household chattel and property growth was debt. It is mere substitution. And a market was created along these lines. Same as Wal-Mart creating a vanpool to take its own employees to a food bank after their shifts. Why pay employees more when there is another outlet equivalent to pay: free food, debt, etc.

Buyers won't return to the market in numbers large enough to buy down the oversupply, and, unless there are wage gains. Oops! Did someone say deflation? That's downward pressure on wages. The downward cycle continues.

This is less about Robin than it is about the DDT in the system destroying eggshells. You cannot find a mortgage bottom unless this mortgage securitization model is outright banned. It's toxic death.

Feb 22 09:24 PM

[Kunst:]

Here, how about this? The government buys up to 50% of your house for the same percent of your mortgage. When the house is sold, the government gets the same percent of the sale price. No need for the government to actually pay off its share of the mortgage; just make that part of the monthly payment. The owner makes the remaining portion. Those who are OK with their current situation won't be interested. Those who can't make the payment get to reduce their burden.

This brings the payment down so people can stay in their houses. Foreclosures and homelessness are in no one's interest. You can put various conditions and limits as appropriate. No one gets a free ride but it solves the main problem, affordability of monthly payments. No worries about forcing down principal, or dealing with many-times-removed mortgage holders. The value of mortgage-backed securities is greatly solidified. And the cost is probably a lot less than the other alternatives under discussion.

Feb 22 09:48 PM

[Bundee:]

"you made a mistake in speculating about what the author knows and dosn't know without reviewing what he has written in the past."

I stand corrected and I thank you for pointing that out to me Mr. Lounsbury. I just get a bit annoyed when the only answer that anyone seems to come up with is "fix housing fix housing fix housing' while the real way to fix housing, an increase in jobs and the confidence that house buyers get from secure jobs is overlooked.

Feb 22 10:02 PM

[Yohei:]

I see a lot of childish magical thinking in the comments. I prefer to see less of this sort of thing as it would signal the approach of the actual bottom in asset prices generally (not just in housing prices).

In practice I see no way to protect the imprudent from the results of their folly. Madoff is just another thimblerig con man, and so were the real estate bubble blowers, the CMDO writers. A fool and his money are soon parted. Don't buy anything you don't really understand.

I do agree that debt security issuance needs to be under severe regulation. Generally I can see no economic use for any CDO type long term securities whatsoever. CDS contracts must not be allowed without adequate reserve for loss.

Feb 23 12:54 PM

[Chester Sing:]

Hi Asbytec,

If you make a trip to the Manila, please e-mail me. I think we'll have lots to talk about.

On Feb 22 09:38 AM Asbytec wrote:

> I meant paradigm shift, in reference to another blog in this site,
> not paradise. Paradise is where I retired, too.

Mar 04 08:40 AM