Real Estate And Household De-Leveraging

Includes: XHB
by: Acting Man

By Ramsey Su

I was flipping channels the other night and came across a TV financial guru giving advice to a caller. To make long story short, the caller earns about $4,200 per month and may be facing bankruptcy. After going through her household numbers, the guru advised the caller that she needs to cut $600 per month in expenses.

I had a chat with a loan officer at Bank of America (NYSE:BAC) last week regarding the applicants for HARP refinancing. In spite of a lenient 45% debt to income ratio, credit scores as low as 620, no worries about LTV, generous rate offers in the 3% range for fixed rates and low doc, she said many do not qualify. Debt to income is the major killer.

Duh! Shouldn't that be obvious? There is no positive outcome if you spend more than you make. What is wrong with our central bankers? Are they brain-dead? Households need to cut down on spending, save more and yet the central bankers are trying to stimulate consumption? For the lady making $4,200 above, even if Bernanke were offering her negative interest loans, she should still be consuming less. Is there something wrong with our economy, if households with $4,200 per month income and no particular unexpected financial disasters have to contemplate bankruptcy?

There are two recent central banker articles that I found interesting. The first is from the Bank of Canada. They made some excellent third party observations: "The U. S. Recovery from the Great Recession: A Story of Debt and Deleveraging"

Pertaining to real estate, the Bank of Canada offered two excellent charts:

Real house prices and the ratio of the housing stock to the population.

The real estate market is currently confused about the term inventory. Just because there are few houses for sale does not mean the housing inventory has diminished. The artificial barriers and the pseudo demand by Wall Street entering the single family market created a skewed supply/demand imbalance. The chart above illustrates how severe the Greenspan sub-prime bubble was and the free market is trying find equilibrium, in spite of the efforts of the Bernanke Fed. We are still a long way from working off the excess inventory, regardless of how many homes may be listed for sale.

The following chart offers excellent support for my theory that watching rental vacancies in key markets would be a solid advance indicator. Houses were built for speculative reasons only during the Greenspan bubble. The current vacancy rates are still higher than the historical norms. Before you buy a single family home for investment, I strongly suggest that you check out the rental market in the area of your purchase first.

Vacant housing units in the U.S.

The second article is by ex-Fed Governor Jeremy Stein: "Overheating in Credit Markets: Origins, Measurement, and Policy Response". It is a long academic mumble jumble that is guaranteed to cure insomnia, but I find the conclusion mind boggling.

These observations suggest two principles. First, decisions will inevitably have to be made in an environment of significant uncertainty, and standards of evidence should be calibrated accordingly. Waiting for decisive proof of market overheating may amount to an implicit policy of inaction on this dimension. And, second, we ought to be open-minded in thinking about how to best use the full array of instruments at our disposal. Indeed, in some cases, it may be that the only way to achieve a meaningfully macro prudential approach to financial stability is by allowing for some greater overlap in the goals of monetary policy and regulation.

In plain English, Stein is basically saying that he has no clue what his array of instruments may cause but he is willing to take wild and blind swings with the big bat, hoping there is a pinata full of goodies in the near vicinity. Is this how one should conduct the Fed's monetary policies? What happened to "do no harm"?
In summary, you can call it deleveraging, austerity or just good common sense, but households have to spend less. A real estate correction is not a bad thing, it will make housing more affordable. While I agree with the slogan "don't fight the Fed", is the Fed strong enough to fight the natural forces of the free market?

Finally, here is an excellent article summarizing many recent studies and opinions on the trend of income inequality. With all the bulk buying by Wall Street fat cats, real estate is heading in the same direction. It is not going to end well.

Addendum: More Charts

Our friend Bart at has conveyed a few charts to us that further buttress what Ramsey has to say above about vacancies and inventories.

U.S. home vacancies by component.

Percentage of housing stock vacant.

Houses held off the market for 'other' reasons.

Rental and homeowner vacancy rates.

An explanatory note by Bart to the above charts:

Chart 2 includes all vacancies for any reasons (seasonal, held off market, etc. - all the items listed in chart 1).

Chart 4 only includes those items that indicate the home or rental is actually on the market, as deemed by the Census Bureau.

It's vaguely like the differences between U3 and U6 unemployment rates.

Charts by: Bank of Canada,