Inevitably, even the grizzlies have been watching economic indicators gauging the housing market "recovery", as talk of a 2009 rebound in the United States has now been confirmed by 3.5% growth in the third quarter. Existing home sales bottoming, construction spending pulsing and extreme incentives for new buyers have sweetened the potential for a repeat of the 2004 housing recovery we all loved so well. Yet there remains the issue of magnitude, regarding a potential housing recovery, which may contrast that 2004's great deal, and could kill the lasting effects of a bottomed housing market on the broader economy. We will attempt to review and assess the American economy in terms of the Housing Market from a historical and quantitative standpoint.
Price To Earnings
Twenty four months spanned between the peak 6.5% Federal Funds Rate mid summer 2000 and the screeching halt to 1% in December 2003, where rates would hover through Independence Day of the following year. Prior to the new millennium, S&P 500 P/Es in the forties and the ensuing share price slashing, one must scroll back to 1961 to sight a Fed Funds Target below 2% and further to 1954 to find the over night rate below 1%. Similarly, we forget that prior to 1995 the S&P 500 last carried a P/E ratio greater than 25 in 1930, yet this fundamental statistic remained above 20 for the duration of the previous recession and until October of 2008.
The American Dream Home
Prior to the 2001 downturn there had been sweeping legislation to extend the "American Dream" of owning one's own home to those in lower incomes. Mortgages were generally originated by third party shops and purchased by the GSE Fannie Mae (FNM) and Freddie Mac (FRE) mortgage strongholds. Beginning in 1996, the United States Department of Housing and Urban Development (HUD) policy mandated that a minimum percentage of the loan portfolios at Fannie and Freddie be sub-median income products, totaling 52% of all GSE guaranteed mortgages by 2003. The appearance of Alt-A, interest-only, and ARM mortgage products became the bread and butter of "lip-smacking" originators, then passed on and digested into fortune 500 banks' balance sheets, as a Moody's/S&P rated package (i.e. CDS & MBS instruments).
Housing Recovery 1.0
The first time around, households stopped short of buying new homes until 30-yr fixed rates ratcheted below 6% in January 2003 and remained there, tethered to near 1% Fed Funds rates, until October of 2005. Prior to 2003 30-yr fixed rates were last seen near 5.71% before 1971, where the Freddie Mac data stops, while the New York Times vouched that such low rates hadn't been seen since the early 1960s. Ensuing asset price inflation derived from cheap money and an unquenchable demand for homes brought the economy out of a recession with a booming pace, as the resultant vector of growth came founded on consumer spending.
Fannie and Freddie
The mortgages purchased by the GSE Fannie Mae and Freddie Mac strongholds, facilitated "zero down" financing to less wealthy individuals wishing to own a home and strong propaganda to hopeful politicians. Barney Frank went on record supporting the HUD policies for riskier mortgages carried by the GSEs and continued to support Fannie and Freddie even as the CEOs endorsed the addition of "Alt-A" products as a major part of their business. Last week the total tally of Government capital infusions at Freddie capped the $60 billion mark, as Paul Miller of FBR Capital claimed "they are going to need [all] $200 billion in capital" promised to the firm by the Treasury.
What The Data Says
GDP data tells us that residential investment increased by an average of 7.35% per year for four full years until leveling off in the fourth quarter of 2005. The mass of capital which flooded the residential real estate market 2002 to 2006 was so great that the four year average residential investment figure jumped 22% from the prior four years, a move of an additional $126 billion/year, while since 2006 residential investment by consumers is down an average of 20% per year.
The yarn of the previous crumbling housing market alone isn't prophetical, but through inspecting recent history we can infer what contribution a recovering housing market could have on GDP, deriving its effect on the U.S. economy as a whole.
Fed Quantitative Easing (QE)
Concluding that the only answer to such an indebted private market was to shift the burden of current debt from private to public balance sheets, the U.S. assumed effectively all risk which had caused the large banks to be shorted in the first place. When the overnight target rate for banks to borrow among themselves crashed at 0% and LIBOR (London Inter Bank Overnight Rate) remained high, the Fed resorted to physically buying and insuring the toxic debt which is still defaulting to this day, simply on the public rather than private watch. When the Fed had thrown the proverbial kitchen sink of QE at the problem and the green Obama administration announced banks' shares would remain private, the financial stocks recovered and the broader indexes followed.
Main Street Stimulus
Shell-shocked lenders left a shrapnel economy in their wake, claiming 700,000 initial jobless claims at peak and awful consumer confidence numbers. Along came the Obama $700 billion stimulus, said to be designed with shovel ready projects and job creation strategies in mind, but once congress dissected and reconstructed the bill it had that same old pork barrel stink. Obama's C.A.R.S. (Car Allowance Rebate System) program was an effective durable goods stimulus on par with those of China and Brazil, known as "cash for clunkers", which drove new car sales statistics above 10 million units per year for the first time since a year prior in August 2008.
Housing Stimulus
The "First Time Home Buyer" tax credit, initially announced in 2008 to buoy the falling demand for new homes, was designed as a no interest loan to be paid back over 15 years. When the plan failed to stick, the administration altered the plan to where buyers never had to repay the tax credit and it was increased to a maximum of $8000. As the tax credit was set to expire in December of 2009, congress rushed through a six month extension of the credit, through June 2010.
Additionally, the tax credit applies to a much higher tax bracket and to any person wishing to buy a primary residence. Keynes would argue that the expectations of consumers for the tax credit to end would have flushed all first time buyers out of the system thus far but that perhaps second or third time buyers would flock to the offer. The program seems to be working in the short term as the following chart depicts in the bottoming of home prices in the largest 10 and 20 city composite indexes, composed by comparing repeat sales of homes.
The Bottom In Housing
It's plainly obvious that homes prices have stabilized in dollar terms from the chart above, combining with the seasonally adjusted existing home sales increase of 9.2% in September 2009 from a year earlier, thus making a "bottom in housing" a technical victory. Doubly encouraging are the "months of supply" of homes on the market that has decreased to 7.8 months from the peak of 11 months in November of 2008. The above data is uplifting and potentially foreshadows a prosperity founded on yet another housing recovery, yet it's equally likely that the devalued U.S. Dollar accounts for much of the shift in prices and that stimulus takes recognition for sales.
(Note: Remaining GDP Component growth normally a driving force in the growth and recession of the economy (dark blue), yet in Q3 of 2009 these remaining components accounted for marginally positive growth. Instead stimulus induced Durable Goods (CARS), Residential (1st Home Credit), and Government Spending components carried the growth with an additional boost from inventory restocking.)
China's Role In U.S. Recovery
A recent article in the Economist explains how a similar recovery of asset appreciation tied to exports may result in frothy demand, should domestic consumers begin consuming Chinese services in addition to goods. It would be possible for China to accomplish such a task only if the G20 succeeds in convincing the nation to float its Renminbi currency and increase the purchasing power of its consumer base, contrary to the export heavy interests of the BRIC leader's central government. How then would an asset appreciation recovery in China effect America's economy, when assets here are only appreciating in dollar terms but remaining flat in foreign currencies (the case in recent months)? We would argue that it would affect America quite badly, and only cause an asset appreciation bubble in China and nations with high enough savings and stimulus to kick start private spending or economies tied closely to commodity production.
Whatever the role housing played in the previous recovery, it's unlikely that early signs of a bottom in the industry will spur favorable growth in the medium term (1-3 years), and that instead this recovery will need to be based in an industry coiled more tightly to spring into production, of which there are no real studs. Perhaps most important is the ability for the global market to truly account for the over-exuberant lifestyles of consumption and greed which led to such hardships, manifested through all forms of global commerce. It was not one flawed industry, cracks in regulation or the failure of markets but instead the failure of self regulation and self inspection at every level, which brought us to the seemingly unanswerable decision between more spending or more pain.
Standing on the pivot, one might see alternate paths to prosperity or destruction given random series of events and outcomes. What will chance hold for the future of global commerce and markets this time? While a sensibly true recovery may be real for some, the exodus of toxic material from financial balance sheets at every level must come to pass for a harmonious global economic balance of growth to sustain over time.
Disclosure: Long SDS, Long SCC, Long DTO, Long BVN, Long TYO
