From Micro to Macro: No Soft Landing for This Economy

I was talking to a friend who is a contractor. He’s been in business for a long time and has a good reputation. Renovations, additions, a custom built house now and then were his specialty. In the good times he had three crews working full time and a payroll of $20 grand a week. The good times are over. I asked him how is business was going. His response, “It stinks.”

I asked him, “What changed?”

He said something that rang a bell:

90% of my business came from homeowners who re-fi’ed to pay for the work that I did. That is over now. No one has equity in their homes anymore and if they do have equity, the banks won’t lend against it .

Jump from the micro to the macro economic impact of this. The following is a graph of total mortgages outstanding. Mortgages debt grew at a 10% pace up to 2008. Since then the total has declined.


This chart looks at the trajectory of mortgage growth based on prior years and compares it to the actual.


The gap is very significant. Of course the trend line of mortgage growth pre 2007 was unsustainable. Assume that instead of a crash we had a soft landing in 2008. This graph looks at a mortgage growth rate half of what we were experiencing. There is still a big ‘debt gap’.


These gaps are what hurt my contractor friend. His business (and a lot of others) lost the grist that made it all work. Money. The home equity ‘piggy bank’ is empty and busted. He has only one crew now. He is not buying any new equipment anytime soon. His business at the lumberyard is down 60%. The bank cut his line. His subs and suppliers want cash. The jobs that are out there are bid low because there are a lot of guys scrambling for work. A business that once paid payroll and income tax is now costing us. There are 15 people getting nine months of unemployment. As far as GDP impact goes, this company went from third gear to reverse.

I don’t know the relationship to mortgage debt creation and GDP. I would guess around 20%. Based on that, the gap I described above would translate into a $300b contribution to GDP. About 2%. We desperately need that 2% right now. We aren't going to get it. We are at least three years away from achieving growth in total mortgage debt.

Total residential mortgages outstanding today are at levels last seen in the 1st Q of 2007. By way of comparison the current GDP level is about where it was at the end of 2006. For me, this means that the economic recovery for the next few years will be anemic at best.

Note: The FRB data is from June 30, 2009, so it is stale. The monthly numbers from both Fannie Mae (FNM) and Freddie Mac (FRE) through October confirm that there is still no growth in mortgages. F/F’s combined books are in decline. FHA has picked up the slack, but I doubt that there is any net growth. FHA will have to reduce its lending in the near future. They can’t keep lending 96.5%, they will go broke. There is no soft landing for this segment of the economy.

Comments

[bob adamson]

Mr. Krasting is describing the very heart of the deflationary sector of the US (and UK, Irish, Spanish, Japanese etc.) economy. Clearly this sector was over built, over leveraged, over capitalized and over priced during the 2003 to 2007 period fueled by bad mortgage lending and investment banking practices related to secularized debt instrument and derivative marketing and we are fortunate that the fiscal and monetary stimulus measures of the governments and central banks of the G20 over the past months have prevented a general deflationary collapse spreading from that sector to the whole economy.

The best that can be hoped for from the residential housing market over the foreseeable future is reasonable stability; other sectors must be the source of growth and lead the recovery. In particular, the refinancing of homes will not be (and should not be) a way for people to raise money for other purchases for the foreseeable future.

2009 Nov 27 02:29 AM

[peterthepainter]

I read somewhere that the economy is going to bounce back without real estate recovering, without rising employment, without rising wages and without more free money...

sure beats me...

2009 Nov 27 07:46 AM

[Old Trader]

I wonder what sector will attempt to "fill the gap" in our economy...(not that I expect it to be filled anytime soon...).

2009 Nov 27 11:57 AM

[Bruce Krasting]

I don't think anything is going to fill the gap. We are just going to bump around the bottom for a few years. Markets will go up and down. But ultimately they are tied to growth...

bk

2009 Nov 27 02:35 PM

[Bjarne Jensen]

Chris, I don't see more credit as the solution rather I see the growth of and the reliance on credit as the structural problem. Fifty years ago people started business and grew their business with saved money rather then borrowed money.

Yes, big ideas in the past required lots of money which was raised in the equity markets. Reliance on credit is a consequence of having a Central Bank.

On Nov 27 04:09 AM chris coonan wrote:

> Not are just House Contractors affected, so are Commercial Contractors,
> Architects, Engineers, Developers, Geotech crews, surveyors, material
> suppliers, product reps, window companies, hardware companies, door
> companies, carpet, lighting, plumbing, carpeting, gardening, etc.
> etc.
>
> There is a huge tree of people who are fed from the waters at the
> roots. Without the credit (water), the tree is dying. This will be
> a problem for years to come.

2009 Nov 27 04:37 PM

[Snitzer]

All the "stuff" we churned out hand over hand just knowing it was already bought, factories revving up on forced draft overtime stretching for higher and higher production levels, with never a doubt that it would all be sold and the need for more, more, and more would always be there. Then came the big bump in the night and suddenly, all over the world, car lots, boatyards, cycle shops, warehouses, stores, backyards, driveways and out of the way flea markets just loaded up with more "stuff", unaffordable, unneeded, unpaid for, unloved and floor planned with nothing going on. We could shut down every factory on the planet and still have enough "stuff" to last us for years. Yeah, it'll be a while before things spin up, a long time before the small businesses that survive can actually think of themselves as survivors, as the verdict will be a long time coming before they can say, with any degree of certainty, that they have "survived".

2009 Dec 03 12:43 AM