The Real Threat of the Housing Bubble

The seriousness of the housing bubble is best illustrated by the ratio of the S&P Case-Shiller Composite Housing Index to Disposable Income per capita (before adjustment for inflation). The previous high of 0.45% in the late 1980s was dwarfed by the reading of close to 0.6% in 2005/2006. There has since been a strong retracement, but the index remains well above the 0.4% level needed to motivate home-buyers.

With real estate exposure exceeding $7 trillion and total capital and reserves of just under $1 trillion, a further 10% fall in house prices would have a devastating effect on the banking system. Much of their normal margin of safety has already been wiped out by the existing fall. While this may appear an extreme scenario, the economy faces falling consumer sentiment and declining incomes from an approaching recession.

I am sure that the problem has been keeping Ben Bernanke awake at nights. With interest rates already close to record lows, the only tool the Fed has left in its toolbox is inflation. By raising nominal incomes rather than lowering house prices they can achieve the same end — but at what long-term cost to the economy?

Comments

[siegfried]

here's an idea for ben: let investment bankers trade their asset backed securities at the fed window for treasuries--then they can issue more of the same and sell them directly to the fed. this liquidity will permit existing homeowners to borrow more against their houses, and then the investment banks can securitize these loans and sell them to the fed for treasury bills. of course the fed should only do this for securities that are rated investment grade by moody's and s&p. this process will cure everything.

2008 Mar 27 09:41 AM

[flatman]

Its been clear to me for a long time that the Fed is really planning for wages to increase through an inflationary spiral. Its obvious that housing is unaffordable under 'normal' credit standards in quite a few parts of the country. There's only 2 choices - prices must fall or wages must go up. The ponzi scheme that juiced housing is done.

2008 Mar 27 09:43 AM

[Lawrence York]

Interesting data. It certainly backs up the marketplace reality that there is not yet enough inducement to buy. Also noteworthy is the fact that bank/brokerage capitial reserves are severely strained. Banks only keep 5% on deposit for housing loans so the decline in housing values has significantly diminished their ability to lend. The Fed is obviously helping and praying time will turn things around. The unfortuate case is that this 'help' delays the tipping point being reached as it delays final repricing of mortgage loans that were made based on excessive valuations. I think the Fed's focus to shore up balance sheets and timing bet to fix the problem may prove to be the highway to printing money as a final cure.

2008 Mar 27 10:40 AM

[User 169182]

Why not let the market work by advancing credit to qualified buyers looking for bargains in the housing market. Now most of the best buyers are locked out of the market due to credit issues or fear of prices falling further due in part to a lack of market for the product for the before mentioned reasons. Right now continuing our current policies will only create a self fulfilling prophecy of housing price collapse. Boosting bank profit margins will not help the problem. Making money cheep money available to great buyers will.

2008 Mar 27 06:50 PM

[Pseudonym: Parikshah]

Less than 18 months ago, as the economy steamed forward, popular articles were being published about the rates of wages to corporate earnings. Although within the historical band, wages could have risen 10% without corp earnings rising, and still remained in that historical band - they were at a low. So we knew companies would have to pay employees more in the future - or earn/grow less. In the interim, prices of goods that drove earning for these companies would have to come down so that people could afford them. Now that prices have come down and earnings growth is slowing, will anyone be able to pay more? Maybe its time for non-banking firms to up their pay.

2008 Mar 28 12:55 AM

[User 170311]

Nick, Any idea where I can find data history for average weekly wages in actual dollars? There are plenty of stats on "real" wage increases (if you believe in CPI and the tooth fairy) but nominal wage increases are hard to find.

It is misleading to calculate housing affordability using Household incomes. Eventually we would see 10 people living in a one-room apartment while the government tells them that housing affordability has never been better.

2008 Mar 30 08:50 PM

[Robert Trudeau]

How does the Fed raise nominal incomes? Is there any limit to the Fed's powers, or is he the wizard of OZ?

2008 Apr 19 07:50 PM