Monday, March 06, 2006

I Hate to Burst Your Bubble

Another great article concerning the current housing bubble on "According to Leonhardt, homeowners ought not to be as concerned about a potential 2006- 2007 housing bust as real estate agents should. But this is partial-equilibrium thinking on the part of Leonhardt. As many of you know by now, Asha Bangalore, my colleague, has documented that about 40% of the feeble job growth in this current recovery/expansion has been housing related.

"But if we do have a housing bust - and we likely will if Bernanke does not soon declare a ceasefire - then a lot more than a rounding error of workers could be lining up for unemployment insurance. The cutback in spending by these unemployed would have a, excuse the Keynesian expression, multiplier effect on total spending in the economy - adding some homeowners not associated with the residential real estate industry to the length of the unemployment lines."

"Today housing is indirectly playing a much larger role in funding expenditures on consumer goods and services than it did in the late 1980s. As shown in Chart 1, in the third quarter of last year, households extracted equity at an annual rate of $633 billion, representing 7.0% of their after-tax income, from their houses. In 1989, home-equity extraction totaled only $82 billion, or 2.0% of after-tax income"

"In recent years, increases in household net worth have been significantly boosted by the appreciation in residential real estate values. For example, in the first three quarters of 2005, the appreciation in the value of residential real estate accounted for 58% of the increase in household net worth."

"Housing today is more highly leveraged than it was in 1989, just before the last bicoastal housing bust occurred. As shown in chart 3, today the housing leverage ratio is about 43%. In 1989, the leverage was about 35%. So what?

"So, as shown in Chart 4, between 40% and 50% of new mortgage debt applied for in the past two years has had an adjustable-rate element to it. Back in 1990, only about 10% of new mortgage debt was of an adjustable rate nature. A lot of these adjustable-rate borrowers in the past two years are in the "sub-prime" category or are speculators. In either case, they probably have little equity in their homes. It has been estimated approximately $600 billion of sub-prime adjustable rate mortgages will reprice over the next two years. Chances are they will reprice at higher interest rates, not lower ones. Chances are mortgage defaults will be on the rise with these repricings. This will put "repos" on the market, which will depress home prices. Speculators, with negative cash flows and slower or no appreciation in their investment properties, also will add to the glut of homes for sale. "

"Again, so what if mortgage defaults are on the rise? No biggie except that, as shown in Chart 5, U.S. commercial banks have a record exposure to the mortgage market. About 62% of bank earning assets are mortgage-related.'

"What I'm driving at here is the potential for a bust in housing to cripple the banking system. History tells us that a crippled banking system renders central banks less potent in combating economic downturns and promoting robust recoveries. In other words, if a housing bust led to large credit losses to the banking system, Chairman Bernanke could cut the fed funds rate to 1% and be surprised that a low interest rate did not have the same magic for him as it had for his predecessor."

As I have to outline in prior posts, the majority of the 'recovery' since the stock market crash in 2000 has been a massive infusion of money into the system by the Federal Reserve, which has simply transferred the bubble from equities to real estate. The entire financial system- banking, Wall Street, NAR, the GSE's, the government, are all responsible for creating this monster. They are now wondering how to push up a rope so to speak, trying to stop the unstoppable forces of economics. It simply won't work. As in prior monetary and business cycles, it is going to 'play itself out.' I would encourage everyone to study the last major real estate decline in the late 1980's- early 1990's as a reference for what lies ahead.


At 2:14 PM, Blogger Gregory Blecha said...

Excellent post! How would you rate the exposure of the commercial banking system to the exposure the S&Ls faced during the S&L crisis? What do you think are the chances that such a banking crisis would militate toward a federal bailout, a la the RTC?


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