Housing Might Drag Economy Down Again

Other than high unemployment -- a lagging indicator in fact -- the economy does seem to be improving, but there is now a renewed threat from the housing sector, suggesting that sector could again face further and significant declines in price. It was the housing sector that dragged us down and threw us into recession the first time. It also collapsed Wall Street’s house of cards. It might well do it again. Here is the problem.

The 10-City and 20-City Composite Home Price Case-Schiller Indices declined 6.4% and 7.3%, respectively, in October compared with a year earlier. As David M. Blitzer, chairman of the Index Committee at Standard & Poor’s put it:

The turnaround in home prices seen in the spring and summer has faded with only seven of the 20 cities seeing month-to-month gains, although all 20 continue to show improvements on a year-over-year basis. All in all, this report should be described as flat.

Others disagree and see a sequential decline in prices in the numbers, claiming the Case-Schiller indices showed only a very slight increase currently and only because each report is an average of the preceding three months, meaning the strong August market was still a component of the October report. Also, they claim seasonal adjustments tend to hide any weakness in the cooler months as the pace of home-buying slows.

The change from improving and rising prices to now flat or falling prices raises ominous possibilities, especially inasmuch as mortgage rates have risen in the last four weeks from 4.71% to 5.14%, making it harder to afford housing.

Karl E. Case, the Wellesley College economist who helped design the Case-Schiller housing index, is alarmed and was recently quoted as expressing his very pessimistic outlook

I’m worried. Everyone’s worried. If [housing] prices sink 15 percent from here, which is a possibility, and the 2008 and 2009 loans [also] go bad, then we’re back where we were before — in a nightmare.

In short, loans written more recently would succumb to a similar fate as subprime and ALT-A loans written earlier. A whole new set of write downs or write offs would be needed if the FASB or IASB standards were strictly applied and there was a reversion to the mark to market rule. We would be awash in another large quantity bad debt.

Several elements reinforce this concern. Housing demand is weak. Median income continues to drop because of unemployment and a long term trend toward flat wages. Also, income is shifting from the labor force to top management and special interests, aided by Congress. The demand for housing is also being hit by selected vastly higher expenses that are driving many into bankruptcy — like medical costs which account for 50% of all bankruptcies. Also, population growth in the relevant cohorts is not adding to housing demand materially.

The net result is housing prices are vulnerable to further declines which could well drag the economy down with them, just as it did the first time. In part, this is the legacy of ill-advised tax laws which favored excessive investment in the housing market for many years in the first place, coupled more recently with Fed policies which aided formation of the housing bubble. Those problems are a lot to dig out from. Regardless, recent developments do not afford an encouraging prospect.

Disclosure: none relevant