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The U.S. economy and housing – part I

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UShouseprices

In 2006 when the housing market popped in the U.S. the sound of fear and uncertainty was heard in hallways of financial institutions around the world. In the meantime most investors have lost their last shirt and millions more their providing jobs over it.

The world’s central banks spear-headed by the Federal Reserve have pumped trillions of dollars into moribund financial institutions to shore up their liquidity and to guarantee the perpetual flow of credit. To this day bankers can prod themselves with mission accomplished, financial Armageddon has been avoided and instead of the Great Depression, Great Recession has taken over the tabloids.

No doubt the Greta Depression is not a very appealing alternative, it is therefore understandable that the captains of this financial fire-sale rescue have become the new heroes of the establishment. The leader of the pack is of course Ben Bernanke, chairman of the Federal Reserve Open Market Comedy, who as a scholar of the Great Depression has led the great rescue operation of 07/08/09 by pumping up the balance sheet of his institution and shoring up liquidity on Wall Street.

Today sure enough reports surfaced of Bernanke’s reappointment as Fed chairman coming January. His guaranteed position at the helm of the Fed serves the current establishment and was therefore all but certain, though his well accepted speech at economist heaven at Jackson Hole last weekend might have helped.

In his speech did he not suggest that financial institutions cannot by themselves, no matter how carefully done, take full responsibility of their liquidity risk management? This sounds surprised but it really should not. According to Bernanke, central banks now and forever must be prepared to provide liquidity and credit provisions to financial firms in trouble.

I can only imagine the applause that erupted on trading desks of Wall Street’s most venerable institutions. From now on no risk can be too big and no bonus too gratifying, ‘cause Ben the savior will always be there to provide the necessary dough and pay with taxpayer’s money for the tab.

Unfortunately for helicopter Ben his success will not be measured by the smirks on the faces of bankers alone but rather by the strength of the economy and health of the job market. This will by and large depend on the recovery in the U.S. housing market. July’s data for existing home sales have been very encouraging, up 7.2 percent from June at the fasted pace of sales rates in ten years. Still much of it is in the from of distressed sales but even there the rate is declining to 31 percent from 50 earlier in the year.

Supply is still heavy but not as strong as it once was, obviously there is light at the end of the housing tunnel. Prices are still coming down nationwide, with the median sales price falling another 2 percent on the month at $178,400. But there is more good news.

In Southern California, one of the hardest hit areas during the downturn of the U.S. housing market, home sales and prices show a surprise recovery. The specter of homeownership is starting to reemerge from the short hibernation of the last couple of years. Its no surprise really and if you can believe it, it never rains in Southern California.

In Los Angeles County sales were up a staggering 19 percent in July compared to last year and the median home price rose to $321,000 but this is still much lower than peak median Southland home sale price of $505,000 at the height of the real estate bubble. Despite its recent rise the median home sale price remains at 2002 levels and is 47 percent below its peak level. Foreclosures are still dominating the sales and suppressing prices but that could change within the next twelve months.

In the San Francisco Bay Area even high end sales are recovering with homes sold at or above the $500,000 range, the highest since September 2008. With jumbo loans reemerging the high end market finally has a pulse again. This is propping up median prices which are still 40.6 percent from peak values but 36.2 percent off the lows in March 2009.

In New York City foreclosures in the five boroughs were up 14.8 percent in July compared to last year. Auction events usually draw crowds of thousand people and more participating in the bidding and snapping up bargains. So far this year Auction.com has auctioned more than 20000 foreclosed homes across the nation for $1.4billion.

Investors are rediscovering their appetite for risk in real estate assets in a big way, with some properties going for cents on the dollar at foreclosure auctions. Private-equity players are turning to IPOs in a rush not to miss the fun at the biggest buying bonanza of troubled real estate assets since the bubble burst. Since June big boys like Apollo Global Management, Colony Capital and Starwood Capital have filed with the SEC to launch their IPOs of new real estate investment trusts (REIT).

The specter of returns in excess of 100 percent is what makes the investor’s heart beat faster. Some are still cautious and think the biggest buying opportunities are twelve months out, but with federal financing programs like TALF and PPIP low cost financing of troubled assets is a win-win-win situation, for some even the best one in the past 50 years. Of course this strategy is not without risk, the economy is far from healthy and the job market is still declining, which could make expected bargain prices still a bad deal if the underlying value does not come back.

Asked if the housing market could set itself up for another bubble, perpetual housing bear and U.S. economist Robert Shiller entertained at least the possibility (see video). According to Shiller low interest rates and high affordability are positive, high inventory of unsold homes and recent experience are negative for the housing market. An exceptionally weak recovery would of course trump everything else and push the U.S. economy closer to depression.

Historic facts do not support those eager housing bulls now crawling out from under their covers. Historically, from peak to trough, it takes more than four years for housing prices to bottom. Since prices nationwide peaked in 2007, for some areas prices will still have to fall further. Moreover, usually it takes 10 years for house prices to fully recover.

For the housing market to turn around the economy needs to recover first. Now the annoying thing is that for the economy to recover the housing market needs to recover as well. A strong interdependence is here at work and the economy reinforces housing and vice versa. In other words what happens to housing is crucially important to the economy.

Another bear, Nouriel Roubini, who correctly predicted the recent downturn in the debt fueled U.S. economy suggests the recession is far from over. In many other advanced economies, similar to the U.S., the bottom in the economy is quite close but has not been reached yet. In the U.S. overcapacity, a damaged financial system and still overleveraged households will dampen any strong recovery in the economy and therefore in the housing market.

Even if some would insist to dip once and then end it, Dr. Doom’s diagnosis is a double dip recession. The dilemma is with monetary policy, because Bernanke and friends are damned if they do and damned if they don’t, mob up excess liquidity that is. All things equal according to Mr. Roubini the economic recovery will be anemic rather than robust.

In the past during economic downturns the economic model of the Federal Reserve has worked like a rubber band, you pull it hard and the economy snaps back. If asset prices plunge on one side a re-inflation trade props up asset prices somehow somewhere else. This time the rubber band could just have popped.

Historically downturns caused by financial crises are not typical cyclical recessions and last on average of 4.8 years. Growth spurts can occur and inventory restocking will contribute to positive growth in the coming quarters, but at this point it is unclear what would come after that.

The key to the gates of heaven or Dante’s inferno for a recovery in housing and the economy are the credit markets. Availability of loans for people and businesses is critical in any sustained recovery going forward. Yet the shadow banking system with its many corridors and lifts of credit distribution is still dysfunctional.

While the recession is raging the ratio of private household debt to the nation’s total economic output rose to 97 percent in the first quarter, up from 45 percent in 1975. Americans are saving more to pay down debt and savings rate has jumped to 5.2 percent of disposable income by the second quarter of this year. Roubini thinks savings rate has to go much higher, and this will hold down consumption. Shockingly, savings going up a percentage point decrease spending by more than $100 billion.

This newfound frugality might be well underway and the world has to prepare for a cutback in consumer spending and residential investment. It is difficult to see what could replace the American consumer in the global economy.

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