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Monday
Jan282013

Raining on the housing recovery parade

Many want to believe that housing is staging a comeback. This is a logical wish since so much of our economy now relies on construction and related Suburban Experiment support endeavors. What we see today in the gyrations of the housing market feel more like the ebb of a losing battle than anything like a recovery. What our economy needs is real productive growth, not another bubble.

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The hard times have past. We've suffered through the worst. The light at the end of the tunnel is fast approaching. These are the platitudes we've been telling ourselves as 2012 came to an end and a new year began. Nowhere is optimism greater than in the real estate, construction and related industries.

I have a fair amount of friends and casual acquaintances that are realtors. I may like and respect many of these people on an individual level, but it was a challenge to my Christian good will to continually be bombarded by them online with stories about the coming boom in housing. As a coping mechanism, I've saved some of these articles to share.

U.S. home sales and prices are poised to rise in 2013, solidifying a recovery that began last year after a half-decade slump that was the deepest since the Great Depression, according to analysts and economists surveyed by Bloomberg. Record-low mortgage rates and attractive prices, supported by declining unemployment, are luring buyers as the inventory of distressed homes shrinks. Homebuilders are responding by adding supply, bolstering economic growth.

“Everywhere we are, we can see it,” Larry Webb, chief executive officer of Aliso Viejo, California-based New Home, said in a telephone interview. “Talk about pent-up demand.”

After a 2012 marked by some hopeful signs of recovery in the Twin Cities commercial real estate markets, 2013 will likely hold more of the same -- provided the fiscal cliff negotiations in Washington are resolved quickly, a group of local experts says.

Top players in the Minneapolis-St. Paul industry e-mailed their predictions to Bricks & Mortar for the coming year, and they indicate fairly strong feelings that the multifamily, industrial, investment and medical markets will continue their strong performances from 2012

“Construction has turned the corner and is coming back,” Chapman University economist Esmael Adibi told several hundred people attending the Building Industry Association of Southern California’s Riverside County chapter’s 21st annual Economic Forecast event in Riverside.

With no major drags on the horizon at the local or national level, Adibi said he believes the Inland economy will add 25,000 jobs across all payroll sectors in 2013 — some 3,000 in construction — for a 2.2 percent gain over 2012, when 18,000 payroll jobs were added. The most recent report from the state Employment Development Department, for December, found year-over-year job growth of 1.1 percent.

That last one was my favorite. With no major drags on the horizon at the local or national level.... 

So let's take a look at housing. Economically speaking, in combination with finance, the construction industry is the primary manifestation of America's Suburban Experiment. Throughout human history, finance and construction (and government, for that matter) were trailing indicators of productivity; places that created a productive economy would then see demand for more construction and financial activities.

In the six decades of America's Suburban Experiment, we wound up reversing that state of affairs. Now construction, along with finance, drives the economy. Increased demand for housing creates employment opportunities for construction workers as well as thousands of support industries, from manufacturers of porcelain toilets and HVAC systems to all the people selling furnishings at the Pottery Barn. Demand for housing also has the virtuous effect of raising home prices which, unlike any other thing we purchase, is considered good since it provides homeowners with additional wealth and purchasing power. This, in turn, fuels consumption and the virtuous, Keynesian cycle of demand-fueled growth churns on.

As James Howard Kunstler is fond of saying, once you take all of the construction-related jobs out of the American economy, all you have left is brain surgeons and KFC workers. That is his satirical way of pointing out that our globalized economy is providing great opportunities for the very few that are well educated and well connected, but few opportunities (outside of construction) for anyone else. Take construction and the trickle down from it and the cupboard is pretty bare.

Let's take a step back and look at the pre-Suburban Experiment and Suburban Experiment housing data as provided by Robert Shiller. It is important to note too that, while we certainly had suburbs and suburban development prior to 1945, America's Suburban Experiment is a combination of three paradigms, each untested, that we have uniquely combined in the post-World War II economy.

  1. An auto centric development pattern for urban, rural and suburban areas.
  2. A centralized approach to management of the economy, including growth and job creation.
  3. A fiat currency used as the world's reserve.

I realize that many would put our one time oil endowment into that mix as well, but -- as unique and impactful as it was -- it was not a man made creation. In other words, we could have used the oil endowment without the other components of the Suburban Experiment as I have outlined them. I have no doubt that the converse of that statement is not true.

Here's what volatility in the pre-Suburban Experiment housing market looked like. Note: there wasn't much. This is why it was so laughable to suggest that our housing price drop was even greater than in the Great Depression. In the 1930's, construction and housing were not the drivers of the economy. Prices went up and down, but nothing like the volatility of the Suburban Experiment.

Data obtained from econ.yale.edu.Continuing this same line with the same set of base data, here is what the Suburban Experiment data looks like. Obviously, a lot more volatility. There are the three modest bubbles leading up to the huge bubble. You'll also note that, while we've dropped quite a bit from the high, housing remains about 23% higher than the historical averages would suggest. While I won't argue that housing values will fall a lot further (although the case for that ultimately happening is strong), it is hard to argue that housing is currently undervalued.

Data obtained from econ.yale.edu.

The narrative being put forth today in the media by "experts" including those at the Federal Reserve is simple: We're in a cyclical recession (although technically out of recession, unemployment remains high) and, as soon as employment starts to creep up, the fundamentals of the economy are strong and we'll start to see a sustained, robust recovery. Time will heal these wounds.

Let me give you a competing narrative. I've marked the four bubbles in that second graph. You'll note that they grow in size as time goes on. The first one is right in that spot I've identified as the end of the first life cycle of the Suburban Experiment. This was the time when the illusion of prosperity from the first generation of growth was starting to wane, when some of the bills were coming due and our economy was starting to stall. 

If our Suburban Experiment contained only the auto-centric development pattern, it would have died here, unable to be sustained financially. Unfortunately, a centralized approach to growth, development and job creation combined with the ability to create as much money as needed and have it be absorbed by the world to extend our great experiment. Like a pain killer for an ailing economy, we can see a little bit of rescue at (1), then when that little amount wouldn't do, a little bit more (2), then some more (3), then a whole lot more (4). We're now just heavily medicated full time, an economy as addict.

The early fuel were things like the Interstate Highway Act, Fannie and Freddie, the FHA and other programs to expand home ownership and drive the Suburban Experiment. The late fuel -- the desperation phase -- involved financial fraud and the complete breakdown of the rule of law. If there is a fifth bubble -- and there very well could be -- it will undoubtedly involve all of the above, plus.

Consider all of the things backstopping the fall of housing today.

  • Continued historically low interest rates in defiance of market forces.
  • Government guarantee of mortgages allowing waiver of minimum down payment and many ability-to-pay criteria.
  • Government subsidies of mortgage interest.
  • Massive Federal Reserve purchasing of securitized mortgages.
  • The continued absence of the rule of law in financial markets.
  • Enormous and ongoing bailouts of banks and insurance brokers.

No major drags on the horizon? Consider just one of these factors: interest rates. My first mortgage back in 1996 was at something like 8%. We were told by family members that 8% was a fantastic rate -- almost a steal. Well, we just refinanced at 3%. If rates went back to where they were during Suburban Experiment bubble #3, then we're talking about cutting purchasing power in half. That's a lot of headwind if the economy ever does show signs of "recovering".

From the website The Big Picture (click image for article). See the trouble here? If interest rates rise, which must happen in an improving economy, the only way to keep housing prices up is for wages to increase. Wages won't increase broadly until unemployment goes down. Unemployment, in the current economic belief paradigm, is solved by keeping interest rates low, stimulating construction and all the related industries. We actually have the negative feedback loop of the addict; we need the financial drug to keep going, but if we get going and the drugs are taken away, we're not fit enough to make it.

To that point, let me throw one last graph at you, this one of unemployment. 

Image by the website ZeroHedge. Click on the image for the complete article.With an economy based primarily on propping up the housing market, we've become powerless to solve the underlying unemployment problem. The private sector can simply no longer borrow and build our way to anything that feels like prosperity, real or not. A fundamental shift needs to take place in how we generate wealth and prosperity, but we're stuck. 

We need housing to go up to solve the unemployment problem, but another housing bubble does not an economy make.

This is going to be painful, but I don't see any way forward except for a local strategy of building strong towns. 

---

There was a lot of data and information I collected that didn't make it into this post. I'm going to be sharing that bonus material and some additional analysis over at the Strong Towns Network.

 

 

If you'd like more from Chuck Marohn, you should really get a copy of his recent book, Thoughts on Building Strong Towns (Volume 1). It is a primer on thr Strong Towns movement and an essential read for those wanting to get up to speed quickly.

You can also chat with Chuck, Nate Hood, Andrew Burleson, Justin Burslie and many others over at the Strong Towns Network. Join the conversation on how to make yours a strong town.

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Reader Comments (11)

The housing price volatility graph from the 1950s confirms what a friend told me about her dad's experiences then. He moved his family every few years in pursuit of some career, and each time he did, he'd buy a new house, hoping not to lose too much when they moved again. Nowadays, I think people now generally think the opposite, that they'll make money, that their houses are investments, which kept long enough can only rise in value. Demographics may yet prove the latest sentiments true -- here in L.A. the real estate crash was experienced as a blip -- but housing is a market subject to the whims of markets generally.

January 28, 2013 | Unregistered CommenterBrent

Are those averages inflation-adjusted? (Another side effect of fiat currency.)

Secondly, it's interesting that between 1945 and 1950 the average cost of housing grew 10% and then stayed there until the onset of the giant '90s-2000s bubble; it's also interesting to note that the bubble never actually bottomed to that rate (it looks like the bubble bottomed 5 percentage points higher than the historical postwar average). Finally, each of the first three bubbles blew only when housing prices were significantly undervalued viz. the postwar average; the fourth started blowing, for some reason, when the price of housing returned to that rate after the failure of the third bubble.

By the by, I'd agree that current conditions are short-circuiting Keynesian structure (much as the maturation of infrastructure expenses did in the stagflationary period), while the collapse of this past bubble has been nothing short of catastrophe to neoclassical (followers of Hayek) economists. There is a significant problem, I think, that the current economics paradigm is not producing anything approaching an adequate explanatory mechanism for current (observed, empirical) conditions.

January 28, 2013 | Unregistered CommenterSteve S.

One of the biggest problems with New Urbanists, in general, in their analysis of the economy is that they often unduly focus on the housing crisis (sub-prime loans and mortgage-backed securities) as being the cause of the Great Recession when the Credit-Default Swap, in fact, was. The type of housing, auto-centric or otherwise, was and is incidental.

Interest rates are low, fundamentally, because lending institutions have become more averse to risk. Increasing regulation and decreasing moral hazard will continue that trend, but aggregate demand, not interest rates, is, ultimately, the driver for investment and job formation. The supply-sider mentality creates a caricature of Keynes when he really only calls for balance. And, that balance is logical. Anyone arguing against countercyclical fiscal policy in the public sector is like a person buying high and selling low in a market. And, this obsession with non-existent inflation does a disservice to everyone. Remember that the Great Depression was prolonged by the same Hooverites worrying about debt in the short term. And, look today at the U.K. and at much of continental Europe. Austerity policies there have created a second and, potentially, a third recession. So, support new public investment in those things that create jobs in the short term and economic growth in the long. Let's just be sure that the new infrastructure spending goes to the places and systems that support resilient local economies and Strong Towns.

January 28, 2013 | Unregistered CommenterMatt Korner

Straw Dog, @Matt. Straw Dog.

Beyond that, to simplify the entire crisis down to the CDS is like saying that the assassination of Archduke Franz Ferdinand was what caused World War I. Convenient for a history quiz but the reality is far more complex.

I would recommend you read Nassim Taleb's latest work. Antifragile. It argues fairly persuasively against the over-simplification you are putting forward here. It takes a lot more than sparks to burn down a forest.

And again -- didn't we touch on this last week -- I think it is far too early in the course of human events to suggest that the UK is on the wrong path while we here in the US are doing the right thing by avoiding austerity. Another potential outcome is that their economy corrects more quickly, albeit with slightly more pain up front, and they avoid the decades of volatility and stagnation. I'm not saying that is what will happen, but it is certainly possible.

The major difference between me and the Keynesians is that I'm not going to pretend I know something when the outcome is clearly unknowable.

January 28, 2013 | Registered CommenterCharles Marohn

Yet another fantastic analysis. It's amazing, how you can quantify 30 plus pages of data so well. I would like to add something:

Overlay the average price of gasoline, over that same timeline. I think you'll notice a correlation between price shocks, and home construction/pricing. The Suburban experiment, is predicated on readily available, inexpensive fuel. All that you wrote, is absolutely true, but if you add in the price of transportation, it becomes even more obvious why it isn't economically sustainable.

We have the unpleasant system, that marries both a "centrally planned" economic model, and a "free market" model. Because of this, any manipulations on a central level, are closely followed by a "market adaption". In essence, when interest rates a centrally kept low, the home prices quickly rise up to take up the slack. Your purchasing power fails to actually increase much at all. The "Free Market" componant, is the fact that there isn't a central entity that tells people where they can reside. Therefore, market forces cause wave-crashes in the single-family home market.

Consider adding to your list of items backstopping the catastrophic backstep in the housing market:

The massive subsidies provided to automobile dependence/requirements. From parking minimums, petroleum subsidies, transfer payments to build, rebuild, maintain the suburban expanse. If these were eliminated, would suburbia ever survive?

January 28, 2013 | Unregistered CommenterDennis

Couldn't agree more, Dennis.

January 28, 2013 | Registered CommenterCharles Marohn

A related issue: a large number of houses (probably numbering in the millions) have been abandoned in the U.S. Millions more are in a state of serious deterioration. I think this plays into the “strong towns” philosophy – which would be to rehabilitate (savable) neighborhoods. (I’m relatively new to the site – and am still playing catch up).

I can see a real employment opportunity in house renovation and restoration. Best of all these would be small mom-and-pop businesses. Best of all – does not require huge financing commitments. It’s pretty much a pay-as-you-go process.

January 29, 2013 | Unregistered Commenterwayne gambel

Chuck,

Listening to your podcast on Keynesianism and reading a few more recent posts, I have a question (thought?). Are you more opposed to the idea of Keynesian inducing aggregate demand in general because it's hard to get off the meds, or are you opposed to the particular brand we've got ourselves locked in to in the US. Seems like the methods we've used in how we construct our infrastructure, what we tie economic indicators and successes to, and how the government has chosen to control/manipulate our currency are the problems. Not necessarily a government choosing to be the ones causing extra demand in times of recession. Thoughts?

One more thing.. If you look at interest rates over the past 45-50 years, one would assume that average home prices would follow a trend that would mirror the bar chart you cite - a near linear relationship between interest rates and price. Lowe interest rates would coincide with rising home prices, and we've seen basically a steady decline in mortgage rates but near home prices that have hung right around +10% of the WWII home price (with a few bubbles, one extremely large). I'm not saying that lower interest rates haven't propped up home prices per se, but over the long haul why don't the trends support that?

January 29, 2013 | Unregistered CommenterAlex

More doomer stuff. Be an optimist. There isn't much sense in being anything else Chuck the economy is what we make it. It is a construct.

January 30, 2013 | Unregistered CommenterEkkidu

Charles, public spending in the U.S. has been severely restricted in the U.S. since the Great Recession, so we have our own version of austerity happening here.

Unemployment would be down to 6% if we had merely maintained historical levels of growth in public-sector spending. But, the point I am making concerns the Credit-Default Swap, which many powerful interests do not want to see restricted. This derivative, however, is responsible for everything. Previously-illegal as a financial instrument, the C.D.S. incentivized the sub-prime loans and the mortgage-backed securities. Everything else referenced in the discussion is politically-motivated obfuscation.

The housing crisis was simply the fuse that lit the bomb, as the C.D.S. holders are the ones who were able to extract trillions of dollars of global wealth and concentrate it in their hands of a very small number of people.

February 3, 2013 | Unregistered CommenterMatt Korner

I won't defend the CDS, but nobody has any credibility with me when they say things like "unemployment would be down to 6% if..."

Again, I strongly recommend Taleb's Antifragile to you. Your confidence in your (or anybody's) ability to fine tune the economy like a guitar is unfounded and dangerous. The CDS would not have been the time bomb it is without an ability to scale it to international dimensions. That scale is only possible from the hubris associated with people who think the economy can be simplified down to a few variables.

We need systems that break early and often, be messy and chaotic. We don't need to orderly but dumb, top down central planning sold to us as efficiency and growth.

Deflecting all of this onto greedy hedge fund operators and their CDS's takes the responsibility (and power) out of our hands. Of course they are greedy; when in hisotry have they not been?. It is our -- the American people's -- deal with the devil that allowed their greed to manifest as it has. That we did it for a two acre lot, a vacation in Mexico paid by home equity and a slightly bigger SUV makes it all the more tragic.

February 3, 2013 | Registered CommenterCharles Marohn
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