According to news headlines, the housing recovery is real and could drive the economy up in a similar way to how housing drove down the economy a few short years ago. Indeed, the data bear out that the housing recovery is real … for now. Home values were up 20% in some markets in 2012, inventory is low, foreclosures are down, and investors are scrambling to find good deals. Whether you are an investor, a note buyer, or just a family wanting a place to live, the future looks bright. Even a financially conservative mortgage buyer like me believes that the next 12-24 months will shine for real estate.
Can this housing recovery keep going? My own analysis and gut feeling are that we are building up to another real estate bubble. There are three overall reasons for this.
1. Credit has Become Overextended
Bill Gross of PIMCO recently wrote an article called “Credit Supernova” that explained how much new credit is needed to generate one dollar of GDP. In the 1980’s, that ratio was 4 to 1. Since 2006, it has required $20 of new credit to create that same dollar. Gross referred to this as Ponzi Finance, as more credit is required and starts to consume itself. Eventually, interest payments get so large that they cannot be managed and then the collateral damage spreads to other entities.
The U.S. government is the biggest debtor, with no way to pay its future obligations. Since no elected official or bureaucrat wants to be the one associated with significant change in government programs and expenses, they continue to extend and pretend, while the mass media gives them a free pass to say that all is well.
2. Government and Wall Street Too Involved
An article in Zero Hedge phrased it well by stating that actions by the Federal Reserve and the U.S. government have prevented housing from having an organic recovery. Low interest rates forced upon us by the Fed allow the government to pay less interest on its debt and encourage citizens to invest in riskier assets to chase yield. ZH also opined that “high levels of speculative activity could be nurturing a false confidence.” I would have used a stronger pair of words than “could be.”
The government is involved with nearly every mortgage in the country in some fashion. Fannie and Freddie already cost the taxpayers billions of dollars and the Federal Housing Administration (FHA) has so many risky loans and such a high default rate that it is setting itself up for an implosion. If we look back over history, it is clear that government manipulated economies and markets have a poor track record.
At the same time, hedge funds and private equity firms like Blackstone Group and Paulson and Co. continue to spend billions to buy up land and foreclosed houses that they will rent out and eventually sell. At the first sign of a housing decline, companies like these would be quick to the exit door to minimize their losses.
3. Weak Household Wealth
One reason that there are so many all-cash buyers, as well as those at the opposite end seeking an FHA loan so that they can just put down 3.5%, is that the average household has suffered declining wealth over the past few years. States as diverse as California, Alabama, and Alaska have seen a near doubling of food stamp usage over the last five years. A report by the Fiscal Times reported that half of U.S. households (132 million people) are not financially capable of handling a weather emergency or finance long-term needs such as college tuition or health care. Additionally, the report states that “these people wouldn’t last three months if their income was suddenly depleted.” Clearly, this is not just the working poor but also includes a sizable segment of the middle class.
Overall, the housing market is not supported by a strong foundation and has way too much government interference. My personal prediction is that low inventory and low interest rates will carry the housing market for another couple of years, but then all bets are off. Until true unemployment drops significantly and the government gets less heavily involved, we cannot have a natural and long lasting increase in home values.