Housing Doom

Doom Transcripts: Index & Guide

Housing Doom is pleased to present a sixth selection from our under-construction transcript of the American Enterprise Institute’s October 22, 2009 event "The Deflating Bubble, Part VI: The Lessons of the Bubble and Crisis".¹

The event site has a number of resources, including an audio and video of the proceedings. There is as yet no official transcript.

This is the presentation by AEI’s Desmond Lachman.

Desmond Lachman: [1:08:20] Alex, thank-you very much again for organizing this conference at a 6-monthly interval.

I think one’s got to go through life counting one’s blessings, and one of the blessings that I’ve realized that I’ve got to count on now is that my name isn’t Tom Zimmerman, and that I come at the end of the presentation.

Because much of what is said, I really agree with. So I can walk through a presentation. I’ve entitled it "A False Dawn for the Housing Market?" [slide 1²]

In the interests of being optimistic I’ve put a question mark whereas I really meant putting an exclamation mark. [laughter]

Let me start just with the lessons that one can draw from this crisis, and I think that there are a whole bunch of lessons. We’re going to be writing books about this for many years to come, much like The Great Depression we’ll be looking through this crisis. And I very much agree with what both Nouriel and John have said, that one really needs to be paying attention to bubbles, that we’re just creating another bubble that is going to be bursting. But I think that there are just a whole bunch of other lessons to be learned.

What is really of concern to me is — What are we learning about this as a society? And I’d say that it seems to me that we’re not learning very much. I look at what occurred after The Great Depression. The Great Depression produced fundamental reforms in the financial system, whether it was the Glass-Steagall Act, whether it was the FDIC, whether it was the SEC, [1:10:00] there were really very basic changes.

What I see occurring this time around is we’ve got institutions that are even bigger to fail, we’ve got more moral hazard, we’re not really dealing with the derivative problems, we’re not really dealing with the incentive problems, we’re not dealing with a whole lot of this stuff that really caused the problem in the first place.

I don’t want to dwell on that too much. What I thought instead is, I would just deal with the one lesson that I think by now we should know is that housing and the economy are joined at the hip, [slide 2] and I think that their being joined at the hip leads me to very much agree with Tom that we’re not at the end of this housing bust. I think that we’ve got at least another 10 percent to go. And I think I’m more in the camp that we’re going to get a W. I just don’t see the basis for a V, but I’ll establish that going forward.

Many of the slides you’ve seen before, but just let me start with the idea that housing’s joined at the hip. You know I think that what’s really important is, what happens to house prices in the sense that it basically affects households’ wealth, [slide 3] it affects their access to credit, it increases losses at the central bank … at the banking system, the finacial system. So if we do get another 10 percent drop in house prices that’s not very good news.

Likewise, I don’t see how you can get stabilization in the housing market unless you get some kind of recovery. So I think that the two feed off one another.

Organizing the slides just a little bit differently from Tom is … I put them in terms of the good news [slide 4] where we’ve already seen this slide. [slide 5] Basically prices coming back more to trend levels, more in line with rents, more in line with income. That indicates to you that you’re probably nearing a bottom, that we’re a lot better than we were 6 months ago.

Mortage rates come down [slide 6] so what we’ve got is we’ve got affordability levels, [slide 7] this orange line, it’s scale is inverted. Affordability levels really at very strong levels historically. So all of that is rather supportive to the housing.

And then basically what you’ve just seen is you’ve seen residential investment collapse, [slide 8] so that what we’re doing is we’ve got 500,000 starts on the housing side where demographically there are 1.5 million units being formed, so you’re basically working off the inventory … you’re beginning to work off the inventory gradually.

That was the good news.

The bad news, as far as I see, [slide 9] is that you do have a substantial overhang of stock. You’ve got, like, a million units above the normal level that are vacant. [slide 10] So you’ve got stock overhanging a market. I don’t see how you can really get prices increasing in any meaningful way.

And then what Tom indicated, and I think that this chart [slide 11] really bears it out, is that you’ve got a real foreclosure crisis unwinding. So you’re going to be just having additional supply coming onto a glutted market, that that has to mean that prices reverse the little increases that we’ve seen to date.

This chart [slide 12] coming from the IMF just indicates how many more people are going to be underwater going forward, which just aggravates the foreclosure problem.

Something that Tom mentioned, this slide [slide 13] I thought you might be be interested in, just indicating that first-time homebuyers have really been the ones who’ve been accounting for the increased sales. So we’ve got a problem … if this $8,000 credit gets wound down. Then we’re going to see sales coming off again.

Tom didn’t mention, I don’t think, the problem with option-ARMs, [slide 14] you’ve got like $200 billion of option-ARMs resetting in 2010, which isn’t going to be much fun.

But I think that this is really the chart [slide 15] that bothers me is the state of the labor market. It’s not simply a question that you’ve got unemployment at 9.8 percent, but as Nouriel mentioned, if you include part-time workers, the number goes up to something like 16 3/4 percent, which just means that you’ve got a lot of job insecurity. That’s why you’re not seeing the affordability converting into sales.

And I think that the issue is, "Where do we go forward?"

The last few slides, but before we quite get there I think that this slide [slide 16] is of particular relevance. This comes [1:15:00] from the Atlanta Fed, which shows what is happening to part-time workers who aren’t in full-time employment in this cycle. That’s the dotted line at the top. And if you compare it to the 1981/82 cycle, which was the worst recession before then, you see them as running at something like double the rate  So what I’m suggesting is that the labor market slack this time around is a lot worse that 1981/82, which is very problematical going forward.

The reason I don’t think there can possibly be a V shaped recovery, and why I think that you’re running the risk of a double dip is that you’ve allowed the gaps in the labor market to really reach very high levels. [slide 17] And what that does is it puts real pressure on incomes that I think one’s really got to be worried that in the 2nd quarter of this year, at a time that you were getting tax cuts boosting incomes the only way in which incomes could rise after-tax-incomes was through these tax cuts, yet consumption fell by 1 percent. [slide 18] So what happens when we don’t have that kind of support and when we’ve still got downward pressure on wages through high unemployment levels?

This chart [slide 19] just indicates that you get quite a nice correlation between the gap in the labor market and what happens to the employment cost index. What it is telling you is that the gap in the labor market is going to widen to something like 4 or 5 percentage points. At least that’s where we are right now. YOu would expect to see a sharp decceleration in the emplyment cost index. Where I come out on this is that if you don’t have income growth it’s very difficult to get consumption. And to make matters worse is you’ve got to look at the indebtedness position of the households.

Households today have debt that is something like 135 percent of their incomes. [slide 20] If we look at what happened in 1981/82 it was only 60 percent of the income, so I don’t think it’s unreasonable to suppose that we’re going to see the savings rate gradually move back towards its historic level of around about 8 percent.

If we get any increase in saving, and we don’t get any increase in income or we’ve got a decline in income this means that consumption has to decline. What Nouriel says I totally agree with. If you’ve got excess capacity, that it’s really very high, you’re not going to get investment. So I think that the probability that we get a double dip is pretty relevant …

Another chart [slide 21] just indicates what’s happening with mortgage equity withdrawal. It’s totally collapsed. Consumers are credit-constrained, so we have that problem as well. [slide 22]

The problem that I’m worried about in addition to consumption is that the charts that Alex had put up earlier, [slide 23] what’s going on in the commercial property market, that with Alex mentioning that this is all that the regional banks really do. If $500 billion in loans come due in … commercial property loans come due in 2010, we have a further collapse in commercial property market prices, I don’t see how regional banks can possibly survive. So what we’re going to get is we’re going to get further tightening in credit conditions.

My bottom line, as I say, [slide 24] I think that house prices fall by 10 percent. [slide 25] We have further decline in the economy and I’ve kept this presentation as optimistic as I can [laughter] by not talking about what’s going on in Europe, where I think that the real problems we’re going to see.

We’re first going to see the Baltic countries running into real difficulties that can only be a couple of months away that has an impact on the Swedish banking system. But the serious problem in Europe are Spain, Portugal, Greece, Ireland, you know, the those places. To me, having worked on Argentina for a long time, I think that that is the area to worry about.

So I’m not particularly worried about the United States, I’m worried about Europe.

Alex Pollock: Desmond, you did that so efficiently you have some time. Would you go back to your lessons slide and do some of the other lessons you had an interest in? Can you make it go backwards? … Give us a quick review here.

Desmond Lachman: [slide 2] One of the lessons that I would suggest that hasn’t been learned is that people haven’t really read Kindleberger’s "Manias, Panics and Crashes." That had they read that they would see that [1:20:00] this is really a repeating kind of cycle which Rogoff and Reinhart have brought out. That basically I think that the Fed hasn’t paid attention to asset price inflation in the past, that it’s really problematic. I don’t know how you can be dealing with it right now.

The other thing that I thought that we really should have learned from this cycle is that GSEs are not a very good idea. So to have the government running these banks, I think that that is rather problematical.

The house lending[ph] needing regulation, that that seems to me fairly obvious, but it’s something that I haven’t put up here is … The way I think of it is a lot of the problems are that you’ve got incentives that aren’t really … not in line with the public interest. So what I’m thinking is stuff like the rating agencies, stuff like the compensation practices from Wall Steet. All of that really needs a radical overhaul.

And what I’m seeing, what Treasury’s proposing and what is actually being passed to date really seems to be skirting at the edges, it doesn’t really seem to be changing the system in the way that I’d like to see.

I would just say that I very much agree with the speech [PDF] that Mervyn King made yesterday that basically, in effect, I think that bringing back Glass-Steagall would be a good idea. But unfortunately I think that the moment to have done that has passed. It would have been at the time when the banks were really in a rather weak position. That the fact that you didn’t do it in March of 2009, I’m not holding my breath for that to occur. [1:21:56]

Notes and References

[1]: "The Deflating Bubble, Part VI: The Lessons of the Bubble and Crisis", AEI event homepage, October 22, 2009.

[2]: "A False Dawn for the US Housing Market?" (PDF slide deck), by Desmond Lachman, AEI, October 22, 2009.

1. Title
2. Lessons from the Housing Bust
3. Housing and the economy are joined at the hip
4. The Good News
5. S&P/Case-Shiller Home Price Indices
6. Mortgage Rates to Remain Focus of FOMC
7. Affordability at Recent Highs
8. U.S. Residential Investment
9. The Bad News
10. Housing Vacancies
11. Foreclosure crisis looms over U.S. recovery
12. Homeowners with negative equity (millions)
13. Home Purchase Market by Homebuyer Type
14. Monthly Mortgage Rate Resets
15. Unemployment and Under-employment as per cent
16. Part-Time for Economic Reasons
17. A fragile economic recovery
18. Personal income, % change, month ago
19. Change in growth rate, in percentage points
20. Household Debt to Personal Income Ratio US (Quarterly) as of March 20009
21. Mortgage Equity Extraction (Net Mortgage Equity Withdrawal, Trailing 12 Months) as of December 31, 2008
22. Bank Loans Fall Further: Bank loans and leases, over 13 weeks, $ chg, SAAR [seasonally adjusted annual rate]
23. The Real Estate Double Bubble: Commercial and Residential Property Price Indices
24. The Bottom line
25. HPD [house price depreciation] forecasts have clustered