Equilibrium is a wonderful concept. To know that conditions will come into balance gives us a sense of stability and reassurance. Whether it is dissolved concentrations on either sides of a membrane (think ‘kidneys’), buoyancy forces acting upon a ship or supply/demand market forces, we are calmed by the knowledge such forces work with little intervention required.
It is this very supply/demand equilibrium which is now beginning to, figuratively, right the housing ship. The supply/demand forces were examined in the July 14 blog and I touched on the financial challenges in the previous post. Today we are going to look in more detail at the financial equilibration taking place.
First, prices have declined. Home prices have dropped in response to the supply of financing available and this has resulted in increased transactions, compared to a base case of no price decline, and reduced supply; i.e., fewer housing starts.
Secondly, private equity is moving to fill the market void created when credit standards were tightened and financing became scarce. On July 15, the Wall Street Journal reported that money managers and REITs are exploring lower rated mortgage securities carrying higher yields. As reported:
Bond issuers, faced with meeting rating firms’ triple-A stringent guidelines or trying to sell bonds with not ratings at all, are considering a middle ground – one that produces profitable deals and could help expand credit that is scarce in today’s housing market.
Thirdly, the rate of housing formations is destined to rise. The Echo generation will drive increased future demand, and that demand may already exist in the pent-up state.
Is there any good news? Yes, equilibration works. Just hang on.
Thursday, July 21, 2011
Tuesday, July 19, 2011
Utility and Intrinsic Value
I was always fascinated by the economists’ definition of utility – the relative fulfillment that comes from ownership or consumption of a good. Given that different goods can have different values to different people at different times, the concept of utility drives economic interactions to optimize fulfillment. The classic question – what is a glass of water worth to a man dying of thirst in the desert?
Money is an exchange of universally agreed value against which all other financial transactions are compared. This works, except…. Recent events surrounding the Greek sovereign debt crisis have eroded this concept of money, or at least for the Euro. Today, rates are rising for the sovereign debt of not only Greece but Ireland, Portugal, Italy and Spain. The Euro is sliding. As reported July 12 by Bloomberg:
"Contagion is running amok," Bill Blain, a strategist at Newedge Group in London, wrote in a research note. "A sovereign default is now being discussed openly. We seem to have crossed that moment when chaos theory takes over and we get a price breakout into unknown territory."
And today, Suki Mann, senior credit strategist at Societe Generale SA in London, wrote:
As another D-day looms on Thursday, we have few soothing words. Greece appears beyond repair, Italy is on the brink and the chances are that the euro might be no more very soon.
Translation – things are going to [insert your favored pejorative]. The Brits always did have a way with words.
But what does this have to do with housing? The US could tip over into such contagion if we don’t get our fiscal house in order. Our debt ceiling crisis could result in the dreaded “self inflicted wound” if not resolved. While few expect the US would fail to rapidly cure any default conditions, the shock to the financial system would be frightening. With the preponderance of all mortgages backed directly or indirectly by the full faith and credit of the US government, mortgage origination would hit a wall.
Looking back, it is precisely this eroding concept of money which tanked housing values in late 2007 and beyond. Pre-crash values were based upon the availability of money, albeit at times recklessly available, to support high valuations. The reduced availability of funds, not the intrinsic value of a house, drove the price declines. (If the intrinsic utility of home ownership had declined, we would see a wholesale migration out of single-family housing independent of available financing. This is not the case. People still want to buy houses but cannot.) Further, the decline has produced a self-reinforcing ‘pain avoidance’ response from those who fear further declines.
The bottom line – the housing industry has EVERYTHING riding on the debt discussions unfolding in Washington. Erosion of faith in our sovereign debt would undermine both the value and availability of US dollars. Regardless of the intrinsic value of homes, the financing mechanism would be heavily impaired.
We thirst for housing in the US, but there is no funding to buy in the desert. Is there any good news? Yes….tomorrow.
Money is an exchange of universally agreed value against which all other financial transactions are compared. This works, except…. Recent events surrounding the Greek sovereign debt crisis have eroded this concept of money, or at least for the Euro. Today, rates are rising for the sovereign debt of not only Greece but Ireland, Portugal, Italy and Spain. The Euro is sliding. As reported July 12 by Bloomberg:
"Contagion is running amok," Bill Blain, a strategist at Newedge Group in London, wrote in a research note. "A sovereign default is now being discussed openly. We seem to have crossed that moment when chaos theory takes over and we get a price breakout into unknown territory."
And today, Suki Mann, senior credit strategist at Societe Generale SA in London, wrote:
As another D-day looms on Thursday, we have few soothing words. Greece appears beyond repair, Italy is on the brink and the chances are that the euro might be no more very soon.
Translation – things are going to [insert your favored pejorative]. The Brits always did have a way with words.
But what does this have to do with housing? The US could tip over into such contagion if we don’t get our fiscal house in order. Our debt ceiling crisis could result in the dreaded “self inflicted wound” if not resolved. While few expect the US would fail to rapidly cure any default conditions, the shock to the financial system would be frightening. With the preponderance of all mortgages backed directly or indirectly by the full faith and credit of the US government, mortgage origination would hit a wall.
Looking back, it is precisely this eroding concept of money which tanked housing values in late 2007 and beyond. Pre-crash values were based upon the availability of money, albeit at times recklessly available, to support high valuations. The reduced availability of funds, not the intrinsic value of a house, drove the price declines. (If the intrinsic utility of home ownership had declined, we would see a wholesale migration out of single-family housing independent of available financing. This is not the case. People still want to buy houses but cannot.) Further, the decline has produced a self-reinforcing ‘pain avoidance’ response from those who fear further declines.
The bottom line – the housing industry has EVERYTHING riding on the debt discussions unfolding in Washington. Erosion of faith in our sovereign debt would undermine both the value and availability of US dollars. Regardless of the intrinsic value of homes, the financing mechanism would be heavily impaired.
We thirst for housing in the US, but there is no funding to buy in the desert. Is there any good news? Yes….tomorrow.
Thursday, July 14, 2011
Little Graph, Big Picture
Today I am going to shamelessly steal data and give it my own spin. First, the data on housing starts from the National Association of Home Builders (NAHB). As shown in the graph below, the rate of housing starts since 1994 has been well above one million per year up until the Crash. After that it has dropped into the 400,000 to 600,000 per year range.
But what is normal? I took the liberty of inserting a ‘normal’ line at the one million starts level and then shadowing out the period prior to 1994. This then begins to show us something – the downturn in housing starts of the past few years has yet to offset the glut of housing built in the prior periods. In other words, don’t look for the upturn as early as 2012 as shown by the NAHB graph.
But what if the normal line is wrong? According to Harvard’s Joint Center for Housing Studies:
So should the ‘normal’ line be 1.2 million? Given historic rates of household formation AND the upward pressure from the Echo generation, this seems plausible. And changing the line make the graph look like this:
Under this scenario, the upturn is upon us, even if multifamily housing absorbs some of the household formations.
The next question is what type of housing stock will serve the coming market. We’ll hold that for another day.
But what is normal? I took the liberty of inserting a ‘normal’ line at the one million starts level and then shadowing out the period prior to 1994. This then begins to show us something – the downturn in housing starts of the past few years has yet to offset the glut of housing built in the prior periods. In other words, don’t look for the upturn as early as 2012 as shown by the NAHB graph.
But what if the normal line is wrong? According to Harvard’s Joint Center for Housing Studies:
While estimates vary widely, the Current Population Survey indicates that household growth averaged about 500,000 per year in 2007-10. This is not only less than half the 1.2 million annual pace averaged in 2000-7, but also lower than that averaged in the 1990s when the smaller baby-bust generation entered the housing market.
So should the ‘normal’ line be 1.2 million? Given historic rates of household formation AND the upward pressure from the Echo generation, this seems plausible. And changing the line make the graph look like this:
Under this scenario, the upturn is upon us, even if multifamily housing absorbs some of the household formations.
The next question is what type of housing stock will serve the coming market. We’ll hold that for another day.
Thursday, July 7, 2011
Lighter Weight, Shorter Life
We’re talking about the GDP here. GDP, or Gross Domestic Product, is the total of all goods and services for a defined economic unit – usually a state, country or region. Alan Greenspan, one of my favorite economists, has determined GDP per dollar is getting lighter and shorter lived. So what does this mean?
Several decades ago our GDP was comprised of things like steam locomotives and industrial facilities; today it includes software and services. As the proportion of software, the average weight of GDP declines. (How many Tweets fit in a McDonald’s bag? Would you like some likes with that?) Similarly, locomotives and factories lasted a long time but internet news updates are gone tomorrow.
In good times this all works great. (Hey, I’m gonna get a backrub and increase the GDP!) The question is what portion of this lighter, more temporal GDP endures throughout economic cycles. And this brings us to the murky boundary between needs and wants.
Needs are warmth, water, shelter and food. (If you don’t buy that definition, I invite you to backpack a mere three days with me. I WILL keep you alive.) Wants are anything else, and it is this reality which is now slowing our economy. Add to this the rising prices of commodities driving up the real cost of warmth (energy) and food (grain, corn) and wants are even more crowded out in the marketplace.
So what is the solution? It appears the precursor signals are already showing in economic reports. First, our currency has to decline. For those who have been hiding under a rock the past few years, this has already occurred and may likely continue. Secondly, manufacturing must move back into the US. Why? Because we are currently using our wealth for two things – ephemeral, short lived items and imported manufactured goods. If this continues ad infinitum, the US expends all of its resources on imports. The good news is the manufacturing index unexpectedly increased last month. While the overall economy may not seem to be robust enough to drive this increase, I believe the declining dollar is beginning to pull manufacturing back onshore.
And by now you are asking “What does this have to do with housing?” The answer is twofold. First, a real increase in GDP will stimulate new household formation or relocation. Pent up demand for new household formation already exists; all it will take is enough available purchasing power to release this demand. Relocation will occur as people move to the sites of new manufacturing.
Secondly, this stimulation of housing will create a reinforcing effect for US manufacturing. Much of the materials used in a home – lumber, shingles, etc. -- are produced in the US. Granted my toilet was made in Brazil, but ….
Guess I will have to wait for Greenspan’s next analysis for confirmation of the trend.
Several decades ago our GDP was comprised of things like steam locomotives and industrial facilities; today it includes software and services. As the proportion of software, the average weight of GDP declines. (How many Tweets fit in a McDonald’s bag? Would you like some likes with that?) Similarly, locomotives and factories lasted a long time but internet news updates are gone tomorrow.
In good times this all works great. (Hey, I’m gonna get a backrub and increase the GDP!) The question is what portion of this lighter, more temporal GDP endures throughout economic cycles. And this brings us to the murky boundary between needs and wants.
Needs are warmth, water, shelter and food. (If you don’t buy that definition, I invite you to backpack a mere three days with me. I WILL keep you alive.) Wants are anything else, and it is this reality which is now slowing our economy. Add to this the rising prices of commodities driving up the real cost of warmth (energy) and food (grain, corn) and wants are even more crowded out in the marketplace.
So what is the solution? It appears the precursor signals are already showing in economic reports. First, our currency has to decline. For those who have been hiding under a rock the past few years, this has already occurred and may likely continue. Secondly, manufacturing must move back into the US. Why? Because we are currently using our wealth for two things – ephemeral, short lived items and imported manufactured goods. If this continues ad infinitum, the US expends all of its resources on imports. The good news is the manufacturing index unexpectedly increased last month. While the overall economy may not seem to be robust enough to drive this increase, I believe the declining dollar is beginning to pull manufacturing back onshore.
And by now you are asking “What does this have to do with housing?” The answer is twofold. First, a real increase in GDP will stimulate new household formation or relocation. Pent up demand for new household formation already exists; all it will take is enough available purchasing power to release this demand. Relocation will occur as people move to the sites of new manufacturing.
Secondly, this stimulation of housing will create a reinforcing effect for US manufacturing. Much of the materials used in a home – lumber, shingles, etc. -- are produced in the US. Granted my toilet was made in Brazil, but ….
Guess I will have to wait for Greenspan’s next analysis for confirmation of the trend.
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