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Will the Housing Bubble Fizzle or Pop?Whiskey & Gunpowder Standard & Poor's reports "Regional Housing Bubbles Vulnerable," and then asks a follow-up question: Will they fizzle or pop? Let's have a look. "With housing prices continuing to outpace both income and inflation from coast to coast, it is hard not to see a housing bubble, according to a comprehensive report published today in Standard & Poor's CreditWeek. The report looks at the implications of the bubble for builders, bankers, and owners in the United States and abroad, as well as in the structured finance and REITs markets, from both the credit and equity perspectives. "'If the past is a guide,' says S&P Chief Economist David Wyss, 'home prices in the United States are less likely to crash nationwide than to stop accelerating and then stabilize until incomes catch up with unsustainably high mortgage debt. This happened after home price spikes in the late 1970s, and again in the late 1980s. The coming rebalancing period could last half a decade, because it will take a 20% correction nationally to restore the normal ratio of home prices to income.' "Echoing a similar theme abroad, Standard & Poor's senior economist in Europe, Jean-Michel Six, forecasts an orderly slowdown in house price inflation in Europe, owing to a combination of demographic, financial, and structural factors, with a soft landing likely in the United Kingdom and near-term overheating in Spain. "'While the overall outlook may be reasonably benign,' Mr. Wyss continued, 'there's a regional danger: the possibility of deeper, more disruptive corrections in the most overvalued markets. In urban areas on both coasts, for instance, housing costs have risen 30% or more above the normal home-price-to-income ratio -- all the more alarming considering that in these regions this ratio was about twice the U.S. average before prices soared. This could make such places particularly vulnerable to economic shocks or rising interest rates.'" The economists at S&P seem to be parroting the consensus view: 1) The overall outlook is benign Wyss did attempt to give himself an out by mentioning a "possibility of deeper, more disruptive corrections in the most overvalued markets," but his overall "benign" view seems to me to be the equivalent of the "permanently high plateau" theory. It is based on his interpretation of "prior history," but more importantly on a belief in rising incomes: "If the past is a guide, home prices in the United States are less likely to crash nationwide than to stop accelerating and then stabilize until incomes catch up with unsustainably high mortgage debt." Well, judging from the experience in Japan, if past history is any guide, U.S. home prices will sink for the next 18 years. Since there are differences between Japan and the United States, let's instead focus on the income side of the statement. Are incomes likely to catch up to "unsustainably high mortgage debt"? I think not.
Mish wonders what the economists at S&P are smoking when they think that rising wages will catch up to the absurd home prices in the bubble areas in any sort of likely "soft landing." We are three years into a recovery, and real wages in general are still declining. Demand for housing, as suggested by rising inventories, is now slackening at the same time. Demand for gasoline even seems to be declining recently. What about real estate sales commissions if home sales even modestly decline? What about other sales commissions if retail spending slackens? Is Wyss aware that there is an 18-to-1 or 20-to-1 wage differential with China that is putting pressure on jobs, wages, and benefits? Under what logical scenario will overall wages finally start rising now, this far into a recovery? The only way I can see wages rising is if the bubble keeps inflating. All that would do is postpone the problem and make it bigger in the long run. Note too, that S&P also seems to be discounting the effects of Katrina, as well as any upcoming recession. Perhaps the economists at S&P think that the spend-and-spend policies of this Congress and this administration have forever eliminated the business cycle as well. Who knows? Whatever they are smoking sure is powerful stuff. I do not buy this "permanently high plateau" nonsense or any talk of a miracle "soft landing," either. Nor do I accept that the business cycle has been defeated and there will be no more recessions. The next consumer-led recession is going to be a doozy, and along with it will come a severe strain on home prices. The upcoming correction is likely to be dramatic in terms of price action or length of time or both. It may come about as a very long, painful slow leak (the Japan scenario) or some sort of faster price crash. I think the latter is the most likely scenario, perhaps in a sloping stair-step fashion. The least likely ending is the widely held fairy tale belief that wages keep rising, jobs will be plentiful, the business cycle is defeated, and "everyone lives happily ever after." Oct 4, 2005 Click here to subscribe.
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