The US housing market is in the middle of a full blown crash

30.04.2008

The US housing market is in the middle of a full blown crash

The US housing market is quite clearly the single most relevant issue that will decide shape, depth, and length of the US economic downturn, and its spillover to the rest of the world – hence our continued interest in the subject. The best information source on the US housing market is not a newspaper, or a newswire, but a blog called Calculated Risk. This morning it contained a whole number of items telling us that the US housing market is not correcting, but crashing. Start here with this graphic of the yoy change in the Shiller Case Price Index, which shows that this is the worst house price recession since the 1980s already – and there is much worse to come. Yesterday’s news was that the Case/Shiller index fell by 12.7% yoy in Feb. (and 14.8% peak to trough). Shiller himself expects the peak-to-trough average to be over 30% to bring back real housing in line with the trend.

Furthermore, while these numbers are national averages, the regional variations are huge, as this chart shows.

Further housing news in the blog relate to the sharp fall in homeownership rates (as people move back into rental accomation), and a downgrade of Alt-A mortgage-backed securities, a category above subprime.

Barry Eichengreen on the US recession and its impact on Europe

The US economist Barry Eichengreen writes in RGE Europe Economonitor that the US recession will be hard and long. Aggressive interest rate cuts have dented consumer confidence. There is a 9 month inventory of unsold homes. It will take until 2010 before the US residential construction sector begins to recover. And this means no growth until then, and a weak dollar. He is particularly pessimistic about Europe with this exchange rate, and says that the IMF’s forecasts for Europe are not pessimistic, as some have argued, but too optimistic.

A plea to help distressed home borrowers

Sheila Bair, the chairman of the US Federal Deposit Insurance Corporation, writes in the Financial Times, calling on the US government to intervene directly in the housing market, through a publicly funded lending programme to distressed home borrowers. The arguments are based on the notion that the US housing market is already overcorrecting (which you would not have thought if you are looking at the Shiller/Case charts, which suggests that we are less than halfway through the correction). Her view is that the plethora of unaffordable mortgages caused a particularly sharp downturn, that has now resulted in an overshooting correction. “Government efforts should focus on helping the market reach equilibrium without overshooting.” (We think this a very strange argument. Equilibrium is at least a year away, if not more. We have no doubt that the US housing market will eventually equilibrium. However, there is a very solid case for government, which is avoid either large-scale homeless if people lose their homes, or to avoid financial stress for banks). In any case, there is a perception among officials in the US that the irrational part of the housing bubble appears to be that it has burst, and that it has built up in the first place.

Germany to cut income taxes

Well, it’s not a full-blown tax reform, but a tax cut to compensate workers against inflation (a sign of the time, perhaps!). A tax system with fixed progressive nominal tax brackets means that marginal income is taxed at higher rates. Peer Steinbruck, the German finance minister, has dropped his previous opposition to the idea, Financial Times Deutschland report, as elections are looming, and as people are subject to a persistently rising tax bill.

Should the ECB modify its inflation target?

The Handelblatt's shadow monetary policy council has published a series of views about whether the ECB should modify its inflation target, since it is persistently unable or unwilling to meet it. It is impossible to summerize the varying view. Some say the ECB’s job under the Treaties is not to produce moderate inflation, but price stability. It would be difficult to argue that 2.5% would be price stability. Others are saying that the ECB should look at the Bank of England, and learn the art of letter writing. In any case, this is a good a selection of views on this issue as it gets.

Why France has a pro cyclical budget

Jean Pisani-Ferry in Le Monde asks why France – more than any other EU country except Portugal and Greece - is running deficits in a boom and depriving itself the tool to counteract recessions. France has the second highest public expenditure in the OECD and has a political tendency to cut taxes. Pisani Ferry argues that one problem is that the French see the deficit more as a result of a distributional conflict than an intertemporal optimization. Budget institutions are of no help: The role of the finance minister, who has traditionally and constitutionally been strong, has been diluted by the high turnover in this job (13 ministers in 15 years). Budget rules such as national expenditure rule within a triannual expenditure plan or the Stability and Growth pact have not been respected in the end. Pisani Ferry argues that it is high time for France to face its budgetary responsibilities and to ensure an institutional setup that is conducive to its engagements.

The Greek government ought to contain wage inflation

In Greece the realization starts to set in that the international crisis may also have an impact on the Greek economy. The European Commission forecasts a noticeable slowdown in economic growth from 4% last year to 3.4%, a rise in inflation and a larger than anticipated fiscal deficit for the first time since elected to power in March 2004. Economic growth in Greece relies heavily on domestic demand. Higher oil prices, a slowdown in the construction sector, and more cautious bank lending practices will certainly take their toll. Kathemerini writes that the main contribution of the crisis is not a direct but an indirect one as it triggers a discussion about Greek’s current wage deals in excess of productivity. The government has now the choice between reaching an agreement with trade unions and employers associations to stop this wage price spiral or to engage in a more ambitious structural reform. Otherwise stagflation is to follow.

Three theories

In his column in FT Deutschland, Wolfgang Munchau categories the attempts to explain the current financial crisis. He comes up with three broad classifications. The first, and most common, is the attempt to explain it primarily in terms of financial market failures – bad regulation, wrong incentives. The second theories tries to explain this crisis as a crisis of global imbalances and distorted international money flows, and the third as a purely monetary phenomenon. Munchau concludes that he believes that the crisis is a monetary phenomenon, albeit a global one.

One large family

Comments about Italy in non-Italian newspaper tend to be on the non-flattering side these days. A commentary by Florian Eder in FT Deutschland is no exception, though it contained some factoids unknown to us. We knew that families have an important role in Italy, in particular in business. What we did not know that the economic faculty of the University of Bari is run essentially by a single family. Six members of the faculty have the same name (we presume they are related, otherwise the claim would be dishonest). Plus, he says, there are countless researchers, junior staff, related to this family but with different names.

Deutsche Bank and the crisis

European financial newspaper are full of the widely expected announced loss by Deutsche Bank, which was some €140m (not a lot), including this article at Financial Times. More importantly is that the bank the last autumn declared the crisis over, is now refusing to make a forecast for this year. This is not another UBS waiting, but this is not trivial either. The bank has tier one capital at 9.2%. Total exposures to securities markets were €33bn at the end of Q1, down from €36bn at the end of last year. That, we suspect, will come down further.

How to measure inflation

There is a statistic that is deeply disturbing. It shows how several old inflation measures would have performed in the US until today. Official inflation indices have been subject to periodic revisions, for example to take account of quality improvements. There is a large community of people out there who have severe doubts about the quality of modern inflation statistics. Here is an entry from the Big Picture Blog showing that under the 1980s measures, today’s US inflation would be well over 11%, while under the Clinton-era measure it would be 7.3%, as opposed to the current official rate of 4%. It is probably worth looking at the methodological issues in some depth here (We noticed a strange regulatory about the gap between those measures, as though the higher numbers were arrived at by adding a constant to the lower number. But there remains a legitimate question about the quality of our official indices, especially as most people “feel” inflation to be higher than official statistics suggest). Here is the chart