The Economy and Housing: Headwinds and Tailwinds

The Housing Market: Factors that affect Short-Term, Long-Term

Every once in a while, I like to share my take on the economic news of the moment and share my thoughts on what that means for the market. I'm not afraid of taking shots at poorly written articles in the same space either. There's a LOT of things to Consider out there, so I'll list a few, and look at them in more depth.

The Election

Call me crazy, but I don't think either one of our potential 2012 winners can actually "Fix" anything. And I'm pretty sure that's what everyone else thinks. We aren't going to pay down the Nations Debt (and the real threat to our country's prosperity, see: Europe), with either more government spending on "jobs bills" or "tax cuts and loophole reductions". Frankly, this populist rhetoric makes me very sad that we can't do better. But to the larger point here, I don't think either one of them can either materially affect the following, so the two of them are basically inert. We'll move on.

QE 3: The Fed moves to support Housing - Again

I Can't find the post where I had it, but way back in the DARK days it was pretty clear to me that Bernanke wanted to put a floor under housing prices, and he wouldn't stop until that market is better. Well, it's better - but apparently not better enough. For those who don't regularly read about economic events, The Fed has done three levels of "Quantitative Easing" or QE 1, QE 2, and now, QE 3. Normally, the Fed would reduce rates to stimulate the economy, but they can't really go any lower than they already are, so the Fed has resorted to the purchase of it's own securities and other banking products to free up capital for banks and support lending. I'm in the camp that this lending will help support housing, but not enough for the future damage it could do the Nation's fiscal issues. As many of us know, you can't borrow your way out of debt. If it would rapidly improving hiring, I'd support it. But it won't: the damage to our economy is structural, and it's going to take a long time to fix. The real problem is that all this debt is a drag on growth going forward, and will really hurt if inflation shows up. See more below! So QE3 helps, but not much.

The US Economy: Housing vs. Unemployment vs. Credit Standards

The reduction in housing demand (both new construction and re-sales, at record lows since WWII for years now) is a factor of high unemployment (people without jobs can't buy houses), tightened credit standards (if you can't borrow you can't buy a house either). The banks, and the agencies that regulate them have let the pendulum go way too far the other way - taking millions of potential quality buyers out of the housing market. As unemployment falls, and credit standards loosen (they will eventually) both these items will increase demand for housing.

Europe: More Banks in Trouble, Does it affect Us?

I for one, am not worried about contagion (the fear that bank failures in Europe will affect banks in the states) which is the key concern about Europe hurting the US housing market. The reason is simple - when the US banks failed, everyone was surprised. It happened very quickly, and no one knew about the risks until it was way too late. Europe is not that case. Everyone is aware of potential failures, and that risk is probably hedged. A European banking collapse would be painful, but probably not disastrous for housing. If that doesn't happen, Europe's woes are good for the US - with little faith in the risky European bonds, money has gone to buy US treasuries, keeping rates for us artificially low. That's mostly why the end of QE2 was a non-event. We're just a better risk at this time than Europe. That could change at some point, but probably not soon. Europe's problems are a net gain to housing for the foreseeable future.

Inflation: The Looming Specter

The struggling jobs market has one benefit: low inflation. Since employers don't have to raise salaries and wages - in fact, they are cutting "expensive" personnel and replacing them with less expensive people, - that decreases their needs to push prices up for the goods and services they sell. That keeps inflation low. If inflation stays low, we can keep interest rates low, and that should, in theory, help growth. Growth means jobs, and jobs are good for the housing market. However, if inflation begins to pick up, the Fed will have to raise rates to counteract inflation, and that will be a drag on growth and the expansion in general. So far, the Fed has been able to dodge this bullet, but history suggests that inflation could be lurking around the next corner, and be here sooner than expected. Rising inflation is bad for home prices, but can be good for home owners, as detailed in this post.

Simpson Bowles and the Death of the Housing Mortgage Interest Deduction

Yes, it is an election year, so there's lots of rhetoric, but I've been surprised that both sides are taking good looks at eliminating the Home Mortgage Interest Decudution. I initially wrote that there's no way they would touch it, but for some reason it seems to be gaining in popularity as a way to solve the US deficit. with so much focus on housing, it would be pretty foolish to tackle it, but hard to put anything past the folks in their Washington Ivory Tower(s), which seems to get more disconnected from the rest of us every day. Make no mistake, an abrupt change in this policy will have a pretty disastrous affect on prices on the West and East Coast.

Housing Market Predictions: Fitting it all together

For the next year, year and a half, I think the forecast for housing is pretty clear. Sustained low rates, increasing employment, and improved fiscal health of the average American will keep pressure on house prices. We're still dealing with a lot of delayed demand as well, that should also feed into it. After that though, it gets pretty murky. I think rates will start to rise, keeping pressure on house prices to stay flat or move in low single digits. It will be a while before we start talking about "peak" prices - and if we see more weakness in the economy at that time, next year may look like a peak in the Case-Schiller Index.