Economic Recovery Awaits the Housing Market Correction

What happened to the recovery? This report from AP:

WASHINGTON (AP) – Sales of previously occupied homes dipped 2.2 percent in May, signaling that a boost from home-buying tax credits is fading sooner than expected.

Last month’s sales fell from the previous month to a seasonally adjusted annual rate of 5.66 million, the National Association of Realtors said Tuesday. Analysts who had expected sales to rise expressed concern that the real estate market could tumble once the benefit of the federal incentives is gone entirely, starting next month.

Sales have climbed 25 percent from the 4.5 million annual rate hit in January 2009 – the lowest level of the recession. But they’re still down 22 percent from the peak rate of 7.25 million in September 2005.

Economists were surprised, say the reports. The feds are still paying buyers $8,000 to buy a house. And still the number of buyers is going down.

What this revealed about the housing market was much less interesting than what this revealed about economists, who seem to be completely unaware of what is going on.

They think the economy is recovering. So, why aren’t more houses selling?

Meredith Whitney: “No doubt we have entered a double dip for housing.”

Well, it may be a surprise to economists. And it’s surely a disappointment to most Americans. But to us here at The Daily Reckoning it’s just another day in a Great Correction.

Housing hasn’t been corrected. There are still millions of homeowners with scores to settle. They paid too much. Their houses are now worth less than what they paid. It’s just a matter of time until they default…or their debt is restructured.

We get our news from CNN en Español on the way to work. We’re trying to learn to speak Spanish. We learned this morning that more than a million Hispanic homeowners are in danger of losing their houses. Typically, they bought a little too late in the cycle. Typically too…they lost their jobs in construction or the service industry.

Detroit is dealing with its surplus housing issue. “Detroit razing itself,” says a news report. Good idea. There are vast areas of Baltimore that should be razed too. Baltimore hit its peak population in the ’60s. It’s been downhill ever since, with only about half as many people in the city today as in its heyday.

But the Great Correction has targeted much more than the housing industry.

“For small companies the credit crunch won’t go away,” says a Wall Street Journal headline. That’s what happens in a correction. Banks are reluctant to lend. The banks are holding onto cash. So are other businesses. And smart individuals hold cash too. Few people want to start new businesses or finance them. Because the odds of losing money are too great. The real economy isn’t expanding; it’s contracting. That means businesses are fighting for market share…and fighting to stay alive. Banks figure they’d rather put their money into a sure thing – US Treasury bonds.

And here’s another aspect of the Great Correction:

“Extremely bad profit margin outlook,” says a Bloomberg report.

The margin outlook is bad because companies have tried to protect profits by squeezing out unnecessary costs – including employees. But there is only so much of that you can do.

Besides, cost-cutting has a negative effect on the economy. One company’s costs are another company’s top line revenue. So you can see where that leads. One cuts and the other must cut too. Pretty soon, you have a correction…maybe a recession…and maybe a depression.

Yesterday, the Dow dropped 148 points. Gold went nowhere.

Our guess is that the Dow has a lot more dropping to do. Ambrose Evans-Pritchard, writing in the Telegraph:

Core CPI in the US has fallen to the lowest level since the mid-1960s. Unlike the blow-off gold spike of the Nixon-Carter era, this rally has echoes of the 1930s. It is a harbinger of deflation stress.

Capital Economics calculates that the M3 money supply in the US has been contracting over the past three months at an annual rate of 7.6pc. The yield on two-year Treasury notes is 0.71pc. This is an economy in the grip of debt destruction.

Albert Edwards from Societe Generale says the Atlantic region is one accident away from outright deflation – that 9th Circle of Hell, “abandon all hope, ye who enter.” Such an accident may be coming. The ECRI leading indicator for the US economy has fallen at the most precipitous rate for half a century, dropping to a 45-week low. The latest reading is -5.70, the level it reached in late-2007 just as Wall Street began to roll over and then crash. Neither the Fed nor the US Treasury were then aware that the US economy was already in recession. The official growth models were wildly wrong.

David Rosenberg from Gluskin Sheff said analysts are once again “asleep at the wheel” as the Baltic Dry Index measuring freight rate for bulk goods breaks down after a classic triple top. The recovery in US railroad car loadings appears to have stalled, with volume still down 10.5pc from June 2008.

The National Association of Home Builders’ index of “future sales” fell in May to the lowest since the depths of slump in early 2009. RealtyTrac said home repossessions have reached a fresh record. A further 323,000 families were hit with foreclosure notices last month. “We’re nowhere near out of the woods,” said the firm.

Companies are worth what people will pay for them. But a correction drives top line revenues down. Companies are not worth as much as they were when the top line was going up. Gradually a depressive mentality takes over. People begin to doubt that ‘recovery’ is right around the corner. They begin to wonder why they paid so much for a house…or for stocks. They begin to figure out how to get out of the deal.

In the case of the house, they let the mortgage company know that they’re not going to continue paying for something that is falling in value.

And in the case of stocks, they sell.

Stocks and housing keep going down and until they finally reach the dismal, desperate bottom.

Bill Bonner
for The Daily Reckoning

The Daily Reckoning