Housing Slump Gains Momentum

The Daily Reckoning – Weekend Edition
August 19-20, 2006
Los Angeles, California
by Kate "Short Fuse" Incontrera


Your editor is in the land of sunshine, plastic surgery and overpopulation: Los Angeles. While out for a jog around West Hollywood, evidence of the real estate bubble is everywhere. Almost every single house was being renovated, every car that drove by on the steep roads was a pick-up filled with laborers, ready to work on these homes perched precariously on the side of the hill.

And the housing bubble is deflating, even in formerly "hot" markets like Los Angeles. The LA Times reports:

"Southern California home sales fell to their lowest level in nine years last month as price appreciation continued to decelerate, data released Tuesday showed.

"’I don’t know how soft the landing’s going to be,’ Eli Broad, Los Angeles philanthropist and founder of giant builder KB Home, told Bloomberg News on Tuesday. ‘I think we’re in for a period of a year or two years where housing prices are going to go down or stay stable, but certainly not go up.’

"At the very least, ‘current trends suggest that the market is heading into a lull,’ DataQuick analyst Andrew LePage said."

According to the article, houses are sitting on the market for a lot longer than they used to, which could account for all of the renovations we stumbled upon.

This week, the National Association of Home Builders/Wells Fargo index of builder confidence fell to it lowest level in 15 years, from 39 to 32 for July. This is the seventh consecutive monthly decline.

"’Two big factors are coloring builders’ perceptions of the market right now, rising sales cancellations and substantial growth in inventories of both new and existing homes,’ David Seiders, chief economist at the National Association of Home Builders, said in a statement. ‘We expect the erosion in market activity to continue through most of this year before stabilizing in 2007.’"

While most are finally admitting that there is – or was – a housing bubble, what analysts and experts are at odds about is how far housing will fall, and its impact on the economy. Some feel that there is only a correction in our future, not a complete collapse.

Of course, there are those on the other side of the fence (ourselves included) who think that with the over-inflated market, and overextended borrower, a soft landing for housing is just not possible. Look out below!

Short Fuse
The Daily Reckoning

P.S. "With sky-high energy prices, rising interest rates and a cooling housing market, can U.S. households continue pulling rabbits out of their hat? Not likely," wrote Benjamin Reitzes, an economic analyst for BMO Nesbitt Burns. We couldn’t agree more. Consumers are being stretched thin, and mortgage payments are becoming increasingly hard to make. What happens when more and more people default on their mortgage payment?

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THIS WEEK in THE DAILY RECKONING: The summer may be winding down, but we’re still chock full of news here at The Daily Reckoning! Find out what’s been going on this week…

Financial Reckoning Night                            08/180/06
by Bill Bonner

"At night, a man’s palms sweat, his breathing turns shallow, he tosses and turns, and wonders if he’s reckoned aright. He’s bet his entire net worth on a couple of houses in the neighborhood; he’s got big mortgages."

A Bullish Scenario for Copper                        08/17/06
by James Boric

"Even if aluminum could be used to replace copper in every function under the sun (which it could not), you would only have enough to last nine days." .

The Book History Conspired to Bury             08/16/06
by Lew Rockwell

"The book is not only a complete economics education on its own; it is a supremely fertile ground for extensions, applications, and advancement in every direction."

Government Exacerbates the Bubble                         08/15/06
by Dan Amoss

"In order for the U.S. housing market to sustain current price levels, either household debt must continue growing exponentially or real wage growth must revive from its current doldrums."

Smoot-Hawley 2006                                        08/14/06
by The Mogambo Guru

"Thanks to the horrid Federal Reserve creating the money to create some debt to buy the debt) – a raise in the minimum wage by 40% in three years would be too, too, too much. Think Smoot-Hawley."

FLOTSAM AND JETSAM: Excerpts from a conversation between Addison Wiggin and Dr. Kurt Richebacher at the good doctor’s home in Cannes, France. These remarks concern the impact of housing market crashes v. those of the stock market variety. [hint: historically, stock market crashes are relatively benign]…

Riskier Than the Stock Market
by Addison Wiggin

"Americans are nomads," Joseph Schumpeter asserted in the 1930s.

The French and the Germans would never think of their homes as an "asset". "Where" you come from and "who" you are is very important in the European culture. While Anglo Saxons, the world over, treat their homes as paper to be traded like a stock or a bond.

There are no investors in the financial markets today… only "players". But the stock market is harmless. If speculators get burned, they generally understand the risks.

The real estate market, on the other hand, can cause problems in the economy as a whole. Rising prices increase the capacity of the consumer to borrow. In France and Germany you can only borrow against the last sale price of your house. You cannot, as we do in America and England, borrow against the potential sale value.

Rising indebtedness across all strata is a hallmark of Anglo societies. Consequently, because of the housing boom, there are many weak people out there… many weak balance sheets. According to the Federal Reserve, overall "valuations" in the stock market have risen about $10 trillion, but against those perceived values – indebtedness has risen $5 trillion.

Those rising levels of debt – backed by house values that are by no means fixed – is precisely why a housing bust can wreak far more damage in the economy than anything the stock market can wreak. For what little evidence there is to support this conclusion, Dr. Richebacher unearthed this little-known study published the IMF in its World Economic Outlook in April 2003:

"To qualify as a bust, a housing price contraction had to exceed 14 percent, compared with 37 percent for equities, compared with 37 percent for equities. Housing price busts were slightly less frequent than equity price crashes…Most housing price busts clustered around 1980-82 and 1989-92, while equity price busts were more evenly distributed across time.

"Housing price crashes differ from equity price busts also in other three important dimensions. First, the price corrections during house price busts averaged 30 percent, reflecting the lower volatility of housing prices and the lower liquidity in housing markets. Second, housing price crashes lasted about four years, about 1 1/2 years longer than equity price busts. Third, the association between booms and busts was stronger for housing than for equity prices.

"An important theme running the foregoing analysis is that housing price busts were associated with more severe macroeconomic developments than equity price busts. Coupled with the fact that housing price booms were more likely (than equity price booms) to be followed by busts, the implication is that housing price booms present significant risks. For this, the authors give the following reasons:

"Housing price busts have larger wealth effects on consumption than the equity price busts…

"Housing price busts were associated with stronger and faster adverse affects on the banking system than equity price busts…All major banking crises in industrial countries during the postwar period coincided with housing price busts.

"Price spillovers across asset classes matter, as evidenced by the fact that housing price busts were more likely associated with generalized asset price bear markets or even busts than equity price busts."

The authors then give a fourth reason, which was true in the past, but in which the situation in America today radically differs. They say: Housing price busts were associated with tighter monetary policy than equity price busts, reflecting the fact that most housing price busts occurred during either the late 1970s or the late 1980s, when reducing inflation was an important policy objective. The disinflation increased the real burden of debt, which exposed inflation-related over-investment and associated financial frailty.

Plainly, the authors were of the opinion that housing bubbles, when bursting, generally do considerable damage to the economy.

Addison Wiggin is the editorial director and publisher of The Daily Reckoning. Mr. Wiggin is also the author, with Bill Bonner, of the international best sellers Financial Reckoning Day and Empire of Debt: The Rise of an Epic Financial Crisis.

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