The housing double dip may very well be the most important story heading into 2011. ?Although local by nature the impact of a continued downturn in housing should not be downplayed. ?Housing was the domino that set the entire credit crisis in motion in 2007. ?In addition, declining asset prices are the most destructive facet of a balance sheet recession. ?Richard Koo has recently described how this phenomena was what ultimately dragged Japan into deflation:
“Real estate, the stock market, and everything else.? When that bubble collapsed, asset prices fell, but the liabilities remained.? Balance sheets all over Japan in the private sector were underwater.? Although they were bankrupt, the cash flow of many of these companies was still very good.? Japan continued to run one of the largest trade surpluses in the world.? So companies had the cash flow, but balance sheets were underwater.
If you put anyone in that situation, what would they do?? They will use the cash flow to pay down debt, because shareholders don’t want to be told that their shares were just a piece of paper.? Bankers don’t want to be told that their loans are all nonperforming.? Workers don’t want to be told that there are no more jobs tomorrow.? For all the stakeholders involved, the right thing to do was to use the cash flow to repair their balance sheets.
The problem is, when everybody does that all at the same time, what happens to the national economy?? If someone is saving money or paying down debt, you better have someone on the other side borrowing and spending money.? In the usual world, we have the financial sector in the middle taking the money from this side and giving it to people on that side.? If there are too many people who want to borrow money, interest rates rise; if there are too few, you bring interest rates down, and the money circulates in the economy.
But what we discovered when our bubble burst was that even with zero interest rates, no one was borrowing money.? Everybody was paying down debt, because their balance sheets were all underwater.? No one wanted to borrow money.”
In the USA it is primarily the household balance sheet that remains underwater (although much of the banking sector also remains deeply troubled).? This is important because Mr. Bernanke is attempting to combat this with a very blunt policy tool – monetary policy. ?Hence, why the Central Bank is attempting to keep asset prices “higher than they otherwise would be.” ?Unfortunately, QE is unlikely to be effective in fighting the housing decline. ?Further housing declines will have wide reaching negative impacts on an already fragile economy.
To highlight the importance of housing it’s worth reviewing the housing market wealth effect. ?Contrary to opinions you might have heard recently concerning the Fed and the equity market wealth effect,?Robert Shiller has come to different conclusions regarding the impact of rising and falling equity and house prices. ?Although he found no evidence of a wealth effect in equities he did find that house values significantly impact economic activity:
“the evidence of a stock market wealth effect is weak; the common presumption that there is strong evidence for the wealth effect is not supported in our results.? However, we do find strong evidence that variations in housing market wealth have important effects upon consumption. “
Lowe’s reported earnings yesterday and they provided some insights on the current state of housing.? On the conference call Robert Niblock, CEO of Lowe’s confirmed that housing is indeed double dipping and that prices are likely to continue falling “at least” through the middle of 2011.? Niblock says prices will only fall 4-8% further.? Zillow and Clear Capital are both reporting declines of -4.3% and -6.8% in the latest quarter.? S&P predicts prices will decline 7-10% in 2011.
Earlier this year I said home prices were likely to remain strong through H1 due to government intervention before succumbing to the supply/demand imbalance as the government stepped aside. ?My estimates are a bit more negative with total declines of ~15% before housing finds a sustainable bottom in 2011 or 2012. ?It’s very important that investors keep close tabs on the housing market and the developing double dip. ?If it materializes into a substantial decline it will have a very negative impact on economic growth in 2011 and could potentially trigger fears of a 2008 repeat.
The pertinent portion of the Lowes conference call is attached:
Michael Lasser – Barclays Capital
Good morning. Thanks a lot for taking my question. So as you think about the relationship between housing turnover and your comps, what do you think the correlation is going to be moving forward? Is that going to become decoupled? Are we reaching—and why might that be? Is it because we’re reaching a base level of demand? How are you contemplating that.
Robert Niblock
I’ll start, Michael, then I’ll ask Greg Bridgeford to join in. I think—in the past, housing turnover has been as important in the past. I would think it’s still important today and it’ll be important in the future because, as you know, it provides a natural incident for the homeowners who need to come and buy products related to the home in our industry. Obviously what’s been challenging is even though that there’s been still continued positive correlation associated with that, the bigger issue is the more than offsetting fact that the pullback you’ve seen in overall demand with unemployment where it’s at and with home prices continuing to drop. You know, home prices were down about 29% when they bottomed in January or so earlier this year. When you had the stimulus programs for the home buying tax credit, you saw a little bit of a pick back up; but now home prices are falling again and probably anticipated to fall through at least the middle of next year, so you’ve probably got another four to eight percent or so, potentially, on home price decline. And even though we’re gaining jobs, that’s still not growing fast enough to drop the unemployment rate on the jobs front So even though you’re seeing fundamental improvement, the majority of the decline of home prices is behind us, we are gaining jobs – all those type of things are positive signs. Those two halo effects – employment and the continued decline in home prices – probably offset or kind of water down what you would normally see as that correlation you’ve been able to draw on in the past between housing turnover and our sales. So housing turnover is still important, but it’s offset by some of these other factors. (emphasis added).
Source: Seeking Alpha
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