We Can't Expect More Than 3% Growth Until Housing Recovers And That's Bad News For The Deficit

In a Technical Note on GDP Bloomberg reports “First quarter Advance Real GDP Real GDP increased 1.8 per cent (annual rate) in the first quarter of 2011, following an increase of 3.1 per cent in the fourth quarter of 2010. The deceleration in real GDP in the first quarter reflected a sharp upturn in imports, a deceleration in consumer spending, a larger decrease in federal government spending, and decelerations in nonresidential fixed investment and in exports that were partly offset by a sharp upturn in inventory investment.”

Underwater Mortgages a Threat to Recovery

Given the renewed housing bust what might one expect going forward?

A senior economist for Wells Fargo believes it is unreasonable to expect more than 3% growth going forward as long as housing remains deeply underwater.

Please consider Phoenix’s Underwater Mortgages Show Weakness in Housing Threatens Recovery

One year ago, there were signs that housing was healing; new home sales were up and prices rising. Now, new home sales are below levels hit at the depth of the recession two years ago, and 23 per cent of all borrowers — more than 11 million homeowners — owe lenders more than their homes are worth. The renewed weakness is keeping a lid on consumer confidence, consumption and growth.

“It keeps the recovery from being all that strong,” says Mark Vitner, senior economist for Wells Fargo Securities in Charlotte, North Carolina. “We don’t see how the economy can get above 3 per cent growth, except for a short period of time, with housing being so deeply underwater,” he said.

In the 18 months after the recession ended in June of 2009, the economy grew at an average annual rate of 3 per cent a quarter. A survey of economists by Bloomberg News produced a median forecast that growth slowed to a 2 per cent rate in the first quarter of this year, not enough to ease the nation’s unemployment crisis.
Further Declines Seen

Further home-price declines this year — expected by analysts such as Robert Shiller of Yale University — would push several million more Americans into negative equity. Home prices dropped 5.7 per cent in February from year-earlier levels, according to the Federal Housing Finance Agency, the fourth consecutive month of backsliding.

Homeowners who are underwater may be slower to relocate for employment, leaving job-poor markets clogged with surplus workers. Would-be entrepreneurs are unable to tap their non- existent home equity for start-up cash, meaning some good ideas for new businesses never get off the ground.

Most of all, millions of homeowners who have seen their principal asset melt in value are in no mood to spend. During the easy money days last decade, rising home prices helped power the American economy. From 2000 to 2005, homeowners funded about 3 per cent of annual consumption spending by borrowing against the equity in their homes, according to a 2007 paper by Alan Greenspan, then-chairman of the Federal Reserve Board.

Misplaced Blame

The Bloomberg article provides many anecdotes, primarily in the Phoenix area, highlighting enormous mistakes people made and how frugality has become the norm for many in response.

The article also depicts the brutally misguided rant of Les Meyers, 74, a real estate agent who moved to Phoenix, personally over-leveraged real estate investments and went bankrupt.

Unsurprisingly, Meyers blames Wall Street for the fact he bought a $330,000 home, put another $70,000 in it then sold it in a short sale for $229,000.

In 2005, Meyers says he made about $300,000. This year, having returned to his roots as a real estate salesman, he’ll be lucky to make $35,000. He filed earlier this month for personal bankruptcy. “We’re starting over. We don’t have a nickel of any asset other than a car my wife owns,” he says.

The experience has left him bitter and broke. Meyers blames “thieves” on Wall Street who have corrupted the political system and left homeowners stripped of their principal asset.

Wall Street Greed or Leverage and Greed?

I fail to see how one goes from making $300,000 in a single year to going bankrupt after spending $400,000 on a home.

Thus, there must be more to this story, and I suspect additional leverage on real estate.

At his age, Meyers should have been deleveraging risk, not plowing into it. Regardless of what the real story is, Meyers needs to look in the mirror and place blame squarely where it belongs.

Elephant in the Room

“The mortgage drag and negative equity? I think it’s a serious problem. It’s the elephant in everybody’s room and nobody quite knows what to do about it,” says Jim Lundy, chief executive of Alliance Bank of Arizona, an eight-year old business lender in Phoenix.

Walking Away maths

Those seriously underwater and walking away are making a wise decision. Those clinging on to belief that housing prices will quickly recover are mistaken.

By walking away, consumers shift part of their loss to the lenders. Those who ride it out, will need to scrimp and save for a decade, hoping to get not ahead (but simply to get back to the point of zero equity).

Effect on the Deficit

I seldom agree with mainstream economists, but in this case I side with Mark Vitner and his no more than 3% growth forecast, on a sustainable basis.

Should that be the case, the revenue projections of President Obama, Paul Ryan, and the nonpartisan Congressional Budget Office are all hopelessly optimistic with obvious implications on the deficit, on interest on the national debt, and on long-term interest rates as well.

Also bear in mind, that virtually no one has penciled in any recession for the next decade. I think it is near-certain another recession is coming.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
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