(This guest post originally appeared at the author’s blog)
Central Banks and governments around the world have thrown everything they can muster at the financial crisis. And up until now, it appears as though they have succeeded. Equity markets are up 60%+ around the globe and investors are beginning to party like its 1999. But a look underneath the hood shows that shiny Cadillac might just be a clunker (don’t worry, the government will take out a loan so you can take out a loan to turn in your clunker for a new car you never needed to begin with). Unfortunately, as we’ve learned over the course of the Fed’s 20 year boom/bust experiment, sound economic growth cannot be built on the back of a printing press. This is most evident in three segments of the economy:
Let’s begin with the housing market. At a recent presentation to investors Whitney Tilson makes a very strong case for continued weakness in housing. As regular readers are well aware, this is a position I share. Although I never expected the record stimulus and wasteful home buyers tax credit I still firmly believe that there is nothing the government can do to counteract the laws of supply and demand. As we learned with Japan, such government programs do not actually solve problems, but simply prolong the inevitable.
Today, we are in an unprecedented housing environment. 2 years after the majority of Wall Street and analysts proclaimed (and built their business models on the idea) that housing prices could never decline they are now calling the bottom 30% later. The recent seasonal jump in prices has many analysts calling the all clear. Our problems have not passed.
While the majority of the subprime problems have passed there is another mountain of resets ahead that will wreak havoc on the housing market. Tilson argues that two waves have passed, but three lie directly ahead. These three waves include prime loans, jumbo prime loans and commercial real estate.
Tilson believes this is the “mother of all head fakes” for 7 reasons:
- Ultra-low interest rates
- The $8,000 tax credit for first-time homebuyers
- More middle- and upper-end homes are being sold (either voluntarily or via foreclosure), which has the effect of raising the price at which the average home is sold – but more defaults of higher priced homes is very bad news for mortgage holders
- A decline in resets
- A reduction in the inventory of foreclosed home
- The FHA is providing massive support to the housing market, in part by doing extremely risky lending
- Home sales and prices are seasonally strong in April-July due to tax refunds and the spring selling season
We are literally in the eye of the reset storm:
Coming into 2009 I predicted that housing would stabilise and rebound primarily due to seasonal trends and low interest rates (I also predicted an 18% jump in the equity markets for those that believe I am permabear). As recent data has shown, the seasonal downturn in housing is beginning to take hold.
Despite seasonality and government stimulus the laws of supply and demand always rule the long-term price trend in any market. While demand has stabilised somewhat the supply side of the equation remains very lopsided. The current housing overhang is 7 million homes. The new housing inventory glut is at 12.9 months. With over 8 months of total supply on the market and a massive shadow inventory it is highly unlikely that these problems will fix themselves in short order.
Housing isn’t the only weak spot. The current jobs market is the worst of the post-war era. Jobs are the lifeblood of any economy. In an economy where 70% of GDP comes from consumers its practically impossible to have a sustainable recovery if those consumers don’t have an income source from which to spend. There is certainly no recovery on Main Street despite what we read about bank bonuses and earnings on Wall Street.
A recent Wall Street Journal piece predicts that the job market likely won’t recovery for over 5 years:
Those who are curious as to why this recession is different from past recessions need look no further than the following chart. You’ll notice that consumer credit is falling at a rate that has never been seen before. In fact, consumer credit declined marginally during the 1991 recession and actually climbed throughout the 2001 recession. Why is this important? An economy that is based on a fractional reserve banking system has trouble expanding if the debt in the system does not continually expand. Consumers are still deleveraging and that means a robust and sustainable recovery is unlikely to occur. The Fed can take this horse to water, but they can’t make them borrow.
Perhaps most important is the need to deleverage. Household liabilities as a percentage of income remain abnormally high at 129% vs the peak of 138%. The biggest risk in such an environment is not whether the consumer recovers – the consumer needs to deleverage and clean up their balance sheet – but whether the government continues to pummel the currency and rack up massive debts as they try to dig our way out of the debt hole. These are the same mistakes Japan made in the 90’s. Let’s hope we wise up and stop the printing presses before they cause another black swan….A black swan that their printing press absolutely will not be able to predict or stop.