Monday, July 26, 2004

Housing Bubble About to Blow

Economic Doomsday Scenarios Dept -
Here's how it all comes apart:  The housing bubble doesn't burst, just starts to recede a bit. That hits consumers much harder than you might think, since equity withdrawals reached 6.3% of disposable income (far higher than the 2.5% of the late '80s boom), and nearly 2% of GDP. That river of cash is going to dry up like the LA river, and then watch out...

"Michael Buchanan, a senior global economist at Goldman Sachs, and Themistoklis Fiotakis, a research assistant there, reckon that at current interest rates, home prices are now overvalued by 10 percent, on average. Because this figure spans the entire nation, the hottest markets - California and New York - are obviously more overpriced.
The economists compute fair value in home prices by using a variety of measures, including interest rates, population and demographic data, and the overall health of the economy. If interest rates increased by one percentage point, the economists said, home prices in the United States would be overvalued by 15 percent.
None of this would be worrisome if homeowners had not turned the paper profits in their properties into cold, spendable cash. But withdrawals from home equities have recently totaled 6.3 percent of household disposable income, according to the Goldman study. In the late 1980's, equity withdrawals reached only 2.5 percent of disposable income.
Federal Reserve studies indicate that as much as half of the equity withdrawals went into personal consumption and home improvements. As a result, the Goldman economists estimate that equity cash-outs added 1.75 percent to the growth in the gross domestic product in 2003. That is a significant increase from the 1.25 percent kick that equity withdrawals added in 2002.
Consumption would slip 1 percent, Goldman estimated, if housing prices fell by 10 percent, to the fair value level. But if prices decline to well below that, as often happens when overheated markets go cold, consumption may fall by 2.4 percent, Goldman reckoned.
Such a housing crash took place in Britain in the early 1990's. At the market's low, home prices had fallen by 27 percent, 5 percent below Goldman's estimate of fair value at the time.
Such a decline is not expected here, said Dominic Wilson, a senior global economist at Goldman. That's because home prices in Britain had escalated much more than they have in this country, even now. And interest rates had soared into the high teens, which is unlikely here.
But even small declines in home prices could hurt the economy. "The precise degree of the vulnerability isn't going to be clear until we see house prices slow," Mr. Wilson said. "You've never seen consumers this stretched, operating at levels of leverage we've never experienced before. House prices are starting at a level that is pretty high relative to what we think fair value is going to be, and the economy as a whole has gotten a lot more sensitive" to housing-related spending.
Indeed, Goldman estimates that home equity lines of credit and the like have magnified the effect of housing wealth on consumption over the past decade, taking it to 10 percent from 4 percent.
Although rising home prices have been stopped dead in the past by sharply higher interest rates, the Goldman economists note that bear markets don't necessarily need major triggers to get started.
Small events can change the market's psychology, and asset bubbles sometimes just cave in on themselves.

No comments: