Notes on the Economy – 03/26/09

1. According to government statistics, consumers lost over $11 trillion in wealth over the past year.  The media has publicized these statistics widely and I am sure that many people who are unaffected by the recession and never knew the real value of their homes and paid their mortgage regularly, have been reminded regularly that they are “poorer” since house prices, the largest asset in their wealth, have declined.  Of course, the stock market has also declined from its peak in late 2007.

Implicit in these “laments” is a notion that somehow once record high levels are reached, they should never decline!  Do consumers feel euphoric when stocks and house values are at record levels?  Of course!  Do they think record levels will prevail forever?  Of course not.  Consumer spending is sensitive to changes in wealth.  But consumers are not totally naive.  The propensity to spend out of increases in “permanent wealth” (expected to stick, like secular trends in home values) is much higher than out of more volatile wealth (like stock market wealth).  In places like Cape Coral, Florida, where in one year home prices rose 40%, most consumers probably did not believe that the gains would last permanently, most did not refinance, did not sell their house to make (alleged) capital gains.  Exceptions might include young home buyers who had not been through a business cycle and some less-than-smart people kept “cashing in” their house appreciation gains by refinancing, especially in California.  Not everyone thinks realistically about changes in their environment and these are the losers when reality is re-imposed.   But most people live with “trends”, not peaks and troughs and that’s why most of us survive.

2.  Finally some good news on housing!  Housing starts rose by 100,000 in February.  Refinancing is taking off but also existing home sales are improving.  And the Fed has said it will buy $300 billion of Treasury Securities in a bid to lower long term interest rates and lower mortgage rates.  Housing affordability is up due to lower interest rates and rising real incomes and, of course, falling home prices.  It’s a great time to buy a house!  The Housing Affordability Index is at its highest reading since data were collected starting in 1971.

The Fed will keep interest rates low all year, but house prices in many if not most markets will start to rise and buyers come back into the market.  The economy will be boosted by an increase in car and home buying and consumer spending in general.

In the transition, it looks like we will build 700,000 fewer houses this year than we normally need to meet the needs of a nearly a million new household formations and deletions from the stock.  Building too few houses will extinguish the excess most supply everywhere except Florida, California, Phoenix and Las Vegas.  House prices will start to recover, making consumers feel better, strengthening banks that hold mortgages on those houses but making houses less affordable to new buyers, even if still cheap historically.  The economy will start its turn in the second quarter.  First quarter, well, it was bad but it’s in the rear view mirror.