Suddenly Summer?

Jobs were being created, but perhaps not in the industries that generate the big bucks.

Lawrence Yun - national association of realtorsPalm Coast, FL – June 16, 2011 – It’s not yet summer, but almost. This time of year – the “transitional” one between late spring and real summer (when all the kids are home from school) – has seen some wild weather – particularly in the Midwest. At the same time, Wall Street seems to have also weathered some ups and downs, but hasn’t yet settled into its summer. In general, the spring economy was basically OK. It was expanding, but at a low rate of growth. Inflation was manageable, but worth watching. Jobs were being created, but perhaps not in the industries that generate the big bucks.

And as for real estate: home sales in April were at a seasonally adjusted rate of just over 5 million units, but that is almost 13 percent off the pace of April 2010. We seem to be trying to maintain an even strain here.

Adding to the challenge is the fact that banks are not lending. How do we know that? The answer lies in real world experience. Hard data from the Federal Deposit Insurance Corporation (FDIC) shows that consumer have been putting more of their hard-earned money into government-insured depository institutions (i.e., banks). [See the table below.] That is not surprising – it’s a natural, expected adjustment of saving more after living through a number of financial overstretched years. Yet banks are still hoarding cash and contracting lending activity. Then there is the public “debate” – government officials are publicly exhorting the banks to lend while banks are blaming the weak economy as well as government regulators for imposing on them uncertain financial rules as the rationale why they need to be extra careful. At the same time, banks are adding profits to their bottom lines, due partly from their ability to access money on the cheap thanks to government backing of deposits and by buying tradable assets such as derivatives and government bonds. The inevitable too-big-to-fail taxpayer bailout if something were to go wrong is also quite reassuring for the large banks.

In the “good old days,” there used to be a rule: the 3-6-3 banking rule. The banker would offer three percent interest to depositors, charge six percent on loans, and then be on the golf course by 3:00 pm. That rubric has now been replaced with a new one: give nothing to depositors, give nothing to those who want to borrow, buy tradable assets, get an easy three percent yield from government bonds, and pretend to work long hours to justify a high salary and bonus.

Partly because of this perverse new banking mindset – that of trading for profits rather than lending to the real private sector economy – pending home sales in April took a tumble, falling 11 percent from the previous month. The weather didn’t help. In fact, April of 2011 registered the heaviest levels of precipitation in 20 years. That put another dent into the recovery momentum. It should be noted that the pending sales figures and closing figures (existing-home sales) do not match up one-to-one because of appraisal issues, short sale delays and from different sampling methods; nevertheless, the upcoming closing sales figure is bound to be soft given the magnitude of the decline. Closings have to increase consistently to absorb the distressed inventories or else the housing market and the broader economy will suffer from an unnecessarily slow recovery.

As for home prices, they rose last year – by 0.2 percent according to NAR’s data and by 1.3 percent according to the Case-Shiller index. But price appreciation has begun to show weakness since the start of this year. The national median sales price was off 5.1 percent from the first quarter of 2010 to the first quarter of 2011 (the latest NAR quarterly price series). The Case-Shiller national price index fell by 3.3 percent in the same time frame. If there’s any good news from this it is that clearly this second round of price declines is much softer than the first. Consider, prices fell about 30 percent from 2006 to 2009, before a slight price gain last year. The first round of price declines was required in order to adjust for the inflated bubble. The second (most recent) round is not really justified if we look solely at fundamental metrics such as price-to-income and price-to-rent ratios. Unfortunately, prices have been weakening in recent months because of lower demand in relation to supply – because of tight lending.

On top of little lending, the economy is also showing signs of stalling. Unemployment insurance claims started to increase again in April after registering consistent declines in the past two years. This implies the pace of job creation could slow markedly. Rather than two million job creations in 2011, less than 1.5 million could be in store. After posting some decent figures early in the year, retail sales slowed and sales at furniture and home furnishing stores actually fell in April. Obviously one chief catalyst in a few things going wrong was oil prices – and the consequent increase in the price of a gallon of gasoline. Not only do rising fuel costs hit consumers’ wallets right away, but they force consumers to be extra cautious in anticipation of future continuing potential pain at the gas pump.

If tight lending conditions worsen and home sales do not recover, then a price decline in the double-digit range is clearly possible and will spell major trouble for the economy. Much lower home values – those below current levels – will mean consumers won’t spend since the value of their major asset (their home) will shrink, strategic defaults and foreclosures will rise, and bank balance sheets will deteriorate since on those balance sheets are less-than-worthy properties. GDP will contract. A second recession with a rising unemployment rate could be in the offing (and in an election year).

Despite having presented such a picture, this is NOT the likely scenario. The more likely possibility is that home values have already posted their declines; any further declines will not be all that meaningful. And not all areas are experiencing the same declines in prices or sales activity. Home values in the Washington DC metro area are quite strong with a price gain that may approach near double digits by the end of the year. The Seattle market has evidently turned a corner, as prices in that metro region are beginning to show positive traction. Many smaller metro markets and rural areas (not covered by the Case-Shiller price data and hence not reported as often in the media) have shown consistent price stabilization. Farm land values have been rising robustly due to rising commodity prices. Home values are also rising in North Dakota and Alaska, where employment conditions are rock solid. If the banking system would return to the old-fashioned way of lending to creditworthy borrowers, that could speed the housing recovery and broader economic prosperity.

Before I end this column – especially considering what some may view as a harsh take on bank profits – I don’t mean to suggest that profit per se is a bad thing. It provides great motivation for entrepreneurs to create new products and services. Profit has been the engine for economic prosperity in many countries. A modern example is China. China was very poor when Chairman Mao came into power to create his “paradise on earth” by punishing and exterminating greedy profiteers and landlords. China remained very poor – some would say became even poorer – with about 50 million of its citizens dying of starvation by the time Mao died. After his death, China experienced an astonishing economic expansion – from profit being permitted and from the introduction of competition into the economy. So the profit motive can serve a country’s economy quite well. But private profits that rely on taxpayer backing (as is the case with banks today or with Fannie Mae/Freddie Mac during the good years) clearly raise questions about economic fairness. If taxpayers support the banks, the banks should give back in responsible levels of homeowner lending. If lenders do so, it will indeed be a summer to remember.

©National Association of Realtors® – Reprinted w/permission


1 reply
  1. BB
    BB says:

    Agree with the comment on banks

    I have a free and clear property for collateral, a near 800 credit score, enough income to cover the debt service and I can’t get ANY bank to loan me $70k to buy an investment property. We have swung to the other side of ridiculous.

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