by Calculated Risk on 6/16/2006 01:30:00 PM

Paul Krugman writes: The Phantom Menace (NYTimes pay)

"It would be an exaggeration to say that there's no inflation threat at all. I can think of ways in which inflation could become a problem. But it's much easier to think of ways in which the Federal Reserve, wrongly focused on the phantom menace of a new wage-price spiral, could be slow to respond to bigger threats, like a rapidly deflating housing bubble."

So far the housing bubble is not deflating rapidly. But I do think a housing slowdown is a greater threat to the economy than inflation.

Krugman writes:

So I don't fear inflation nearly as much as I fear the fear of inflation. And I wish the Fed would lighten up on the subject.

But by talking about inflation, perhaps the Fed can lessen the fear of inflation. So I think the Fed is correct to talk openly about inflation concerns.

For excerpts of Dr. Krugman's column, see Economist's View.

by Calculated Risk on 6/15/2006 06:29:00 PM

Harvard's Joint Center for Housing Studies last week released a new report on housing: State of the Nation's Housing 2006. The report suggests that a "soft landing" is likely for housing, mostly because other factors are not present (loss of employment and overbuilding).

... when and if house prices do fall, the so-called bubble is more likely to deflate slowly rather than burst suddenly. History suggests that appreciation eases for a year or two before prices come down in nominal terms. While dips of a few percentage points are common, nominal house prices rarely drop by 10 percent or more.

Still, over the past 30 years, nominal house prices have in fact fallen by five percent or more at least once in about half of the nation’s 75 largest metros. In most cases, it takes significant job losses—or a combination of overbuilding, modest job losses and population outflows—to drive house prices down substantially. In terms of magnitude, price declines associated with episodes of major job losses alone average 4.5 percent, while those occurring in and around periods of overbuilding alone average 8.3 percent (Figure 11).
emphasis added

Click on graph for larger image.

Figure 11 shows historical price drops associated with minor and major job loss and overbuilding,

However, one of the co-authors of the Harvard study, Rachel Drew, was quoted in Business Week: A Soft Landing for Housing?

Drew notes that the Harvard study was based on the state of the market at the end of 2005 and admits her optimism has been tempered a bit by the slowdown that's occurred so far this year. "The first-quarter numbers showed the housing market slowing a little faster than we expected," she readily admits. But for the most part, she stands by the conclusions of the report.

Overall I think the Harvard study is reasonable, however I think the price declines will be more significant than JCHS expects. There are several reasons for my pessimism: 1) Housing is now a larger portion of the US economy than in previous periods. So a housing slowdown will have a larger ripple effect on the overall economy. 2) As noted in the report, homeowners have been extracting equity from their homes to maintain their lifestyles. As housing prices flatten out and start to decline, this mortgage equity withdrawal will slow, impacting consumer spending. and 3) there has been significant speculation and the use of leverage to purchase homes in recent years (the exotic or nontraditional loans). This will probably lead to more foreclosures and lower prices.

As Harvard noted: "[historically] appreciation eases for a year or two before prices come down in nominal terms". What Harvard didn't add is the nominal declines are historically slow and steady over a multi-year period.

“Actually, what we are seeing is a very typical slowdown in the market so far—there is nothing particularly soft about it (the landing in bubble markets). The claim is that because unit sales are falling but prices are still going up, that this is an unusual slowing. The fact is that most breaking markets start with activity, and it takes three to four quarters for that to take all the wind out of price appreciation. How hard it will be, remains to be seen.”

UCLA's Dr. Christopher Thornberg (from Smart money is leaving the real estate market)

by Calculated Risk on 6/15/2006 12:10:00 PM

For Fed Watchers, the question is now what happens in August?





Images from the Cleveland Fed.

by Calculated Risk on 6/14/2006 02:14:00 PM

From the Fed's Beige Book Summary:

Residential real estate markets continued to cool across much of the country--with most Districts reporting slower homebuilding and sales of existing homes. In contrast, commercial real estate activity continued to strengthen in most Districts. A few reports noted concern about too much building.

Some softening of the market for existing homes was reported by ten Districts--Chicago, Cleveland, Dallas, Kansas City, Philadelphia, Minneapolis, New York, Richmond, St. Louis, and San Francisco. Dallas and Richmond noted that activity remained quite strong, and Chicago reported slowing from high levels. San Francisco reports hot housing markets in Utah and parts of the Pacific Northwest. Several Districts said sales had weakened for some of the most expensive homes, except in the Dallas District where demand for lower-priced homes "had dipped noticeably." Atlanta reported that residential sales were near year-ago levels in most parts of the District, but that sales weakened and inventories increased in Florida. The Philadelphia District said sales of homes in resort areas have declined sharply. The New York District reports a sharp deceleration in prices in the suburbs around New York City, but a tightening of the Manhattan rental markets.

Homebuilding slowed in most Districts--Chicago, Cleveland, Dallas, Kansas City, New York, Philadelphia, St. Louis, and San Francisco. The New York District reported that some homebuilders in New Jersey are withdrawing from the authorization process and allowing their options to build to expire, noting that increases in fuel and materials costs are pinching profits. Homebuilders in the Atlanta District reported that single-family home construction was near year-ago levels in most parts of the District, except in Florida, where sales slowed. The Atlanta District also reported that Florida condominium sales continued to weaken and several projects were cancelled.

by Calculated Risk on 6/14/2006 08:44:00 AM

The Mortgage Bankers Association (MBA) reports: Mortgage Applications Increase by 7 Percent in Latest Survey

Click on graph for larger image.

The Market Composite Index, a measure of mortgage loan application volume, was 571.9, an increase of 7 percent on a seasonally adjusted basis from 534.4 one week earlier. On an unadjusted basis, the Index increased 17.9 percent compared with the previous week but was down 34.3 percent compared with the same week one year earlier.

The seasonally-adjusted Purchase Index increased by 4.8 percent to 414.6 from 395.6 the previous week and the Refinance Index increased by 10.6 percent to 1499.4 from 1356.0 one week earlier.

Mortgage rates increased slightly:

The average contract interest rate for 30-year fixed-rate mortgages increased to 6.61 percent from 6.60 percent ...

The average contract interest rate for one-year ARMs increased to 6.09 percent from 6.05 percent ...

Change in mortgage applications from one year ago (from Dow Jones):

Total	-34.3%
Purchase	-21.1%
Refi	-49.5%
Fixed-Rate	-34.1%
ARM	-34.6%

Although mortgage activity picked up slightly this week, Purchase activity is off over 20% from 2005.

by Calculated Risk on 6/13/2006 07:08:00 PM

The San Diego Union reports: San Diego County home prices take a tumble

The median price of all homes sold in May was $490,000, down $15,000 from April, although it was still slightly higher than a year ago.

Sales slowed for the 23rd straight month on a year-over-year basis, reaching 4,217 transactions in new and existing homes and condos.

Local real estate agents reported about seven months' worth of unsold inventory, but argued that the pace of activity reflects a normal market rather than a crash.

DataQuick will report on all of California over the next couple of days.

by Calculated Risk on 6/13/2006 02:24:00 PM

From CNNMoney: Housing slowdown could hurt construction jobs

"Although construction employers expect to hire at a brisk pace again during the third quarter, hiring in this sector has inched downward throughout 2006," said Jeffrey A. Joerres, Chairman & CEO of Manpower Inc. "There is rampant speculation about the state of the housing market, and these survey results are another piece of evidence that point toward a cooling trend."

According to the survey, construction employers "in the West have the strongest hiring plans, while those in the Midwest report considerably weaker staffing expectations."

Manpower President of North America Jonas Prising added, "It's the only sector in the survey with a distinguishable tick downward. We may be seeing some of the housing backlog come to an end."

This is just the beginning of the impact on employment from the housing slowdown. I expect employers will be optimistic about the "next quarter" during the entire down trend.

Also, Reuteres reports: Freddie Mac sees slowdown in U.S. housing market

U.S. mortgage finance company Freddie Mac said on Tuesday that rising interest rates would lead to a slowdown in the U.S housing market but added it did not expect the market to crash.

"Rising interest rates will lead to a slowdown in the U.S. housing market," said Chief Executive Richard Syron, speaking to Reuters in Paris where he was on a business engagement.

"We do not think that there will be a crash. We think that by and large, overall, nationally, there will be a material slowing of the rate of appreciation of housing prices, but not an absolute decline," he added.

I also don't think there will be a "crash"; I expect housing prices to decline in real terms over several years.

by Calculated Risk on 6/13/2006 12:29:00 AM

From MarketWatch: During the Q&A tonight ...

[Bernanke] also said the Federal Reserve would offer guidance "in the not-too-far-distant future" about nontraditional mortgages.

Not-too-far-distant future?

This year? This century?

by Calculated Risk on 6/12/2006 02:36:00 PM

Barry Ritholtz has an interesting post on housing's impact on the economy: Housing Leads the Economy Up AND Down



This graph is from Barry's post. It shows that consumer spending and the housing market move together. Barry's post includes several other graphs, including one that shows housing leads GDP growth (both up and down). This has been a familiar theme on this blog!

by Calculated Risk on 6/11/2006 10:26:00 PM

Stephen King paints the picture: Warning signals that have made the Fed ultra-cautious

We have reached one of those occasional critical junctures in the world economy, one of those multiple forks in the road where, for both policymakers and markets, choices really do matter.

One road threatens inflation. Another risks a possibly serious economic slowdown.

And a third, the worst of all worlds, leads in Escher-style madness to both destinations.

And Dr. Duy argues the Fed will choose to raise rates: Ascendancy of the Hawks

Bottom line: The Fed is poised to tighten at the end of this month.

Perhaps most interesting to me is that Dr. Duy suggests the Fed isn't very concerned about the slowdown in the housing market:

Fed officials will discount the impact of the housing slowdown. The focus on housing we saw last year appears to have reflected Greenspan’s views. I should have picked up on this earlier. From MarketWatch: "Poole said the financial press puts to much focus on "highly visible" sectors like the housing sector, even though it only amounts to a small fraction of overall GDP growth." The Fed discounted the impact of the NASDAQ meltdown as well – technology was thought to be too small a part of the economy. The housing slowdown will be even easier to discount, as it will happen in slow motion.

I think the housing slowdown will have a far greater impact than Poole is suggesting. Duy is concerned too:

I would rest easier if the economy didn’t look to be slowing, or if experience had not taught me to be wary of asset market (in this case housing) reversals.