Mortgage Mess Could Delay Recovery


The correlation between confidence and spending is undeniable

How bad is the real estate market? A friend has been trying to sell her home in northwestern Connecticut for four years, asking about half the dollar amount she has invested in it. In that time, she has received only one bid, which she immediately accepted; the deal fell through. Next week she is having the property bulldozed. Literally! The carrying costs of the property are too high; she thinks the most economical plan is to destroy her house while continuing to hold onto the land.

That’s how bad the real estate market is. Which is why the current flap over mortgage foreclosures is so unwelcome. The only way housing prices will stabilize is to get through the tsunami of foreclosures as quickly as possible, put those homes back on the market, let prices bring supply and demand into balance and move on. It’s harsh, it’s painful for hundreds of thousands of Americans, but it has to happen.

Here’s why: Though the rate of new homebuilding has collapsed – from an historical annual average of 1.5 million units to about 586,000 – the inventory of unsold homes is still enormous. To put that number in perspective, historical annual “starts” going back to the 1960s have averaged 1.8% of all households. Today’s level is 0.5% of all households. That’s some dire fall-off.

Notwithstanding that low level of new additions, the current pile of unsold homes threatens the market. There are 3.6 million homes for sale today, another 2.6 million in foreclosure and 4.9 million additional properties with delinquent mortgages. Thus, the total potential inventory is some 11 million homes. The only good news is that we have a growing population and there are still people getting married – so demand is climbing. According to one analysis, it will take about two years to work off this inventory overhang, with new household creations, destruction of homes and people looking to move out of rentals all contributing to the rebalancing.

The current stalemate on mortgage foreclosures will extend home price deflation and draw out the misery. The sloppy and possibly illegal processing of foreclosures by some of the largest banks and processors has attracted public outrage – and sympathy. Any story of someone losing her house is heartbreaking, but to do so courtesy of some anonymous and thoughtless “robosigner” adds insult to injury. Let us hope, however, that political posturing doesn’t get in the way of resolutions. The economy faces too many uncertainties already; paralyzing the housing sector will only add to our economic stalemate.

Among those uncertainties has been the scope of further Federal Reserve intervention. This morning Chairman Ben Bernanke said he favored further quantitative easing – the process by which the Fed infuses more money into the economy by buying Treasury securities. He also said, however, that he hadn’t concluded how large such a program should be. At a recent (off the record) investor meeting, one prominent analyst suggested that, to be effective, the Fed Funds rate should drop to a negative 5%; since that is impossible, he proposed the Fed’s balance sheet should expand by more than one trillion dollars.

This breathtaking assertion raises an issue I have written about before. This same economist had just concluded that the No. 1 focus of government policy should be restoring consumer confidence. The correlation between confidence and spending is undeniable; the recovery requires that Americans open their wallets. My view is that gigantic further increases in government fiscal or monetary stimulus will dampen confidence, offsetting the expected boost. Caution drives up the savings rate – which has jumped to around 6%; it was 1% before the recession. That defensive reaction by U.S. consumers is not helping our recovery.

Meanwhile, confidence is certainly not being boosted by the dollar plunge, which is driving up commodity prices and at the moment providing little relief in the way of increased exports. Our trade deficit widened in August, thanks to a jump in imports and drop in exports. The entire world seems hell-bent on deflating their currencies in order to prop up exports. I wrote about the prospect of a trade war many months ago. This was one of the triggers to the Great Depression; it is discouraging to see history repeating itself.

Despite all the gloom, the stock market has surged nearly 9% over the past two months. How can this be? There are two primary reasons. One is that investors are migrating back to stocks, looking for better returns than are available from safer Treasury securities, for instance. The other explanation is that corporations are in good shape. Profits are strong and balance sheets even stronger. Companies are sitting on enormous amounts of cash, which will likely be invested in productivity and profit-enhancing investments like capital equipment and acquisitions. Though they will not hire until demand picks up, many companies have been raising dividends, and the rise in stock prices somewhat offsets the deflating impact of lower home values.

Overall, the outlook is not entirely dark. The economy is likely to crawl forward, spurred by capital spending and some improvement in exports. My guess is that the Chinese will head off a more serious trade spat by allowing the renminbi to rise gradually, cooling hostilities with Japan, the U.S. and its other trading partners.

The most important issue for investors, and for all of us, is how the U.S. is going to tackle our long-term budget problems. Rising deficits are not going away; we face decisions critical to the long-term health of the country – to our ability to care for our neediest citizens; to guarantee our security; to educate our young; to compete with younger, faster-moving rivals. In a perfect world, the deficit commission report would be delivered after the midterm elections and would inaugurate serious and grown-up debate about turning around our runaway deficits. Let’s hope that Americans, having vented their spleen on the midterm elections, will be in a mood to listen.

Editor’s Note: Liz Peek is a financial columnist.

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