Saturday, August 26, 2006

A good economy?

My friend Tom over at BizzyBlog and I have slightly different opinions about the state of our economy. His opinion is that the economy is doing great and the doomsayers are taking molehills and making mountains out of them. I am by nature an optimistic person but because of our business, we see a lot of molehills.

First, foreclosures. When a family faces foreclosure, their financial condition is usually in very serious distress. Many people facing foreclosure have judgments against them for non-payment of credit cards, utilities or medical bills. The foreclosure is usually the last in a long line of non-payments. Still. Foreclosures occur even in the best economic conditions, so in and of themselves, they do not indicate a systemic problem with the economy. Despite the 70% increase in foreclosures nationwide during the first quarter of 2006, we are talking about less than one million foreclosures in a market of over 75 million. A relatively small percentage. In our area, we saw a similar foreclosure rate in our area, but it has settled down to about 30% increase for the 2.66 quarters of this year. Based on previous history, it will probably finish the year nearer 50% increase. A troubling issue, but we are talking about 2500 foreclosures in an area of about 850,000 people. Of those 2500 foreclosures, about half will actually be able to come up with the money to stave off the loss and keep their homes. This will of course lead most reasonable people to dismiss the issue as a molehill. But I do want to use one more stat to suggest it is a bigger problem. Last year about 14,000 homes were sold in the area, meaning about 10% were foreclosures. There is a current unsold inventory of almost 5,000 homes in our area. Foreclosure increases will lead to additional inventory and because of their nature, pressure on pricing.

The impact of foreclosures will not show up in many econ stats: people still need a place to live and most people evicted by foreclosure will end up in rental housing. Based on a general opinion, most people will net a reduction in housing costs freeing up money for other expenses.

Foreclosures and housing bubble? Markets that had significant investor involvement were getting very overheated last year and those markets are the ones experiencing 'bubble' like results. Other markets with moderate increases in values and sustainable growth seem to be weathering things just fine. Regional housing recessions are likely but not expected to spread - IMO.

Second issue: gas prices. We have several truck drivers as clients. Over the last 18 months, they have experienced almost 100% increase in fuel costs. Even average drivers have seen significant increases in fuel expenditures. Miles driven have not decreased (though the increase is minor) over the last year. I will be interested to see how the 'vacation' areas did over this summer.

I think we have a good economy. Two million people filed bankruptcy last year with practically no impact on the economy (or the profit margins of the credit issuing industry...kinda makes you wonder why they were all in a huff to get the law changed). Katrina practically wiped out New Orleans and parts of the Gulf Coast also with little or no economic impact to the country. However, there ARE problems.

...cash-outs from refinancing to total $162 billion for the year but, as rates continue to rise, the figure would fall back to $69 billion for the whole of 2006. In 2004 homeowners extracted $140 billion in equity through refinancing their homes.
http://www.mortgagenewsdaily.com/852005_Cash_Out_Refinancing.asp

Based on the refinancing, there was a net pre-tax savings of over $31 billion in 2003. That number was certainly higher in 2004 and 2005. Equity refinancing added almost $200 billion to the economy in each of the last three years, not an insignificant change. If however many of the refinancings were to ARMs or other non-standard mortgages (interest only for example) then interest rate increases will make it harder to refinance in the future and increase the demand upon family budgets. 3 year ARMs sold in 2003 are coming due for their increases and we are seeing contractual limit increases (2-2.5%). On a $150,000 mortgage, payments are jumping as much as 28%. Those that can, are selling their homes when faced with stiff increases, but the market has slowed. Home sales are down almost 5% over last year. This situation is worse in those markets that had active investor involvement driving prices.

Over the last 5 years, real estate has driven a lot of our economy. A slowdown in housing sales and construction, already underway in many markets, will lead to increased unemployment as the fall progresses. Unable to refinance and faced with higher gas and maybe mortgage payments, retail sales may slow also - though there is little indication of that occurring yet. Consumers are getting pinched.

We have a good economy, but certain pillars of that economy are showing serious signs. High fuel prices are going to force prices in many parts of the economy higher. Unable to refinance and facing higher mortgage payments, consumers will be unable to sustain their current spending habits. A slow down in housing will increase unemployment. Every good economy ended, sometime. In hindsight, the writing was on the wall.

Remember this: By the end of the year, 500,000 families will have lost their homes.

The question for us optimists is: are we looking at the wall now, or keeping our backs to it...

2 comments:

BizzyBlog said...

That's a great post. My post this morning was more towards the longer view than whether the current situation isn't going to have some short-term bumps.

The foreclosure houses thrown onto the market might explain why the inventory of unsold homes is so high.

If you saw the housing post, the point I made there, which has been reinforced with a bit more research, is that not only are we not in a "bubble" yet as the investor world defines it (3-5 years of flat nominal home prices), the time period for measuring a bubble period hasn't even started yet. That may change when OFHEO issues their report on Sept. 5.

What's irritating is when writers like the guy at MarketWatch I picked not only assume that one is taking place, but that it's been taking place for a year or two (he essentially told me that in an e-mail I didn't publish, as he was upset that I published his previous one -- hey, if you're in a reporting business and communicating with a business that is a reporting business, i.e., the blog, you'd better TELL me you don't want something published).

So maybe I'm overreacting by not mentioning the real storm clouds that I have from time to time mentioned (foreclosures, ARMs and IOs up for conversion, overextended people, too-easy credit, etc.). But I think the reporting on the housing market assumes facts not in evidence, and assumes a negative outcome that is not assured.

tracy said...

I apologize to my few readers that have never heard of my research into nonlinear behavior and economics but the situation is consistent with the concept of rolling regional/industry recessions. We can have localized areas of high unemployment, deflationary prices and higher cost of living expenses without a general economy wide recession. 91/92 and 2002 were good examples.

That said, it is possible to have a good economy and severe hardship on a segment of the population. Three to five million people failing to make ends meet over periods of time will result in foreclosures and bankruptcies even when the general economy is great. A rising tide may lift all boats, but if yours leaks, you are just as likely to drown in the deeper water as not.

My research says we will never have another economy wide recession, but those proclaiming a 'good economy' must acknowledge not only the potential, but the actual suffering of people is part of the function of the economy and not necessarily due to their own foibles.