Housing: "With a pfffffffft or a fizzle"

In The Economist, Buttonwood asks: “The air is coming out of America’s property-price bubble. Will it pop or go quietly?”.

“Mortgage applications were down by about 5% in October compared with September, and were lower than the same month a year earlier. The stock of unsold new houses is rising. The only bullish sign is that homeowners continue to take equity out of their homes at a healthy clip: in the third quarter, they withdrew more than $60 billion, on figures from Freddie Mac—about the same as the previous three-month period.”

The level of mortgage equity extraction appears ominous to me, and Buttonwood agrees:

“… even [if housing prices] just … rise less quickly … that would be bad news for the economy. Consumer spending accounts for 70% of growth these days, so closing down even part way the home-equity cash machine that has fed consumption would put the economic brakes on sharpish.”

But will the slowdown lead to a soft or hard landing? Buttonwood considers the possibilities of rising financial distress:

“What could give this scenario an uglier twist is the sharp increase in funny loans to funny borrowers over the past few years. ‘Subprime lending’ to people who would not normally be able to make the grade is running at about $500 billion a year. Much of it takes the form of variable-rate, interest-only and negative-amortisation loans. Both debtors and creditors are now more exposed to interest-rate changes.

So it all comes back to interest rates, and to how determined the central bank is to keep raising them until house prices retreat. … the housing market reacts to monetary tightening after a lag of one to two years, it seems, so the temptation will be to overshoot. In which case the Fedsters will bring down house prices and the economy itself not with a whimper but a bang.”

I think we can put Buttonwood in the hard landing camp.

And a couple of mentions: Dr. Duy believes (FED Watch: Headed for More of the Same) that the FED will keep raising rates until they see clear signs of economic weakness:

“If I am reading all this correctly, the Fed will not react until it sees significant stress on the consumer (assuming that is the correct channel of transmission) – again, in the data, not anecdotally. Note that such a point could still be months away: A housing slowdown will need to become evident, then spread into consumption, and then show up in the data.”

That sounds like Buttonwood’s possible “overshoot” scenario.

And a great addition to Professor Hamilton’s Econbrowser: Dr. Menzie Chinn is now a regular contributor. Chinn’s latest: Is trade deficit stabilization at hand?

Best Regards, CR Calculated Risk