“A global house-price slump is coming,” The Economist, edited.
I find this article to be interesting although I do not agree with much of it. Prices are an issue; but so are interest rates. Much of the costs of housing can also be from house manufacturing waste. I was watching my new home being built. The scrap is horrendous. The do-overs because of a lack of critical path are numerous. Quality is inspected into homes and not built into a home. I explained this to the construction manager as well as the Uniform Commercial Code.
We went to closing prepared to close. Our mortgage was complete. If we could not close, we faced a penalty of several hundred dollars a day. Upon taking possession, there were twenty-one issues to be fixed in our home. No penalties for the builder. Some painfully obvious such as an incomplete sidewalk in front of the house and another being a driveway sloping from right to left as you looked at it.
Built into the builder’s price are all of their mistakes and scrap. Can the Japanese build better homes in the US? Would the Toyota Production system work in the US to build homes?
Over the past decade owning a house meant easy money for many. Prices rose reliably for years and then went bizarrely ballistic in the pandemic. People could borrow against this equity. Today if your wealth is tied up in bricks and mortar, it may be time to get nervous. There is a Housing Price slump coming due to too high pricing and Fed rates increasing.
House prices are now falling in nine rich economies. The drops in America are small so far. In the wildest markets they are already dramatic. In condo-crazed Canada, homes cost 9% less than they did in February. Inflation and recession stalking the world portends a deepening correction being likely. Even the real estate agents are gloomy. Although this crisis will not detonate global banks as it did in 2007-09; it will intensify the downturn, leaving a cohort of people with weaker finances, and start a political storm.
The forthcoming crunch cause is soaring interest rates. In America, prospective buyers have been watching the 30-year mortgage rates rise to 6.92% and beyond. These rates are over twice the level of a year ago and the highest since April 2002. The initial pandemic housing mini bubble was being fueled by low interest rates, stimulus cash, and a hunt for more suburban space. Now most of the interest rate caused lunge is in reverse due to the increasing Fed rates.
AB: More Fed rate increases is coming as promised by Fed Chair Powell. To add to this on mortgage interest rates, 6.92% was a great rate forty-something years ago. Our first home as an 8.25% rate in the late seventies with 10% down. Since it was less than 20%, we had to absorb mortgage insurance also. Several years later, we had a 12% VA mortgage rate. Both nice homes and memorable. So, what is the big deal? The cost of the housing. The homes appreciated.
To make matters worse, builders do not understand their prices are causing the slowdown in new home buys. I explained this to one builder and telling him the difference in upcharges on a mortgage payment due to price and interest rate.
Also, as I see the amount of scrap and damage caused by the lack of a critical path analysis process, deliberate damage from dropping dumpsters on concrete, driving over sidewalks having drop-offs on the sides, breaking up surfaces to lay piping, electrical line, etc., scrap wood, scattered loose nails, nail and screw usage, etc.
Take the example of the impact of the increasing interest rates. Someone a year ago could afford to put $1,800 a month towards a 30-year mortgage. Back then they could have borrowed $420,000. Today the payment is enough for a loan of $280,000 or33% less.
AB: I quickly ran the numbers on this example. At a 3% interest rate, 10% down, PMI, homeowners’ insurance, and property tax at $4200 annually; the monthly cost would be $2200 monthly. If that is a third of your income, it is doable with a gross income beyond six digits and few other external expenses.
From Stockholm to Sydney the buying power of borrowers is collapsing. This collapse making it harder for new buyers to afford homes, depressing demand, and squeezing the finances of existing owners who, if they are unlucky, may be forced to sell.
AB: As one commenter from the Philippines commented, as the US Fed goes so does the Philippines in costs of the dollar. They have no choice but to use the global dollar as exchange currency.
The good news of falling house prices will not cause an epic financial bust in America as they did 15 years ago. The country has fewer risky loans and better-capitalized banks which have not binged on dodgy subprime securities. Uncle Sam now underwrites or securitizes two-thirds of new mortgages. The big losers will be taxpayers. Through state insurance schemes they bear the risk of defaults. As rates rise, taxpayers are exposed to losses via the Federal Reserve, which owns one-quarter of mortgage-backed securities.
AB: The problem I have with this initial comment is what caused the financial bust. Wall Street went a bridge to far in it gambling with derivatives (CDS, naked CDS, tranching, etc.). There was to be a clearing house for derivatives which never came to be. CDS derivatives backing were pennies on the dollar after traders took their bonuses and fees, leaving little to back the CDS up. Greenspan’s famous last words in conclusion; “regulation of derivatives transactions privately negotiated by professionals is unnecessary.” And then Goldman Sachs made the call on its CDS with AIG. Familiar name, Brooksley Born. Anyone?
Complicating all of this were financial and banking liar loans or mortgages to customers. People extending loans from their home equity. When the economy collapsed, they found they were under water, unemployed, and not making the payments. Also, banks did not register the loans with the county.
Some other places, such as South Korea and the Nordic countries, have seen scarier accelerations in borrowing, with household debt of around 100% of GDP. They could face destabilizing losses at their banks or shadow financial firms: Sweden’s central-bank boss has likened this to “sitting on top of a volcano”. But the world’s worst housing-related financial crisis will be in China. Their problems being speculative excess, mortgage strikes, people who have pre-paid for flats which have not been built—are, mercifully, contained within its borders.
Even without a global banking crash, the housing downturn will be grim in the US. The property markets will be a drag on the jobs market. As interest rates rise and prices gradually adjust, the uncertainty makes people hesitant about moving. Sales of existing homes in America dropped by 20% in August year on year. Housing relator firm Zillow reports 13% fewer new listings than the seasonal norm. In Canada, sales volumes could drop by 40% this year.
When people cannot move, it saps labor markets of its dynamics. It creates a big worry when companies are trying to adapt to worker shortages and the energy crisis. When prices do plunge, homeowners can find their homes are worth less than their mortgages. making it even harder to up sticks. People can not afford the losses.
Lower house prices also hurt growth in another way by making already gloomy consumers even more miserable. Worldwide, homes are worth about $250trn (stock markets are worth only $90trn), accounting for half of all wealth. As capital crumbles, consumers cut back on spending. Though a cooler economy is what central banks intend to bring about by raising interest rates, the resulting collapsing confidence can take on a momentum of its own.
An additional problem is a concentrated pain of adjustable interest rates as borne by a minority of homeowners. Those mortgage holders not having locked in interest rates face increased mortgage payments. Relatively few are found in America, where subsidized 30-year fixed-rate mortgages are the norm. But four in five Swedish loans have a fixed period of two years or less, and half of all New Zealand’s fixed-rate mortgages have been or are due for refinancing this year.
When combined with a cost-of-living squeeze, a growing number of households face financial distress. In Australia, an ~fifth of all mortgage debt is owed by households who will see their spare cashflow decease by 20% or more as interest rates rise as expected. In Britain 2 million households could see their mortgage absorb another 10% of their income, according to one estimate. Those who cannot afford the payments may have to dump their houses on the market instead and take losses.
Here is where the political dimension comes into play. Housing markets are already a battleground. Housing build rules and regulations came about due to builders past practices. As a result, it is harder to build new homes in big cities or start developments which contribute to shortages.
AB: As I mentioned in an earlier post, 1989 found the bottom 50% of the population holding 4% of the nation’s wealth. By 2019, the same 50% of the population held 2% of the wealth. Let’s get to the real story.
Bernie Sanders; The obscene level of income and wealth inequality in America is a profoundly moral issue that we cannot continue to ignore or sweep under the rug. A society cannot sustain itself when so few have so much while so many have so little.
No, America’s bottom 50% are not living high on the hog enjoying the best pork cuts as taken from the back and upper legs. Occurring under Democrats Biden’s policies is a doubling of the net worth of the lower 50 percent since the first quarter of 2020. It is now far higher than it’s ever been in U.S. history. Even as prices have gone up, wages have mostly kept pace.
A generation of young people in the rich world feel they have been unfairly excluded from home ownership.
Although lower house prices will reduce the deposit needed to obtain a mortgage, it is first-time buyers who depend the most on debt financing, which is now expensive. as Economist reveals.
And a whole new class of financially vulnerable homeowners are about to join the ranks of the discontented.
Having bailed out the economy repeatedly in the past 15 years, most Western governments will be tempted to come to the rescue yet again. In America, fears of a housing calamity have led some to urge the Fed to slow its vital rate rises. Spain is reported to be considering limiting rising mortgage payments, and Hungary has already done so. Expect more countries to follow.
They could see governments’ debts rise still further and encourage the idea that home ownership is a one-way bet backed by the state. Such would also do little to solve the underlying problems bedeviling the rich world’s housing markets. Many of the problems are due to ill-guided and excessive government intervention, from mortgage subsidies and distortive taxes to excessively onerous planning rules. As an era of low interest rates comes to an end, a home-price crunch is coming. There is no guarantee of a better housing market at the end of it all.
The last couple of paragraphs will be the subject for another post.