Jan Hatzius, chief U.S. economist for Goldman Sachs, puts the odds of a consumer-led recession at one in three. His reasoning for this bearish assessment goes as follows: The current housing slump could negatively impact consumer spending which would bring down the economy. But there’s one glaring problem with this sequence of events: There simply is not a lot of evidence that real estate has hit a rough patch.
Last month the Office of Federal Housing Enterprise Oversight (OFHEO) released its House Price Index. The index shows that while there has been a slowdown in price appreciation, home prices were still “10.06 percent higher in the second quarter of 2006 than they were one year earlier.”
Just as federal spending cuts in Washington most often are reductions in planned yearly increases in spending, the supposed slowdown in the residential property market merely is a reduction in the rate of appreciation relative to past increases. In the second quarter of 2005, yearly home-price appreciation was 14 percent; thus the housing “slump.”
Since real estate is ultimately a local market, let’s look at what the states are telling us. Arizona, Florida, and Idaho have each seen home-price appreciation of more than 20 percent in the past 12 months, while the states of Washington, California, and New York have respectively seen annual home-price appreciation of 17, 14, and 10 percent. Not so shabby.
Yet even if home prices were falling in the aggregate, it’s folly to assume that such an event would bring about the negative economic impact that has so many worried today.
Indeed, the basic economic reality that bearish economists can’t escape is that mortgage cash-outs on appreciated home values represent nothing in the way of economic growth. One man’s mortgage loan is another man’s savings. There is no wealth creation in these transactions; just a transfer of money to consumers from those who have chosen to save. If one were to assume a hypothetical decrease in home prices — say, a hefty 25 percent decline — homeowners would surely be less wealthy. But by this logic prospective homebuyers would be 25 percent wealthier.
It also has to be remembered that when a home is purchased, capital is consumed. Conversely, when money is invested in the stock market, capital is offered up to entrepreneurs who through their innovations bring about true economic growth.
Returning to the OFHEO report, annual home-price appreciation since 2000 has averaged 8.96 percent. Over this timeframe, the Dow Jones Industrial Average is up 1 percent. On the other hand, annual home-price appreciation averaged 2.9 percent during the 1990s, yet the Dow rose 289 percent during that decade. The housing market also boomed between 1972-74 and 1976-79, yet the Dow fell respectively 4.4 percent and 6.3 percent during these periods.
The numbers tell us that housing in the U.S. does particularly well when the currency is weak and the economy uncertain. That the dollar was in freefall for much of 1970s goes far toward explaining why property did so well across that decade. Since the beginning of the new millennium, we’ve experienced 9/11, tariffs on steel and lumber, Sarbanes-Oxley, and a fall in the dollar that drove the gold price well past its ten-year average. And housing has once again boomed.
For an international perspective, the Wall Street Journal recently reported that since 2002, annual construction activity has grown in Argentina at a record annual rate of 27.9 percent, with home prices rising over 50 percent. That year — 2002 — is instructive. It was the year Argentina devalued its currency and defaulted on its debt obligations. While Argentina’s economy cannot in any way be compared to ours, the experience there once again suggests that property booms are very often indicative of economic uncertainty, as opposed to optimism.
Over the last two months, despite sky-is-falling headlines about a housing bust that will supposedly send the U.S. economy into a recession, the Dow has returned 5.1 percent. The performance of the Dow suggests that the slowdown in home-price appreciation is merely indicative of renewed economic optimism.
Looking ahead, history shows that money will be made by those who buy equities in response to “bad” news about real estate. In this instance, the bears are behind the curve.
– John Tamny is a writer in Washington, D.C. He can be reached at email@example.com.