Inflation or Deflation?
Back in 1998 we wondered here how long the boom would last. In our EcoWorld post “Bulls & Bears” we noted that aggregate public stock multiples were much higher than historical norms, and wondered how they might experience a soft landing. As it turned out, stocks appreciated for nearly two more years, and the soft landing they got was because the housing bubble inflated to replace the deflating stock bubble, keeping employment up and the economy strong. Now the housing bubble is deflating. How bad will it get?
We have blamed the unaffordability of housing on the underlying cost increases, which are (1) land costs too much because environmentalists successfully oppose most development, which restricts the supply of available land, (2) construction materials cost too much, because environmentalists successfully oppose most new sources of building materials - mines, quarries, lumber - which restricts the supply of materials, and (3) public infrastructure costs too much, because public employees have taken over our state, county and local governments and have negotiated themselves (and their contractors) wages and benefits that are far higher than the market-driven wages and benefits that competitive private sector companies pay their employees.
The reasons nobody cared about these grossly inflated underlying costs, however, was because of the rise of one of the most irresponsible periods of lending practices in American history, the subprime “liars loans” that induced tens of millions of people into borrowing money at low initial rates - rates that are now resetting and destroying the ability of these millions of homeowners to afford the monthly payments for their grossly overpriced homes.
To figure out how bad this is going to get, consider these excerpts from recent posts on four respected blogs that are covering this disaster:
“Finally, the Crossroad” by John Rubino - “the past two decades of low inflation and steady expansion have been purchased with ever-greater amounts of debt. In the 1960s it took about a buck-fifty of new debt to produce a new dollar of GDP. Today it takes about six bucks…” and “Total debt in the U.S. economy grew at a seasonally-adjusted annual rate of $3.7 trillion, and now stands at $46 trillion, up from $29 trillion in 2001…”
“Interview with Paul Kasriel” by Michael Shedlock - “Shedlock: Would you say that consumer debt in the US as opposed to the lack of consumer debt in Japan increases the deflationary pressures on the US economy? Kasriel: Yes, absolutely. The latest figures that I have show that banks’ exposure to the mortgage market is at 62% of their total earnings assets, an all time high. If a prolonged housing bust ensues, banks could be in big trouble. Shedlock: What if Bernanke cuts interest rates to 1 percent? Kasriel: In a sustained housing bust that causes banks to take a big hit to their capital it simply will not matter. This is essentially what happened recently in Japan and also in the US during the great depression…”
“Real Estate & Housing Update” by Mike Morgan - “The deterioration of the housing markets over the past six weeks has been devastating. I really don’t care what we hear on the conference calls this week, because I’m here to tell you from ground zero, it is much worse than anyone has discussed, and it is going to get far worse than any of the builders want to admit…”
“US Housing Crash Continues” by Patrick Killelea - “Prices are still disconnected from fundamentals. House prices are still far beyond any historically known relationship to rents or salaries. Yearly rents are 3% of purchase price. Mortgage rates are 6.5%, so it costs more than twice as much to rent money than it does to rent a house…”
So does it now appear the subprime loans and the housing bubble were necessary to postpone the inevitable? Perhaps, but meanwhile we’ve added another $29 trillion of debt to the US economy, and more importantly, banks can’t continue to lend, even if the Fed cuts the interest rate to zero, if 62% of their earnings assets are home mortgages, and the value of the underlying loan collateral - the homes themselves - has crashed.
It appears to this non-economist that managed inflation is the key - just as it appeared back in 1998. Let these homes grow into their inflated values, as the real value of the dollar slowly falls. But at this point, it is unlikely America can postpone their reckoning with unsustainable levels of consumer and government debt. And as we restore sustainability to our economy, if new homes are ever to become affordable, we must also address the issues of inflated costs. To complete this housing cycle we need to restore rationality to the environmentalist lobby, and fiscally reform the public sector. Bottom line: Sustainable economics are just as important as sustainable ecosystems.
