How Falling Home Prices Will Impact The Economic Recovery

Post-stimulus US housing may be limping toward recovery, but it’s doing so on its own instead of dragging down the economy. Money is better spent on stimulating small …

Post-stimulus US housing may be limping toward recovery, but it’s doing so on its own instead of dragging down the economy. Money is better spent on stimulating small business and creating jobs, rather than bailing out housing, and investors should be wary of betting it all on this fickle market. See the following article from Money Morning for more on this.

U.S. housing prices still have further to fall -perhaps a lot further.

In fact, depending upon the circumstances, the additional price declines could be quite steep.

But here’s the shocker: That decline won’t necessarily cause a “double-dip” recession.

In fact, it probably won’t even derail the U.S. economic recovery.

Let me explain.

Anatomy of a Housing-Market Decline

Early in 2010, it appeared that U.S. house prices had bottomed out and were beginning to recover. In April, however, the $8,000 subsidy to first-time buyers ended.

Since that time, house prices have resumed what seems an inexorable decline, which seems likely to continue considerably further. However even in that event, it is unlikely that housing’s new problems will do more than stem the overall U.S. economic recovery.

It is now clear that the George W. Bush economy of 2003-07 was a thoroughly unhealthy one. Artificially low interest rates courtesy of U.S. Federal Reserve chairmen Alan Greenspan and Ben S. Bernanke prevented the stock market from bottoming out properly after the 2000 bubble burst and inflated a huge housing bubble. That caused lots of “mal-investment” -to use the term beloved of Austrian School economists -in which houses were built far ahead of demand, and mortgage loans were created that should never have been allowed to exist.

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As a result, investment in truly productive enterprise was suppressed, and the country was forced to undergo a huge and painful recession as the “mal-investment” worked itself out. According to Austrian economists, a similar surge in “mal-investment” was responsible for the Great Depression of 1929-41. Following our experiences of the last couple of years, the credibility of this theory has increased considerably.

When the bubble burst, policymakers were extremely worried about the effect that the U.S. housing “bust” would have on balance sheets of big U.S. banks. So they invented ways for this “mal-investment” to continue. For instance:

  • Interest rates, already far too low, were pushed down even further.
  • First-time buyers were given $8,000 subsidies.
  • And various schemes -all of them expensive -were devised to prevent foreclosures.

The result: The U.S. housing market -like the U.S. stock market of 2003 -bottomed out prematurely, allowing home prices to start to recover in late 2009.

Our story doesn’t end there, however. Once the subsidies were removed in late April 2010, the market fell back.

Statistics bear this out. The Case-Shiller 20-city home price index dropped by 1% in September and by 1.3% in October. Indexes of mortgage applications fell to multi-year lows.

If you do the arithmetic, you can determine that U.S. house prices are still only at just about their average level in terms of incomes. In nominal terms, prices remain more than 40% above their January 2000 level, having almost kept up with consumer prices since that time.

But there’s still a key point to consider. If you look at this from an economic standpoint, January 2000 was not a recessionary period, but the top of a crazy boom. And that means that we can expect housing prices to fall even more -perhaps an additional 10% to 15%, or even more if interest rates back up a long way.

That sounds like a dire prediction, but it isn’t. Admittedly, you don’t want to own stock in Bank of America Corp. (NYSE: BAC), which acquired a huge portfolio of dodgy home loans when it bought Countrywide Financial Corp. in January 2008. If U.S. home prices were to drop an additional 10% to 15%, it would admittedly create a whole new batch of homeowners who are “underwater” on their mortgages, and tempt even more borrowers to default on their Bank of America home loans.

However, there is no law compelling you to own Bank of America stock. In the long run, the additional home-loan losses the bank is virtually certain to incur will very likely end up as a taxpayer problem. In fact, that’s equally true for any future loan losses that will be incurred by Fannie Mae and Freddie Mac, the home loan behemoths nationalized in 2008.

A Look Ahead

The important truth to remember is that -outside the housing market -the rest of the U.S. economy is now looking perkier. The Institute of Supply Management indices both rose more than expected in December, indicating that U.S. growth is picking up beyond its previously anemic pace in the 2% to 3% range. December job growth was robust -the first such report since the recession hit in 2007.

This is not a paradox. The heavy federal “stimulus” spending plans are winding down. Most were wasted, having been designed to provide subsidies for public-sector unions: Their demise frees up financial resources for the private sector -sort of a reversal of the so-called “crowding out” effect.

Now that the government has stopped trying to prop up housing, we can see that the less money that’s “mal-invested” in housing, the more that is available for productive investment -particularly for small businesses, which are the main engines for job growth in this country.

If taxpayers and the new Republican Congress are suitably mean with bailouts of housing-related disasters, this trend will continue. In the long run, a U.S. economy that devotes fewer resources to housing and state spending is a U.S. economy that can devote more resources to productive, job-producing uses.

Unfortunately, not everything is this rosy.

The over-creation of money by Fed Chairman Bernanke and his international counterparts has inflated a commodity-price bubble, which will almost certainly bring about inflation. What’s more, money spent on oil imports at more than $100 per barrel is also money that cannot be devoted to productive investment. Thus, further increases in the price of oil and other commodities could produce a second “dip” to the recession.

After that, the rising interest rates that are a virtual lock if inflation resurfaces will themselves depress home buying and other asset-heavy investments. However, the inflation itself will tend to support the prices of housing and reduce the real value of debt -both benign developments.

At the end of the day, what we find is that housing’s renewed decline is mostly a positive development.

It will cause problems, to be sure. But in the long run, it will produce a healthier economy with more jobs. And hopefully the whole experience will teach us that houses are not a one-way bet (meaning that prices don’t only increase -they can go down, as well). Thus, we should know better than to commit the bulk of our wealth to such an unproductive investment.

This article has been republished from Money Morning. You can also view this article at Money Morning, an investment news and analysis site.

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