Housing and the Economy

Over on the Barry Ritholtz Big Picture blog they have a piece from RAB Capital’s Dhaval Joshi that breaks down the housing overhang and the macro drag effect it could create for years. Worthy read.

There are two salient points I took away from this:

1. I may have to re-think my take on the Fed, specifically that they are trying earnestly to create inflation, but failing. Consider this bit:

A recent study by the Federal Reserve (The Depth of Negative Equity and Mortgage Default Decisions by Bhutta, Dokko and Shan) investigated the question: at what point do underwater homeowners “strategically default” on their mortgages? Surprisingly, it found that the average borrower doesn’t walk away from his home until negative equity reaches a very high level, -62%. But the fascinating thing was that there was something that could trigger underwater borrowers to default much, much earlier – and that something was an interest rate rise.

With a quarter of US mortgages underwater, and likely to stay that way for some time, the Fed must follow its own research if it wants to prevent a cascade of defaults. Hence, expect US interest rates to stay ultra low for an ultra long time.

That suggests they cannot allow any inflation, lest “a cascade of defaults” blow up the banking system they have worked so hard to save. If “extend and pray” really is the strategy here, rather than trying earnestly and failing, could it be the Fed are giving the appearance of trying but have no intention of succeeding? Perhaps that’s a bit Machiavellian, but think about it.

2. The chart showing a long term secular decline in household formation over the last 30 years is astonishing, to me at least. There is a good amount of information out there on demographic trends, the economy, and financial markets (aside from Harry Dent, who kind of scares me). I don’t have the time just now to go gather some up, but anyone can find it.

This suggests more than housing taking a very long time to recover. I’m a finance guy, not an economist, but it seems to me it would have forecast something like what we’re seeing today: weak aggregate demand, excess capacity, dis-inflation in a number of areas.

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