Could Adjusting the U.S Housing Market Strengthen the U.S Economy in 2017?
A prominent California based real estate consulting firm, Rosen Consulting Group, believes that homeowners can strengthen the U.S. economy. The prescription is simple, but as explained below, it is also flawed. The idea is that the U.S. housing market in 2017 could revive the stagnant U.S. economic growth rate. (Source: “Fixing housing could bring $300 billion back to US economy, new data show,” CNBC, March 27, 2017.)
Rosen clearly hopes for an optimistic real estate market forecast in 2017. The basic premise for the optimism is that the United States has struggled to grow since the Great Recession began because the housing market has dropped to a fifty-year low. Could this be a valid prescription then? The short answer: no.
The number of U.S. households increased by 7.5 million in the decade from 2006 to 2016. Yet, there were almost a million more homeowners in 2006. (Source: Ibid.) Thus, an elegant solution to the slump in gross domestic product (GDP) would be to prompt a housing market adjustment in favor of more home ownership.
Rosen believes that if Americans bought more houses, it could generate some $300.0 billion or 1.8% to economic growth. Indeed, he suggests boosting home ownership could be the single most effective way to speed up the U.S. economy in 2017. (Source: Ibid.).
As logical as that sounds, the argument that more home sales can boost the economy turns logic on its head. The U.S. housing market has suffered because of a stagnant economy, not the other way around. Thus, Americans are buying fewer homes because they can’t afford to do so. Moreover, the banks, despite the bailout, have been tightening credit to prevent another subprime bubble, as happened in 2006 and 2007.
In doing so, the prescription implies, banks have been facilitating mortgages and keeping interest rates low. Easing the restrictions imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act, which limits their speculating activities, would be another part. All that is great, but the reasons why people—and presumably this implies young people—aren’t buying are clear.
First Comes Economic Growth Then Optimism and Mortgages
Even discounting the fact that first comes economic growth and optimism, and then come the signed mortgages, there are clear reasons why housing sales are stagnating. All the evidence you need is the U.S. housing price index. The index shows that house prices reached a 31-month high last January, rising almost six percent. (Source: “U.S. Home Prices Rise to the Highest Level in Over Two Years,” Business Insider, March 28, 2017.)
Now, consider that the Federal Reserve has recently increased rates by a quarter point. It doesn’t look like much at first, but the Fed might raise rates three more times in 2017 alone. It would be premature to believe that the effects of the rate hike on demand for mortgage loans are negligible. That’s what the housing market bulls are recommending.
A U.S housing market analysis shows that demand for homes and rising prices have depended on a tight supply and demand based on low interest rates. (Source: Ibid.) But house prices have been rising much faster than wages, worldwide, not just in the United States.
This discourages current homeowners to “move on up” as a popular 1970’s sitcom celebrated. It also prevents younger people who are joining the workforce, the so-called Millennials, to even consider buying a house. In fact, some 40% of them live with their parents. Stuck with ridiculous salaries—with few exceptions—millennials are already too worried about paying for the basics and their student loans.
It might be true that more housing sales stimulate an economic recovery of sorts. New homes require new appliances, new furniture, new TV cable subscriptions, new roads, and so on. (Source: Ibid, CNBC.) But if aggregate housing demand is hampered by tight mortgage rules and ever higher prices, then the growth multiplier effect is zero.
Growth Through Housing Market Idea Falls Flat
Thus, the economic growth through housing market proposition falls flat. It’s the other way around. Economics often operates beyond the realm of statistics, which more often reflect rather than influence reality. Now, a healthy GDP can eventually encourage financial institutions to take more risks by lending—without requiring a regulatory boost.
But, more often than not, economic sentiment based on the experiences of the actual workers and would-be consumers and homeowners themselves, is a better guide. A steadier and better distributed economic recovery—that is not just one that favors Wall Street.
Thus, the current prospects for economic growth, and even higher chances of economic collapse, the housing market may already have overinflated. It could bust before it could bloom. The entire housing market discussion has to be relegated to one about overall economic growth. Some, might think that Trump policies have already started to work.
Indeed, the stock market has certainly taken a positive stance on Trump. The Dow Jones Index has hit record highs. Even as it has dropped from its all-time record of over 21,000, it remains comfortably around the 21,000 level. The government has not had a chance to adopt any Trump policies yet. Some of these have fallen flat.
Trump had to repeal his plan to replace Obamacare. Meanwhile, the markets have moved on pure assumption. Trump’s policies, his proposed tax cuts and easing of regulatory restrictions are intended to increase demand. But so far, there’s no evidence of actual growth in the real economy. That’s what needs incentives.
U.S economic growth in the fourth quarter of 2016 did increase. But it increased only by a very small margin—2.1% from October to December 2016. Rather than optimism, the small margin of growth is so small as to prove that economic growth last year was among the weakest in the past five years.
Over the whole of 2016, growth averaged 1.6%, a full percentage point lower than the 2.6% growth rate of 2015. Meanwhile, if advocates of the housing market as an engine insist, they could wait. Real estate prices have risen thanks to the side effect of low interest rates on mortgages over the past ten years. The change of policy at the Federal Reserve favoring higher interest, therefore, could curb demand rather quickly and sharply.
The protracted policy of low interest rates has led to a strong appreciation of the real estate sector. Not only has this come without a corresponding increase in GDP, but in the event of a black swan event, a shock, it could crash and destabilize the entire financial system again. In the 2007 and 2008 crisis, it was the banks that took the big risks.
The Mortgage Rates Are Going Higher
In the United States, the sensitivity between residential real estate and the level of interest rates has always been very strong. Low rates have increased the number of owners. Even those who never dreamed of owning, got mortgages. This impacted the new and old real estate market.
But, while U.S. banks relaxed access to mortgage credit to extend access to property for all Americans. These high-risk mortgages had a built-in trick. Low interest lured homebuyers, but rates quickly rose beyond what these new “owners” could make for their monthly payments.
These enormous injections of liquidity boosted the equity, mortgage, and real estate markets between 2002 and 2007. But, they also generated the conditions for the subprime burst, the Lehman Brothers Holdings Inc. crack and the Great Recession. In order to boost the housing market now, the banks should adopt similar policies, putting the whole system at risk again. Instead, mortgage rates will go higher.
But, as banks often do, they pass on those risks to consumers. In 2009, despite their having engaged in the sort of reckless behavior they are so quick to point out about consumers through credit scores, they got a nice bailout. The bankers on Wall Street and the City in London did not go without a bonus.
To be clear, the problem isn’t so much the housing sector itself. It’s the weakness of the entire economic system; housing is just a byproduct. A major economic shock would force real estate prices to crash, leading to significant losses for indebted owners. They risk having to pay off mortgages that are worth more than the value of their houses.
Then there’s the problem of foreign investment in the United States, particularly from China. The higher interest rates and expectations of the dollar rising encourage capital flight from China. Foreign, especially American, real estate is a favored haven for Chinese people in search of higher returns as their economy slows down.
That might be good on paper. In reality, the higher interest rates add to the inflationary trend of real estate prices, by driving up demand from abroad. Higher rates will add even more headwinds in the face of job creation, the main factor affecting growth. The recent job creation numbers and U.S. economic outlook for 2017 are not optimistic.
Exports have fallen more than expected after a fluke 10% increase in the third quarter of 2016, boosted by unusual soybean sales due to drought in other producing countries. But this trend is destined to worsen. President Trump appears determined to impose higher import tariffs across the board.
Trump should expect retaliation from the U.S.’s main trading partners, Europe, China, and Japan. In 2017 the U.S. government would like to speed up GDP growth, but the politics that same government is pursuing don’t match with the intent.
For much of 2016, Fed Chair Janet Yellen was reluctant to raise interest rates. She feared provoking an economic recession and a correction of the financial and real estate markets. Yellen was unable to hold back much longer, she was under pressure to raise rates. Thus, she has finally taken that risky step into the abyss.
The risk now is that if she doesn’t continue to raise rates, the market sentiment will react negatively. The feeling will be that the U.S. economy is too weak to sustain higher rates. Vice-versa, higher interest will put an additional obstacle before the housing market. Only sustained economic growth can help.