Thursday, October 2, 2014

The Aggregate Demand Problem: Housing Edition

As QE3 comes to a close, home price increases dwindle while real estate lending remains dead and all-cash buyers head for the exits.  Homes remain overleveraged, keeping the market of current homeowners tethered down.

What might we expect to see?  How about this (HT: CR), from the New York Times: "Indians Join the Wave of Investors in Condos and Homes in the U.S."  According to the article, foreign buyers make up 7% of the market for US homes, and the number is up 35% in the past year.

This gives me some hope for the housing market.  The quantity of foreign buyers may not be large enough to make up the difference, though.  Homes probably need to appreciate at least another 10% to reach normal leverage levels.

I will take this as evidence in favor of my view of housing, in any case.

It may be true that wages have largely readjusted with the passage of time, despite substantial inflation.  However, with the zero lower bound, short term commercial investments still have to be funded with above-market interest rates, and homeowners are still living in homes with less equity than they expected to have, funded with mortgages that are being paid back in dollars worth more than they were expected to be worth.

Possibly, the natural short term interest rate is near zero, so that the commercial investment problem has also moderated with the passage of time.  But, the problems with home and mortgage values have not been fully solved.

What if our declining Federal deficit is pushing developing world savers from the Treasuries market into the housing market?  "Austerity" to the rescue!  If only we could have "austerity" and an aggressive central bank.


  1. TravisV here.

    In case you missed it, Prof. Sumner wrote the following:

    "I’m asked a lot about falling inflation expectations. At this point it looks like an aggregate supply thing—falling commodity prices. But we need to watch it closely, to look for confirmation in other markets like stocks."

  2. Amen, excellent blogging. I suspect US hits zero inflation ahead...the job figures were heartening but...seems like some stalling going on

  3. Thanks for the input, you two. Time will tell.

  4. The problem is that the Fed at this point is arguing about when to tighten. What if we are seeing the first stage before inflation? Is there any possibility that they would do another round of QE? I don't think they would unless things get really, really bad first. The downside risks right now are scaring me a little bit.

  5. Sorry - the first stage of deflation....

  6. This is a sign of hope:

  7. TravisV here.

    Excellent graph! Maybe I should buy Lennar!

  8. TravisV here.

    I haven't read these yet but these headlines give me pause. Gundlach is a smart guy.

    1. I think I did get ahead of myself with a bullish housing call. The Fed pulled back the reins too soon. Until there is some ray of light in the mortgage market, I am holding off on it. I agree with him that exposure to the investor market and rental markets is probably best right now. I still don't know where the chips will fall though.

      I was short on bonds, but I've pulled out of my position. The risks have become too skewed to the negative. The Fed's accommodative language was good to hear, but their lack of ability to act forcefully with liquidity if it is needed, and their tendency to see falling rates as a positive sign, make the downside very bad. It's a skew thing, though. I still see the economy continuing to improve in the most likely scenarios. But, if it does, housing will probably lag. Once homeowners deleverage enough to make a functional real estate market, though, I do still expect an unusual growth spurt, led by housing, late in the recovery cycle.

      Where do you stand?

  9. TravisV here.

    The question of the housing market is very complex, so I defer to the judgment of smart guys like you, Scott Grannis and Gundlach.

    More broadly, it looks like a huge negative demand shock is happening in Germany, while something in Asia (uncertainty about China's future economic leadership?) is creating another (smaller) negative demand shock. And yeah, in an effort to offset those shocks, vague Fed gestures that they'll keep rates low for really really really really really REALLY long aren't very effective. They need to commit to more aggressive forward targets (at least some are expressing concern about inflation breakevens, since those reflect market expectations of the future).

    Some U.S. stocks and high-quality multinationals have now dipped substantially so I'm looking to buy. The fact that domestic stocks like Hershey, Sysco and TJX have held up indicates that the U.S. hasn't reached emergency territory just yet.

    The Germans are stubborn so I'm inclined to wait on stuff like Irish / Spanish real estate right now.

    China / South Korea / Asia are falling off a cliff but they're more pragmatic so I'm looking for possible deals there too.

    Here are some equities / ETFs that happen to be on my radar screen at the moment:

    Bank of America
    Goldman Sachs
    Quanta Services
    Cummins Engines
    ExxonMobil (Buffett!)
    iShares South Korea (EWY)
    Posco Steel (Buffett / Munger / Mohnish Pabrai)
    Irish and Spanish REITs (Green REIT, Merlin Properties, Hispania Activos)

    Ford Motor and Sturm Ruger have also fallen a lot but I haven't studied them as much........