It's the economic collapse, stupid
From the Center for American Progress, 12/8/06.
ECONOMY
End of the Boom
Dark economic clouds are gathering ahead. After six years of booming home prices, the great American housing bubble has finally popped, and the market is now on the verge of collapse. Tens of millions of families who bought homes at bubble-inflated prices "now face the prospect of seeing their life savings disappear." This development will have wide-ranging effects on the American economy. "Over the last few years," writes Princeton economist and New York Times columnist Paul Krugman, "most good U.S. economic news has been the result of soaring home prices." With this engine of economic growth now broken down, America faces a potential future of "rapidly falling house prices, rising default and bankruptcy rates," lost jobs, fewer consumption, even a possible recession. The dark clouds ahead may be a perfect storm hitting the U.S. economy. (Read "The End of the Great American Housing Boom," a new report by American Progress Senior Economist Christian Weller.)THE GREAT AMERICAN HOUSING BOOM: Over the past decade, home prices in the U.S. have climbed to never-before-seen heights. Traditionally, home prices tended to rise at the same pace as rental costs (since both reflect the price of a roof over one's head). In 1975, the home price index was equal to 108 percent of the rent index. By 2000, the ratio of home prices to rents had jumped above 130 percent for the first time. By the beginning of 2006, the ratio of home prices to rents had grown to a whopping 178 percent. Similarly, home prices compared to other prices remained relatively stable until 1999, when the ratio of home prices to other prices surpassed all previous ratios and grew to 208 percent at the beginning of 2006. U.S. ECONOMY DEPENDENT ON THE BOOM: "The economic recovery since 2001 has been disappointing in many ways," Krugman writes, "but it wouldn't have happened at all" without the housing bubble. The boom spurred the economy directly by surging spending on home construction and renovation, which created jobs and poured cash into the economy. It fueled the economy indirectly by making it "easy for consumers to spend freely by borrowing against their rising home equity." Homeowners have been borrowing "more than $700 billion a year from the equity in their houses," and economists estimate that "annual consumption is approximately $250 billion (2 percent of GDP) higher than it would be in the absence of the housing bubble." This spending spree, bolstered as it was by home equity borrowing, had consequences: For the first time since the Great Depression, savings rates have fallen into negative territory. The average American is spending more than he or she earns.THE BUBBLE HAS POPPED: Nationwide, house prices are down between 4 percent and 5 percent from their levels at the same point in 2005, adjusted for inflation, and "price declines in some of the most over-valued areas, like Washington, DC, and parts of Florida and California, have been considerably sharper." The glut of unsold homes "is the highest since 1993 and the year-over-year price decline is the biggest since 1990." The health of the U.S. economy will be determined by the direction of home prices in the next year.PREDATORY LENDERS AND THEIR 'NEUTRON BOMB': Traditionally, mortgages have been low risk lending. That changed during the recent housing bubble, which was in large part driven by high-risk loans given to "subprime" lenders (people who have "troubled credit records or otherwise have difficulty obtaining a mortgage," disproportionately black and Hispanic Americans). For instance, option adjustable-rate mortgages (ARMs) "have soared in popularity" particularly among subprime borrowers, jumping from as little as 0.5 percent of all mortgages written in 2003 to at least 12.3 percent through early 2006, estimates show. (In some booming coastal housing markets, they represent up to 40 percent or more of loans.) Today, as these subprime loans come up for renewal and are reset to even higher interest rates, delinquencies and foreclosures are rising. "Most of the pain will be born by ordinary people," according to BusinessWeek. "And it's already happening. More than a fifth of option ARM loans in 2004 and 2005 are upside down -- meaning borrowers' homes are worth less than their debt. If home prices fall 10 percent, that number would double." Roughly $2 trillion in option ARMs come due in the next two years, about one-third of the $6 trillion U.S. mortgage market. The option ARM is "like the neutron bomb," says George McCarthy, a housing economist at New York's Ford Foundation. "It's going to kill all the people but leave the houses standing." Progressives have long warned against marketing these loans to a vulnerable subprime market. "Subprime lenders are fueling their business by aggressively marketing these risky home loans without considering whether families can truly afford them," according to the Center for Responsible Lending. WHAT A CRASH MEANS FOR THE ECONOMY: The downturn following the collapse of the housing bubble is "likely to be far more severe than the downturn from the stock bubble," says Dean Baker, co-director of the Center for Economic and Policy Research. Housing construction and sales directly account for more than 6 percent of GDP, and housing wealth "is far more evenly distributed than stock wealth." Declines in residential construction and housing related sectors will have a severe impact on the economy, and will be amplified by a decline in consumer spending. "With home prices falling, millions of homeowners will soon lose the ability to borrow against their homes," which have lost their value. That means less money spent on cars, travel, appliances, and other goods. "The economic picture over the next couple of years is likely to be one of rapidly falling house prices, rising default and bankruptcy rates, which will be associated with job loss and sharply higher unemployment." The problems don't end there. "Other critical sectors are not picking up the slack," Christian Weller writes. With the government mired in deficits, consumers running out of steam, and trade deficits at new record highs, "business investment must carry the economy forward. This will have to lead to job creation domestically, predominantly in the manufacturing sector, to be successful. This has not happened. Manufacturing employment also fell by a whopping 39,000 jobs in October." Paul Krugman says "the odds are very good — maybe 2 to 1," that the U.S. will teeter towards a recession in 2007. Renowned Morgan Stanley economist Steven Roach says the economy is "dangerously close to what we call stall speed. The odds of the U.S. economy tipping into recession are about 40 to 45 per cent." The Swiss Reinsurance Co., "one of the world’s foremost experts on risk," puts the chance of recession at 35 percent. And Dean Baker predicts "The Housing Crash Recession of 2007."
ECONOMY
End of the Boom
Dark economic clouds are gathering ahead. After six years of booming home prices, the great American housing bubble has finally popped, and the market is now on the verge of collapse. Tens of millions of families who bought homes at bubble-inflated prices "now face the prospect of seeing their life savings disappear." This development will have wide-ranging effects on the American economy. "Over the last few years," writes Princeton economist and New York Times columnist Paul Krugman, "most good U.S. economic news has been the result of soaring home prices." With this engine of economic growth now broken down, America faces a potential future of "rapidly falling house prices, rising default and bankruptcy rates," lost jobs, fewer consumption, even a possible recession. The dark clouds ahead may be a perfect storm hitting the U.S. economy. (Read "The End of the Great American Housing Boom," a new report by American Progress Senior Economist Christian Weller.)THE GREAT AMERICAN HOUSING BOOM: Over the past decade, home prices in the U.S. have climbed to never-before-seen heights. Traditionally, home prices tended to rise at the same pace as rental costs (since both reflect the price of a roof over one's head). In 1975, the home price index was equal to 108 percent of the rent index. By 2000, the ratio of home prices to rents had jumped above 130 percent for the first time. By the beginning of 2006, the ratio of home prices to rents had grown to a whopping 178 percent. Similarly, home prices compared to other prices remained relatively stable until 1999, when the ratio of home prices to other prices surpassed all previous ratios and grew to 208 percent at the beginning of 2006. U.S. ECONOMY DEPENDENT ON THE BOOM: "The economic recovery since 2001 has been disappointing in many ways," Krugman writes, "but it wouldn't have happened at all" without the housing bubble. The boom spurred the economy directly by surging spending on home construction and renovation, which created jobs and poured cash into the economy. It fueled the economy indirectly by making it "easy for consumers to spend freely by borrowing against their rising home equity." Homeowners have been borrowing "more than $700 billion a year from the equity in their houses," and economists estimate that "annual consumption is approximately $250 billion (2 percent of GDP) higher than it would be in the absence of the housing bubble." This spending spree, bolstered as it was by home equity borrowing, had consequences: For the first time since the Great Depression, savings rates have fallen into negative territory. The average American is spending more than he or she earns.THE BUBBLE HAS POPPED: Nationwide, house prices are down between 4 percent and 5 percent from their levels at the same point in 2005, adjusted for inflation, and "price declines in some of the most over-valued areas, like Washington, DC, and parts of Florida and California, have been considerably sharper." The glut of unsold homes "is the highest since 1993 and the year-over-year price decline is the biggest since 1990." The health of the U.S. economy will be determined by the direction of home prices in the next year.PREDATORY LENDERS AND THEIR 'NEUTRON BOMB': Traditionally, mortgages have been low risk lending. That changed during the recent housing bubble, which was in large part driven by high-risk loans given to "subprime" lenders (people who have "troubled credit records or otherwise have difficulty obtaining a mortgage," disproportionately black and Hispanic Americans). For instance, option adjustable-rate mortgages (ARMs) "have soared in popularity" particularly among subprime borrowers, jumping from as little as 0.5 percent of all mortgages written in 2003 to at least 12.3 percent through early 2006, estimates show. (In some booming coastal housing markets, they represent up to 40 percent or more of loans.) Today, as these subprime loans come up for renewal and are reset to even higher interest rates, delinquencies and foreclosures are rising. "Most of the pain will be born by ordinary people," according to BusinessWeek. "And it's already happening. More than a fifth of option ARM loans in 2004 and 2005 are upside down -- meaning borrowers' homes are worth less than their debt. If home prices fall 10 percent, that number would double." Roughly $2 trillion in option ARMs come due in the next two years, about one-third of the $6 trillion U.S. mortgage market. The option ARM is "like the neutron bomb," says George McCarthy, a housing economist at New York's Ford Foundation. "It's going to kill all the people but leave the houses standing." Progressives have long warned against marketing these loans to a vulnerable subprime market. "Subprime lenders are fueling their business by aggressively marketing these risky home loans without considering whether families can truly afford them," according to the Center for Responsible Lending. WHAT A CRASH MEANS FOR THE ECONOMY: The downturn following the collapse of the housing bubble is "likely to be far more severe than the downturn from the stock bubble," says Dean Baker, co-director of the Center for Economic and Policy Research. Housing construction and sales directly account for more than 6 percent of GDP, and housing wealth "is far more evenly distributed than stock wealth." Declines in residential construction and housing related sectors will have a severe impact on the economy, and will be amplified by a decline in consumer spending. "With home prices falling, millions of homeowners will soon lose the ability to borrow against their homes," which have lost their value. That means less money spent on cars, travel, appliances, and other goods. "The economic picture over the next couple of years is likely to be one of rapidly falling house prices, rising default and bankruptcy rates, which will be associated with job loss and sharply higher unemployment." The problems don't end there. "Other critical sectors are not picking up the slack," Christian Weller writes. With the government mired in deficits, consumers running out of steam, and trade deficits at new record highs, "business investment must carry the economy forward. This will have to lead to job creation domestically, predominantly in the manufacturing sector, to be successful. This has not happened. Manufacturing employment also fell by a whopping 39,000 jobs in October." Paul Krugman says "the odds are very good — maybe 2 to 1," that the U.S. will teeter towards a recession in 2007. Renowned Morgan Stanley economist Steven Roach says the economy is "dangerously close to what we call stall speed. The odds of the U.S. economy tipping into recession are about 40 to 45 per cent." The Swiss Reinsurance Co., "one of the world’s foremost experts on risk," puts the chance of recession at 35 percent. And Dean Baker predicts "The Housing Crash Recession of 2007."
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