Are Economists Too Optimistic on Housing’s Soft Landing?

A large part of our Slow-Motion Slow-Down thesis has been based on Real Estate — the prime engine of economic growth the past few years — grinding towards a much weaker posture.

This is notably different from what most economists see, as they are expecting a "soft landing" in the Housing market.

As previously mentioned, I do not see a Housing Bubble; rather, we have an extended asset class based on ultra low rates, and as those rates tick higher, the biggest housing boom in U.S.
history will end and then retrace.

The key question for the economy is "how bad will the aftermath be?" Most economists expect a "soft landing," a gradual decline that
won’t derail the the 5 year stimulus driven economic expansion.

A few data points to consider when contemplating Housing:

  1. Inventory is now at 9 year highs, having increased in many
    areas 75-150% over last year; That inventory issue is why the Home Builder’s Index is down 50%
    from recent highs;
  2. Home affordibility index is at 15 year lows, as rates AND price have moved higher during the past 36 months;
  3. Real Income gains have been negative or the past 5 quarters, challenging middle income buyers to afford new homes;
  4. Home ownership ticked up to record levels after Mortgage Rates dropped
    to 5.25%; There simply aren’t many new buyers coming into the market;
  5. Residential construction accounted for about 6.1% of the economy —
    close to a 50-year high; When that reverts tot he mean, it will take
    0.75-1% off of GDP; If (as I suspect) it swings past the mean, as these
    thngs tend to do, 1-3% of GDP can get lost;
  6. The NAHB Home Builders Index — a sentiment reading of builders — fell to a 15 year low last month;
  7. Mortgage Apps for new purchases are down 24% year over year; Refis are off 37% y/y; ARMS are still 42% of dollar volume;

Despite all of these facts, the Dismal set remains optimistic about a gradual slowing and a soft landing. What if they are wrong?

click for larger graphic

courtesy of WSJ

Here’s an excerpt from a columninm yesterday’s WSJ, As Data Point to Slowdown, Housing Market May Land Harder Than Economists Predict:

"But there is a good chance [Economists] are being too optimistic. The boom has depended heavily on the upbeat psychology of consumers, builders and lenders. As moods swing, the landing could be very hard indeed.

"We could be underestimating the dark side," says Mark Zandi, chief U.S. economist at Moody’s and among the first to seek to quantify the housing boom’s broader effects. "Euphoria could turn into abject pessimism very quickly."

With each passing data point, signs of the housing slowdown grow stronger. In June, total single-family-home sales fell 8.7% from a year earlier, to an annualized rate of 6.9 million — the sharpest year-to-year drop since April 1995.

The government’s report on second-quarter real gross domestic product, the inflation-adjusted value of the nation’s output, showed that fixed investment in housing by companies and individuals declined at an annual rate of 6.3% in the quarter. That was a sharp change from a year earlier, when it was increasing at an annual rate of 20%. As of Friday, futures markets were predicting about a 5% drop in house prices by May 2007.

Still, judging by most economists’ forecasts, the fallout from a slowing housing market doesn’t look all that unpleasant. Typically, they expect the decline in housing — and housing-related activity — to shave about a percentage point off inflation-adjusted GDP growth in 2007, compared with the estimated one percentage point the sector contributed to growth in 2005. If business investment and exports accelerate as expected, that would bring inflation-adjusted GDP growth to about 2.8% in 2007, down from a forecast 3.5% this year.

Economists, however, have few clues on which to base their predictions. Today’s housing boom differs radically from its predecessors. For one, it has been bigger and longer-lived. House prices are still more than twice the level of 1991, when the boom began. Even after the recent decline, June’s rate of home sales is 40% above the 20-year average."

How does this impact the rest of the economy? Consider how much the housing slowdown will affect consumers:

"If house prices plateau or fall, homeowners will feel poorer, and thus less willing to go out and buy more cars, boats and refrigerators. Typically, this "negative wealth effect" would be only about three to five cents of spending for each dollar of wealth lost.

But modern mortgage finance has magnified the effect of home values on spending, says Jan Hatzius, chief U.S. economist at Goldman Sachs in New York. He estimates that when people take cash out of their homes through home-equity loans and refinancings — which they were doing at an annualized rate of $558 billion in the first quarter — they tend to spend about 50 cents of every dollar. If house prices merely stabilize, people’s diminished ability to use their houses like automated-teller machines would subtract about 0.75 percentage point from annualized GDP growth in 2007, Mr. Hatzius says."

Ian Shepherdson, chief U.S. economist at consulting firm High Frequency Economics estimates that the decline in residential construction could subtract about 1.5 percentage points from annual GDP growth in each of the next two years. He thinks Real Estate is "a 15-year bubble unwinding in two years."  Net result? "It’s going to hurt."

See also the Sunday NYT article, titled: "The Houses That Wouldn’t Move."


As Data Point to Slowdown, Housing Market May Land Harder Than Economists Predict
WSJ, August 7, 2006; Page A2

The Houses That Wouldn’t Move
NYTimes, August 5, 2006

Ohio foreclosures on the rise
JIM SABIN, Aug. 3, 2006

California Mortgage Default Notices Soar 67%
20,752 homeowners in the state were warned last quarter. That’s still below the average.
David Streitfeld,
L.A. Times, August 3, 2006,1,824432.story

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What's been said:

Discussions found on the web:
  1. James Bednar commented on Aug 8

    It is Kahn’s banana all over again. There is no bubble, bubbles are scary. People panic during bubbles. Instead, we’ll replace bubble and crash with all manner of nonsensical analogy. Ships turning, soufles deflating, beautiful hot air balloons slowly gliding back down to Earth. Breath in, breath out. Ahh, that’s it, don’t you feel calmer already?

  2. tjofpa commented on Aug 8

    “Euphoria could turn into abject pessimism very quickly.” …
    Do u mean like the $TRAN dropping 4.5% from Friday’s open to Monday’s close? Take a look at the 5-yr on the $TRAN and tell me the run-up after Katrina spiked fuel prices wasn’t a hedge-hog induced short squeeze.
    If the shorts are all gone now, nothin but air under this baby until about, oh, say, 3800. … another 500 pts.

  3. Psy commented on Aug 8

    great stuff Barry

    I live in NY , my 2BR condo’s + 400% in 10 years…. the previous owner lost $$ after owning for 14 years after a conversion —- do we slow bleed ???
    question is , do we soft-land ? or implode ? …. how can we forecast with all the “prognosticators” out there ???

  4. PeterB commented on Aug 8

    The amazing thing is that the home builder stocks have been rallying in the face of all this “good” news. Of course, you can point to the easing in mortgage rates recently and the anticipated pause by the Fed as the underlying cause, but I’m dubious. There are just too many other factors pressing against the housing market to believe that interest rates are going to provide salvation.

    Indeed, the Spring and Summer selling season has been disasterous for all the home builders. And now that the looming prospect of recession is going to force the Fed to halt rate hikes, how can this be good news? A weak job market and recession are going to put even more pressure on the housing market. And inflation, meanwhile, continues to corrode what little remains of consumers buying power. It’s going to get a whole lot worse before it gets better.

  5. ss commented on Aug 8

    “As previously mentioned, I do not see a Housing Bubble; rather, we have an extended asset class based on ultra low rates, and as those rates tick higher, the biggest housing boom in U.S. history will end and then retrace. ”

    So let me get this straight…we DON’T have a housing bubble…just extended market. You are basing your gloom and doom stagflation argument on the backs of higher rates? OK…so what happens if rates don’t go up (as COT positions have bet)?

    Inquiring minds want to know!

  6. drsq commented on Aug 8

    Single women have bot alot of those homes. That is not sustainable incremental demand.

  7. Barry Ritholtz commented on Aug 8

    Cut rates to half century lows, and of ocurse Housing prices will skyrocket.

    What I ifnd so astounding is all the folks who missed the biggest bubble in human history have now become experts at spotting bubbles. That’s why we have a Bubble in Bubbles.

  8. Ned commented on Aug 8

    Ignoring the housing ATM (overdiscussed at this point), how much employment is based directly or indirectly on housing? I know several people who just recently became brokers…

  9. ss commented on Aug 8

    Yes, agree on bubbleheads Barry…but what happens to your outlook when/if rates don’t go higher…or decline?

  10. Craig commented on Aug 8

    Maybe Barry.

    If I offered you 1/2 the market rate right now would you buy RE NOW? Even with excellent rates RE will perhaps make it’s historic return of 4%, if you are lucky and don’t get a short haircut. Not a bet I would take in the current environment with inflated prices.

    You can make 5.25% in a FDIC insured MM account, why borrow, even at low rates, for questionable returns?

    I’ll bet a RE chart looks like a extreme ski run to the lower right corner.

  11. ss commented on Aug 8

    Since you don’t want to address my direct question…I will.

    This economy is much more resilliant than the cult of the bear has described for the last 6 years. Despite all the staglation armwaving, we will emerge from this like after every other “tipping point” item of the past — The demise of our economy makes “sensational” copy, and will be proved wrong again.

  12. lola commented on Aug 8

    My girlfriend just bought a new condo for 1.8m and put her house on the market-it sold in one day for 2.45m. She paid under 1m three years ago.

  13. vikram asrani commented on Aug 8

    While the decline may be evident at the macro level, I still don’t see any evidence of decline in my local area. Out here in the Bay Area, I still see several places where demand is still higher than supply. Houses being put out in the market for sale are still priced at 400-500 times what they would rent for. These prices are comparable or even higher than the quoted price 6 months back.

    Will these markets also experience a decline in the coming months ? If there is a decline at the macro level, will the local market also experience price drops ? Can any inferences be drawn at the micro level from data available at the macro level or would it be erroneous to make any such conclusions ? Also, while data is available at the macro level, is it possible to get accurate data for the local area ? (as in number of sales, median sale price, number of foreclosures, new number of mortgage apps, how many of the existing mortgages are ARMs). Do local government organizations track this information ?

  14. RW commented on Aug 8

    It seems difficult to get hard numbers on the ‘real’ sale prices of homes (contract price less incentives) but here’s one article, available at , that suggests real prices can be far lower than one might imagine, at least in previously red hot markets such as Florida. Here’s an excerpt on point:

    “Some builders are giving homes away just to get them off the books. How about a $490,000 home sold at $315,000. The contract read $490,000 top line, but within the contract are “builder’s incentives” of $275,000. Not sure how they get away with this, but they do.”

    I’m inclined to doubt this is anything close to typical nationwide but if this sort of ‘incentivizing’ is becoming widespread in markets markets previously hot enough to have attracted significant numbers of speculators, flippers, etc. then those markets are clearly doing much worse than reports based on contract prices would indicate.

    Personally I never thought a discount on a home could be so large or, more to the point, that it could fail to show up in the publicly reported contract price. If this is even close to typical in the new housing developments than home builders engaged in the relevant markets should probably be assumed to have a ‘real’ negative P/E.

  15. KirkH commented on Aug 8

    “I do not see a Housing Bubble; rather, we have an extended asset class”

    “I’m not fat, I’m big boned”
    Eric Cartman

  16. jkw commented on Aug 8

    As previously mentioned, I do not see a Housing Bubble; rather, we have an extended asset class based on ultra low rates, and as those rates tick higher, the biggest housing boom in U.S. history will end and then retrace.

    What is your definition of a bubble? Isn’t a bubble when an asset class is overvalued by a significant amount for a while and then the bubble pops leading to a retracement back to normal values? So if housing is overvalued by more than 50% and you expect it to come back down to fundamental levels, how is it not a bubble?

  17. ac commented on Aug 8

    While I agree with most everything posted on this site, I couldn’t disagree more with the suggestion that “this is not a housing bubble”.

    We’ve had a huge increase in demand and prices for homes due to rampant speculation and the resulting market euphoria.

    I would define a “speculative bubble” as something driven primarly by psychological forces. Yes low interest rates and liquidity were enabling factors, but if you’ve know people who own and are (were) buying houses, and you’ve seen that insane gleam in their eyes as they babble on about their investment genius and future riches, you know you’re dealing with a classic speculative bubble… at least as I’ve seen it defined.

  18. adam commented on Aug 8

    As soon as the Bank of England paused, home prices started to RISE again. The bank recently resumed tightening, in part to nip this trend in the bud.

  19. sw commented on Aug 8

    I see why BR is reluctant to call it a bubble. In order to get back to trend, real estate would have to fall about 50% in real terms. The NASDAQ took less than 3 years to unwind from its peak, the housing “bubble” is going to take a lot longer than that. If it doesn’t “pop”, is it a bubble?

  20. jkw commented on Aug 8

    The best measure of the proper value of housing is wage levels. House prices have maintained a relatively constant ratio to wages for long periods of time, with occasional deviations up or down. Wage growth has been very small for the past 6 years. Which means that all the housing gains since then have been temporary or that wages are about to double or triple. Housing falling by 50% or wages doubling would cause serious problems for the economy. The housing bubble will cause a depression. The only question is whether it will be inflationary (wages go up) or deflationary (houses go down).

    There is no soft-landing scenario because the US economy is too far off-balance. Wage inflation has to exceed general inflation for an economy to be stable. That way productivity growth can lead to higher standards of living. The alternative is wealth concentration, which can only go on for so long before the economy falls apart due to a lack of a consumer class. Having the fed target wage inflation is a recipe for disaster in the long-run. And the long-run isn’t very far off any more.

  21. Bob A commented on Aug 8

    Some markets still show no signs of slowing, like Seattle area, which seems to be based on strong local employment situation and relative value compared to California. Seattle Times shows a home today listed for around $500k that had five offers and sold for around $600k.

  22. wcw commented on Aug 8

    $600k just doesn’t impress a guy who lives in a two-bedroom apartment that, were it a condo rather than a rental, would sell for 30% more.

    In re: inventory, if you believe the Current Population Survey numbers (I do), then we are not at 9-year highs, we are at 40-year highs. Cf

    As you can see, I like the souffle analogy. That’s because if you look at the price history, residential housing does not like to show nominal declines.

  23. Dan B commented on Aug 12

    The real estate bubble is real and is just starting to implode. The reason for the implosion is pure and simple: most people just cannot afford to buy these homes. The will of the buyer to buy these homes at these prices is gone forever. I have been a REInvestor for some time. In August 2005, I sold all my properties. At the time, many amateurs were buying. Like buying the NAZDAQ in March 2000.

    Consider that 70 year old 2500 sq. ft. homes in Long Island, NY are selling depending on the neighboorhood for $500,000 to $1 million. Property taxes $12,000 to $18,000. Add commuting and utilities of another $1200 to $1500 per month. How may people can afford these homes?? Where are young people just starting out supposed to buy a home??

    This bubble caused by insane lending practices, not by the accumulation of wealth. Adjustable mortgages will adjust and cause massive and record foreclosures. Already started.

    Robert Shiller, Yale PHD who predicted tech wreck is predicting same for RE. He sees 50% decline in high areas.

    Nouriel Roubini, PHD NYU is predicting severe recession starting in 1st Q of 2007, which will be caused by housing collapse among other things. I think they are both correct.

    In Florida, investors who got in late are dead. They are even having trouble renting because of massive overbuilding. The ones who can rent are way upside down on carrying costs.

    This bubble will implode and take economy and market down with it.

    Mr Ritholz, I believe your cult of the bear is correct. Housing collapse will take everything down!!!!!

  24. Naminoriyaro commented on Aug 18

    RE apologists and agents are quick to point out that sales have only slowed to levels of 2002 or 2003, which were good years. What they fail to mention is the other side of the economic coin, supply. Inventories in most major metro areas are at all time highs (see Phoenix numbers here at

    Just like the tech sector in 2001, the housing bubble will also follow economic laws and oversupply will force down prices and deflate the bubble.

  25. CS commented on Aug 25


    An almost perfect storm was created a number of years ago by the following occurrences: mortgage backed securities that spread capital risk to more participants (as opposed to savings and loans and banks assuming the risk) that resulted in huge capital flows for more mortgages, much more aggressive lending (higher l/vs, i only products, home equity loans, sub-prime lending); increased capital flows to public homebuilders, an otherwise overlooked industry prior to 2001 that was perpetuated by the Wall Street “expert” analysts who were until recently, making buy recommendations to most of the industry – these homebuilders then had to fulfill those expectations by going on drunken land binges that pushed those prices to astronomical levels and that doubled their supply; the ability for the average consumer, including all walks of life (including those with prior bankruptcies!), being able to use the wonderful concept of leverage (and commit mortgage fraud right and left); and an increasingly stronger national economy.

    The obvious result – higher home prices and extraordinary (and not sustainable) appreciation rates. No market or small town could escape this result.

    What’s the bottom? An example might be California during the early to mid 1990s; the demise of the savings and loan industry (drying up any sort of capital for any form of real estate), defense job losses of 500,000, a national recession, huge Japanese real estate investment (the “smart” money), lingering effects of riots and earthquakes, the Gulf War, (to name just a few) all resulted in the market coming to a virtual standstill in 1991. All the price gains prior to 1991 were wiped out, and for many areas of So. Cal for example, the price recovery period took over 6 years. The classic bid-ask spread existed for some time, until market forces acknowledged the inevitable. During that situation and between 1991 and 1995, a 20 to 40 per cent decline occured from pre-1991 levels (price declines correlated to overall housing prices).

    Those issues that resulted in decreased prices in So. Cal. don’t exist in this environment. Nonetheless, the existing situation is troubling at the least. A 10 to 25 per cent decline based on what has occurred in this “bull” market would not be illogical. Giving back the extraordinary appreciation rates over the past few years could justifiably occur.

    In any event, don’t forget that the housing market does not react fast; the downturn, realignment and inventory issues (new and resale/existing) will take several years (depending on specific market factors) to resolve.

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