Zeev's Turnips Patch-No Politics (ZEEV)

[Culmus]

Zeev, re housing market and consumer debt

I have been looking into precisely these matters last year, if I may add some comments to the discussion:

Household debt service has indeed reached a close to record high again during the third quarter last year at 14.0% of disposable income, though it was down from the record high of 14.39% during 2001Q4:

http://www.angelfire.com/indie/culmus/Household_Debt_Service_Burden.pdf

The previous record high was at 14.38% (ggg) during 1986Q4. There is no reliable data available prior to 1980. The debt service burden of private households reached a record for mortgage debt during 2001Q4, while consumer debt service at 7.8% of disposable income currently is indeed below the previous record of 8.5%, reached also in 1986Q4.

I believe the single most important point to ponder in this discussion is the fact that interest rates are vastly lower compared to the last time debt service was at such an elevated level. Looking at the picture in the context of interest rates now and then:

http://www.angelfire.com/indie/culmus/Household_Debt_Service_Burden_and_interest_rates.pdf

Ooops, I realize I forgot to translate that one (g). Same graph as above, total debt service in pink, consumer debt service in green, mortgage debt service in in blue and the interest rate of 10-year treasury securities with constant maturity in red.

IMO this shows that the impact of any notieceable rate hike will have a disproportionately negative impact on private consumption as the debt service burden will increase sharply.

As mlsoft rightly pointed out, even as interest rates are at record lows the number of private bankruptcies reached a record 1.5 million during 2002:

http://www.angelfire.com/indie/culmus/Household_Debt_Service_and_insolvencies_2002Q4.pdf

The same goes for credit and debit card charge-offs of banks and their reserves for bad debt.

In my personal opinion the US economy is living on borrowed time as the strong housing market is keeping the consumer afloat, for the moment. But there is underlying weakness, portending economic distress once this housing boom runs out of steam. Just look at the sharply lower equity stake in household real estate taken from the Flow of Funds accounts:

http://www.angelfire.com/indie/culmus/Owners_Equity_of_Household_Real_Estate.pdf

Households' equity in real estate is down from around 70% in the early Eighties to around 57% now, all this while household real estate ownership has reached a new record level.

This, of course, is due to refinancing activities which have been extremely high during the last one and half years. The majority of households have increased their mortage when refinancing and many used the proceeds to improve on their homes:

http://www.angelfire.com/indie/culmus/Housing_Market_-_Mortgage_and_Refinancing_Activity_MBAA_200210...

But cash-out refinancings also have reached record levels, which has boosted private consumption, especially during 2001 and 2002:

http://www.angelfire.com/indie/culmus/Housing_-_Cash-out_Chart_TSC_20020926.jpg

I agree that all this does not pose a problem as long as home prices continue to increase and as long as inflation remains low. However, this should not be expected indefinately.

That the situation does not further improve but rather starts to deteriorate is evidenced by record high vacancy rates:

http://www.census.gov/hhes/www/housing/hvs/q402tab1.html

Note, vacancy rates now are much higher than they were at the end of the Eighties after the savings and loan debacle. While home prices continue to rise and construction continues to boom due to record low interest rates the rising vacancy rate indicates that it makes less and less economic sense to build homes intended for rent. Probably the most telling aspect of all this is evidenced by the following graph:

http://www.angelfire.com/indie/culmus/Housing_-_Home_Prices_-_CPI_-_Rents_200301.pdf

Home prices have been increasing a lot faster than both, the CPI and owner's equivalent rents as shown with the indexed comparison posted above. It is the same discrepancy that preceeded the slowdown in the real estate market after 1988. Mind you, for a profound (negative) impact of the housing market on the economy we don't need a bursting real estate bubble. If prices do just stop to increase at their current rates it will put a noticeable damper on private consumption. This happend from 1989 to 1994 and we had a recession in between. According to the housing association the real estate market comprises about 20% of the economy, if that slows down a lot of the forces keeping the economy afloat right now will dissipate.

If interest rates should increase just 2 percentage points the debt service will hit the consumer quite hard.

The next consumer led recession resulting from rising inflation and hence followed by interest rate hikes could turn into a rather nasty one. IMVHO.

Regards,

Culmus

ps. Thanks for all the work you are doing here. ggg