By Rick Ackerman | 23 September 2007
We’re convinced that no amount of monetary stimulus can revive the real estate boom at this point, even if the Fed seems determined to try. But suppose we’re wrong and home prices take off again? Does anyone actually believe that that would lead the economy back to health? Of course not (Larry Kudlow aside). It would simply postpone a debt deflation that by now has become as likely as…the next recession. Keep in mind that when the Fed eased aggressively following the 9/11 attack, it required "only" about $2.70 of new borrowing to create a dollar’s worth of GDP growth. These days, though, the figure is even worse— far worse— and has been running well above $8.00.
What this suggests is that the task of getting consumers to aggressively ramp up the spending of borrowed money on big-ticket items is going to prove well nigh impossible. While the indefatigable and globally indispensable American shopper can never be completely counted out, it strains the imagination to think that he will be able to outrun the economic avalanche that has been gathering destructive momentum in the housing sector these last few months.
Even so, as counterpoint we offer another possible scenario from a friend of ours, John D., whose observations have been featured here before. John is in the commercial construction business in Southern California, and it never fails to astound us whenever we hear from him about how strong the industry has been, and continues to be, notwithstanding the collapse in residential building that has already occurred. John is not exactly an optimist, not by any stretch, but his forecast does leave a bit more room for an escape than ours:
- A False Spring
"I don't believe a ‘housing boom’ is about to start," he writes, "but just enough good news to make people think the worst is over and that the price deflation is, or almost is, done. In California in the late 80's early 90's the housing recession was very nasty. I watched a house I bought for $265k go ‘up’ in value in a year and a half to $350k, only to be worth about 220k or less after the Northridge quake and everyone left town. I agree with you that we may one day see the Aspen [ski] house with no value, and the ultimate decline in price will make the 90's look like nothing.
"[But] there has yet to be a decline in commercial and industrial real-estate. The signs are out there, but vacancy rates are still very low in our area and the ‘For Lease’ signs are not on every corner. Lease rates for office and light industrial are still are at a premium. In the early to mid 90's it was cheaper to buy an existing building then it was to build a new one. We still have a ways to go before we get there, though I realize the climate can change overnight in the leveraged world we live in.
Getting Out Now
"My family, through a trust my dad set up, owns some mid-sized buildings in East Los Angeles, all three in the 30k square-foot range. We are in the process of trying to sell the buildings now, while prices are still high and there are still buyers, we just need things to hold together for a little while longer. One advantage is that we owe nothing on the buildings; they were all bought with cash in the 1990's. At the same time, there is no problem leasing the buildings to quality tenants.
"[The information you sent me] confirms a lot of what I already am seeing and do believe is ahead of us. I was reading another ‘deflationist’ (Tim Wood) who puts out a newsletter, and in his September issuer he sees a ‘perfect storm’ (my words, not his) coming. He has housing topping first and then commodities. He says commodities are the key, as reckoned by the CRB index. He is looking for the index to drop below its January 2007 low. If it does, then deflation is here; if it does not, and commodities continue to inflate, then the markets may continue to rise for a time.
Not Enough Euphoria
"It seems to me that if the Fed successfully inflates assets, then we are moving into an incredible blow-off top that has never been seen. [[1928 - 1929 redux?: normxxx]] With all the euphoria over the 50-basis-point cut, it finally does seem like we are going to be seeing fewer doom-and-gloomers on CNBC. Everyone is going to be talking about their 401k profits in a few months— especially when the Dow hits your 15k target. Up until now there has not been enough euphoria, only caution everywhere you turn. It is going to take one more run-up to get us to the top.
"I'll bet we start to hear about a housing turnaround within the next month or two, with sales and closings up, etc. All the jobs we have bid and which the owners have been holding back will probably go forward, and we will enjoy one last money making year. Everyone from business to the consumer is going to be leveraged to the hilt. Gold, silver, and the Dow will be at record highs, and then boom!! Nobody will know what hit them. I think it is time to sit on the sidelines, or to enjoy the final ride up and then watch out!
"It will be perfect. Hilary will be entering the White House and the people will be crying for socialistic government solutions! GWB and the do-nothing Republicans will be blamed, and the Clintons will be able to be the next Hugo Chavez's of the world. (How depressing!). It's the American people’s fault. We just can't help ourselves. We must consume and spend— that's the way we were raised. We live in interesting times, for sure."
Normxxx
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