Why Housing, Market Drops Will Translate Into Recession

“Now the big question is: Will (the credit crunch) spill over into the broader economy?” This question comes from chief investment strategist Byron R. Wien in a New York Times story that details how the markets crashed over the last few weeks

My single word answer? YES.

Look, I don’t like being a purveyor of doom, but you can’t take billions and billions of dollars – soon to be trillions – out of the economy and not expect repercussions.

For those who don’t follow the economy closely, let me explain what has been happening:

Housing Mess – Lending
By now, most people know that something is wrong in the housing market, though it’s amazing to me how many people believe we’re near the bottom and proclaim it’s about to get better. (Fewer and fewer are doing so, though.)

That is just not the case. Things are about to get much, much worse.

Up to now, only the poor and lower middle class have been shut out of the housing market. Most subprime lending institutions are gone or have changed their business models.

Now lenders are making it incredibly difficult for the average guy to buy a home, reports the Los Angeles Times. Most lenders are seeking higher credit scores, more documentation and requiring borrowers to have at least six months-worth of mortgage payments in the bank before approving a sale. That means an additional $12,000-$18,000 in your checking or savings account on top of the 10-20 percent down payment of $40,000- $80,000 on a $400,000 house.

Buyers who need mortgages over $417,000, which is like every decent house in California, will have an even more difficult time, reports The New York Times. Lenders such as Countrywide are having trouble obtaining those huge sums at reasonable rates. Higher mortgage rates for the buyer means less likelihood of getting approved by the lender. Ergo, fewer buyers.

Less demand for high-end houses means sellers must lower prices.

Housing Mess – Foreclosures
In case you think that foreclosure wave is almost over, think again. This chart from Tradingmarkets.com really puts things into perspective:

Adjustable Mortgage Reset Rates
(in Billions)

Jan. 2007	$22
Feb.	25
March	35
April	37
May	36
June	42
July	43
Aug.	52
Sept.	58
Oct.	55
Nov.	52
Dec.	58
Jan. 2008	80
Feb.	88
March	110
April	92
May	76
June	75
July	50
Aug.	35
Sept.	26
Oct.	20
Nov.	15
Dec.	17

Do you see the problem? Consider what will happen from September until June 2008, when another $744 billion worth of loans reset. How many more Americans will walk away from their homes?

Housing Mess – Inventory

Up to now, many sellers have chosen to hold out for their price point, have been slow to cut prices, or keep their properties off the market. It’s not clear how many bank-owned properties have been kept off the market, but the potential numbers are huge.

Sooner or later, that will change and more homes will flood the market. John Doe may not need to sell today, but he may tomorrow, as economic conditions worsen. And sooner or later, cash-strapped institutions and investors will need to unload their inventory.

The Markets
Consider what has been happening in the financial markets: Intense volatility and a shortage of cash. Financial and lending institutions are facing bankruptcy or are being forced to merge.

I could go on this topic for another 1,000 words, but this is getting long: Several times buyers disappeared completely from the market, precipitating a 10 percent overall drop. The markets came back up after Europe and the United States pumped cash into the system through a variety of means.

Simply put: Somebody out there lost a LOT of money and now governments are printing cash to help the losers.

In one fashion or another, those losses will be passed down to you and me. It could come in the form of inflation, higher bank fees, less lending, government bailouts or a dramatic drop in pension values. No matter how you look at it, market problems are ALWAYS passed down to average Joes.

The Economy
I’ve read repeatedly that the economy is strong, unemployment is low and it really is separate from these other problems. These are the same people who told you the housing market couldn’t possibly crash.

Here’s what I see happening:

1. Families lose homes.
2. Spending drops on all things house-related: washing machines, dish washers, ovens, home furnishings, lawn service, new flooring, construction workers, exterminators, etc.
3. Home building and repair slows dramatically.
4. Work disappears for laborers, contractors, real estate agents and mortgage brokers.
5. These job losses do not show up in federal employment figures because these people are self-employed or illegal aliens.
6. Retail sales start slowing.
7. In the meantime, money disappears from financial markets. Losers include investors stuck with CDOs, lenders, pension funds, mutual funds and huge investment houses.
8. Some financial firms and lenders close or consolidate.
9. Consumer confidence drops.
10. Jobs start to disappear in the financial industry. While the numbers may not be high at first, many of these lost jobs are extremely high-paying. (This is where we are now.)
11. Home prices start to drop, decreasing the paper wealth of many Americans.
12. Consumer confidence continues to drop and spending slows more.
13. Retailers really start to feel the pinch.
14. Layoffs begin.
15. Foreign economies such as China see huge drop in orders. Economies slump.
16. European countries face similar problems as United States.
17. Financial market turmoil continues to worsen.
18. Housing situation worsens with more and more properties dumped on the market.
19. Downward cycle accelerates and repeats.
20. Full-blown recession.

It may not happen in that order – and I can’t give a precise timeline – but I believe an extremely difficult recession will begin late this year or early next. Please remember, I say this not as an expert, but layman. Then again, the experts predicted the housing market would surge indefinitely.

Comments

[Autumn]

Oh oh oh!! I know. I once heard the best way to help the economy is for the government to go to war...

oh... wait.

Seriously though, I feel little surprise as I read this, hear all this news on NPR, and think to myself... Brett was right all along, fancy that.

Now if only I had the money to buy a house on cash. *sigh* Next year would have been a perfect time.

[Nadine]

...2. # Spending drops on all things house-related:

Yes, that's already happening where we live. We put in an additional gutter downspout, and the fellow who did it said that he had two jobs in the last four months. Normal would have been over one hundred.

Also a brick mason dropped his quote price for some repairs by 50%.

[Johnny]

OH gosh..what a grim future. You got me thinking..

(1) Who is at fault?
(2) What can we do to protect our self-interests?
(3) 10 years down the line, what jobs can I get with a Masters Degree in Physics or Economics?
(4) reminds me of the 1920's

[brettdl]

Autumn: Hang in there a couple years and save your cash. Affordable housing might be on the way. (Unless the Prez and Fed tinker with the markets some more.)

Nadine: Note that people like your repairmen don't show up in official employmnet numbers.

Johnny: 1. Greedy bastards.

2. Maintain a very tight ship -- hopefully better than myself -- financially.

3. No problem in that department; 10 years from now a new boom cycle will probably be in effect.

4. Maybe, but maybe not. It's hard to tell until more market truths are revealed.

[Amanda]

My parents have been waiting to sell until this year and now they're really hesitant to even list... not that I'll pretend to even understand why although my father has tried to explain... is this a reason why than? Your post was clearly understandable.

[brett]

Thanks Amanda. I think a lot of Americans sensed the problem but were afraid to pull the trigger at the market's peak. Now people are wondering if they should sell or hold on.

We sold near the peak because we knew we didn't want to live in that house for 10-16 years, the amount of time we expected it to take for another peak to hit.

If your parents want to sell they should consider the state of their local market, whether they're willing to rent for a while until prices come down, the state of the market they want to move in, etc.

One thing that is hard to understand is that only a small percentage of homeowners are actually in trouble. But that small percentage has a HUGE effect on the overall market.

Whatever your parents choose, I wish them the best.

[jessie]

so, now i am terrified. we don't own... and were hoping to look sometime in the summer of '08 or maybe save money till summer of '09. I hope what you told Autumn will work out. Thank you for writing this (even though i am not sure how i will sleep tonight now that i understand better) uggggh.

[brettdl]

It is difficult. We so want to own again, too. But when you're messing around with huge price drops logic wins over emotion.

[Credit Expert]

It's all so true! I'm really wondering how the $700 million buyout is going to affect things.