US housing market

The next bubble to burst?

ET July 28, 2005
WASHINGTON - Average U.S. interest rates on 30- and 15-year mortgages inched upward for a fourth straight week, rising to their highest level since May, mortgage finance company Freddie Mac said on Thursday.

http://library.hsh.com/?row_id=92

http://msnbc.msn.com/id/7148582/

I do not think a burst is in order. I believe a slow down may come after a year or so. But I do believe the low interest rates is exactly what add fuel to the housing market boom!

NEW YORK --For the past several years, U.S. consumers have been
famously treating their homes like giant ATM machines.
By extracting home equity through borrowing, cash-out refinancing and
capital gains on home sales, they have been doing their part to keep
consumption moving along.
But amid signs that house price gains may be peaking, which some see as a
precursor to a wider slowdown in the housing market, those times may be
coming to an end - and that may be felt in the economy in a major way.
Households can spend the wealth accumulating in their homes in several ways:
Refinancing is one channel, selling the home is another. Homeowners can also
borrow up to the maximum limit on their credit cards and spend money that
way, on the presumption the debt will be offset by appreciation in their
homes. Or they can simply not save a dime and spend all their income.
The spending of those funds is what shows up in gross domestic product.
According to Lehman Brothers economist Joseph Abate, these various forms of
home equity extraction have been responsible for 40% of GDP growth since
2001.
The economy "has become so dependent" on these various forms of spending
that the effect could be quite pronounced on GDP growth when strong home
price appreciation and housing turnover (the rate of sales) slows, he said.

This is a bubble waiting to burst. Since 2000 the value of US residential property has risen by $6.5 trillion and consumer debt has correspondingly risen by $4 trillion. The US homeowner today has considerably less equity in his home than he had 5 years ago in spite of rising property prices. This is largely as a result of refinancing to withdraw the equity appreciation to spend on consumer goods and services. At the same time the Fed is committed to continuing the serial increase in interest rates at a 'measured pace' for the forseeable future. It seems unlikely that they will pause until rates have reached 4.0 - 4.5%.

Why are they continuing to raise rates ? Greenspan says that their prime objective is to restrain inflation yet if you look at the accompanying Fed statements they are constantly stating that inflation remains under control. The biggest inflationary threat comes from rising oil prices but hiking the domestic interest rate will have zero affect upon that.

It seems evident that the real motive behind continuing rate hikes is the housing bubble. Greenspan denies that there is a bubble and talks just about "froth" in certain areas such as Florida and California. However the Fed is concerned that what they call "froth" is either already a bubble or on the verge of being a bubble. Don't forget that the way that Greenspan dealt with the collapse of the dotcom stock bubble was by lowering interest rates to prevent a recession. This in turn led to the housing bubble which was stimulated by ultra low interest rates. Greenspan does not want to see the housing bubble burst with severe consequences for the US economy. Therefore, with the example of both Australia and the UK as an indicator, he is now increasing interest rates with the intention of trying to engineer a soft landing for US house prices. Will this succeed ?

The level of personal savings in Australia and the UK are not high but they are astronomic in comparison with the US. The level of personal debt in Australia and the UK gives rise to concern but is comparatively insignificant when compared to US personal debt levels. The US economic recovery over the past four years has been predicated entirely by a vast stimulus to consumer spending engineered by interest rates that were reduced to 1% and this has produced a housing bubble and an unprecedented trade deficit as consumer s were primed to spend, spend, spend the economy out of a potential recession.

The chickens are now begining to come home to roost and Greenspan knows it. He has 6 months of his tenure remaining as Fed Chairman and he is determined to ensure that the bubble wont burst and herald a recession on his watch. So he will continue to hike the interest rate by 25 pts each month for the remainder of his time in office hoping that this will result in both a slow down in house price increases, rather than a property crash, and also prevent a run on the dollar (which would be inflationary with all of those cheap imports) which will be contained by further treasury bond sales at more attractive interest rates. In the meantime the trade deficit will continue to expand especially as oil prices continue to increase.

The denouement will almost certainly be next year after Greenspan has left office and his successor will be left holding the can. Rising interest rates will act as a break on house prices and there is a real danger that the property bubble will burst will the consequential affect on consumer spending. Ultimately the only way that the US can tackle their trade deficit is through a combination of lower consumer spending (fewer imports) and a strong currency (to continue to attract foreign capital to fund both the trade and fiscal deficits).

The US markets will fall as a result of this - maybe by as much as 15% to 20%. The question is when. This might start with the Dow back down to 10000 this year but the real decline is most likely to occur next year when Greenspan is sunbathing in his Florida retirement home.