All Fingers Point to Housing

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The loudest debate in financial circles these days is why the recovery is so slow.

It's also one of the easiest to answer: We had a housing bubble. It burst. The end.

A Federal Reserve study last year concluded that the plunge in housing construction and the knock-on effects from the industries it supports is responsible for about half of all jobs lost since 2007. A new paper (PDF file, Adobe Acrobat required) by a group of private economists looked at housing's impact on the recovery and found about the same. "More than half the underperformance in this recovery is associated with housing-related sectors," they wrote.

About that underperformance: Ten quarters after the end of most recessions, gross domestic product rebounds an average of 11.5%. After a deep recession, the average recovery is 13.4%. Since our latest recession officially ended in 2009, GDP has increased just 6.2%.

Of that shortfall, the authors found that more than half is directly tied to four sectors either entirely or mostly driven by housing: residential investment, housing services, local governments (influenced heavily by property taxes), and consumer durables.

It usually doesn't work this way. Ten quarters after most deep recessions, residential investment rebounds over 60%. This time around, it's declined. Housing services usually jump 7%. This time, they've inched up 1%. Local governments usually rebound 4%. Since 2009, they've declined over 5%. "In every previous post-war business cycle," the authors write, "home construction has had a V-shaped collapse and recovery; by contrast, the current cycle looks L-shaped."

It comes down to this: After most recessions, consumers buy homes and furnish those homes, causing consumption -- and debt -- to rise. Since this recession was caused by too much debt, and consumers have been getting rid of that debt, household liabilities are falling. Plunging, actually:

Sources: Federal Reserve and author's calculations.

This is good long-term. Deleveraging makes consumers more stable, and washes away the sickness that caused the recession in the first place. But in the short term, it makes the recovery menacingly slow. Money that used to be spent on goods that stimulated the economy is now used to pay off debt, and money banks once used to make more loans is now used to cover losses on defaulted debt.

Now here's where the report gets interesting. The authors broke up states into two categories: Those where home prices suffered a high decline (Arizona, California, Florida, etc.), and those where home prices escaped with a fairly low decline (Alaska, North Dakota, Texas, etc.). Then they looked at how each has fared over the last few years.

The results were unmistakable. States where housing collapsed are doing miserably, while states where declines were moderate are doing well.

Remodeling permits in high-decline states are down over a quarter since 2006. In low-decline states, they're up over 20%. Auto sales in high-decline states are down roughly 40% since 2006. In low-decline states, they're off a mere 10%.

Another study from last year looking at debt accumulation showed the same thing. Auto sales in regions where debt accumulation was the highest during the boom are down 40% since 2005. In regions where debt accumulation was the lowest, auto sales are up 30%. Same for housing investment. Regions with the lowest debt accumulation have barely seen any dip in residential investment. Regions where it was the highest have seen construction plunge as much as 60%.

Since the vast majority of household debt is in the form of mortgages, you can connect the dots: When wondering why the recovery is so slow, all fingers point to housing.

So what happens next? It's impossible to time when housing might actually turn around, but there are signs that a meaningful rebound isn't far off. After hitting a 50-year low in 2009, housing starts are rebounding virtually every month, are now up 46% from the bottom, and are expected to rise another 15% this year. As Warren Buffett wrote in his latest letter to Berkshire Hathaway (NYSE: BRK-B  ) shareholders:

This hugely important sector of the economy, which includes not only construction but everything that feeds off of it, remains in a depression of its own. I believe this is the major reason a recovery in employment has so severely lagged the steady and substantial comeback we have seen in almost all other sectors of our economy.

Fortunately, demographics and our market system will restore the needed balance [between supply and demand] -- probably before long. When that day comes, we will again build one million or more residential units annually. I believe pundits will be surprised at how far unemployment drops once that happens. They will then reawake to what has been true since 1776: America's best days lie ahead.

Do you think he's right? Let me know in the comments section below.

Fool contributor Morgan Housel owns shares of Berkshire Hathaway. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (18) | Recommend This Article (28)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 05, 2012, at 5:04 PM, HighVoltage627 wrote:

    I've argued this for a while(well, not here, but with friends). The "national housing numbers" are misleading. Certain areas like California and Nevada radically overbuilt. These numbers are severe enough to drive up the national number to make things look terrible for the country.

    As this article demonstrates, if you didnt participate in the overbuilding, then the housing situation is not nearly so dire. It may take the worst offenders a decade or more to dig their way out of their overbuilding binge, but things keep right on going for other places in the country.

  • Report this Comment On March 05, 2012, at 5:27 PM, CaptainWidget wrote:

    Recessions are about misallocated assets. Recoveries are about RE-allocating assets. The velocity of a recovery is 100% about the institutional burdens to that capital being reallocated.

  • Report this Comment On March 05, 2012, at 6:04 PM, cfravel wrote:

    All fingers point to employment. The housing bubble was merely a symptom of the employment vacuum post dot-com bubble. That vacuum still exists. Housing cannot return to previous levels without the earnings power of yesteryear, especially in terms of absolute dollars. We can inflate our way to relative dollars have the same number values as a few years ago, and that might have some psychological impact for housing investment. But, until the policies of the U.S. reward investment in domestic employment generating enterprises over other investment vehicles, there will be no recovery or growth in domestic purchasing power. As of today, the tax code strongly favors foreign investment and long term capital gains, neither of which generates domestic opportunity, the precursor to strong consumer demand and domestic expansion.

  • Report this Comment On March 05, 2012, at 6:07 PM, bretco wrote:

    what is Captain Widget really saying ?

    I don't get the "institutional burdens" thing

    unless he is talking about the government

    which is and will remain a burden for a long

    time to come.

  • Report this Comment On March 05, 2012, at 6:19 PM, xetn wrote:

    All of this debt should have been liquidated in 2008-2009 through bankruptcy, not bailouts. If that had occurred, we would now be well on the road to a real recovery. As it now stands, the "recovery" is being produced by the Fed's constant QEs. All that has happened is to kick the can down the road.

    A lot of that new Fed money is finding its way into the stock market where before it found its way into the housing market.

    As for employment: the labor participation rate peaked in 1999:

  • Report this Comment On March 05, 2012, at 7:41 PM, seattle1115 wrote:

    @xetn: "the labor participation rate peaked in 1999"

    Really? The labor participation rate peaked just as the Baby Boomers were preparing to enter retirement? Color me shocked!

  • Report this Comment On March 05, 2012, at 8:08 PM, CaptainWidget wrote:


    I don't get the "institutional burdens" thing

    unless he is talking about the government

    which is and will remain a burden for a long

    time to come.>>You nailed it. The barriers to moving around capital in the US are astronomical. Banks would rather sit on their money and make nothing than wait for an SEC investigation to collapse their business.

  • Report this Comment On March 05, 2012, at 9:22 PM, TMFMorgan wrote:

    Bingo, Seattle1115. As Rob Arnott pointed out in WSJ today:

    "This very year, for the first time in U.S. history, the population of senior citizens rises faster than the working-age population. Less than 10 years ago, when the baby boomers' kids were coming into the labor force and the very skimpy roster of Depression babies was retiring, we had 10 new additions to the working-age cadre for each one new senior citizen."

  • Report this Comment On March 06, 2012, at 12:20 AM, Chontichajim wrote:

    The localized nature of the recession is dramatic in our California county with almost no impacts to the west where there was little building in 2000-2007 to 3 of the top 100 city foreclosure rates in the east county.

    We should recover well even with an aging population as I see most of our new neighbors are a mix of generations with older members supplying credit and down payments while younger members contribute income.

    As long as extended families each play a roll at every age I do think the nation's best days are still to come. This is a model common in my wife's native country, and they do well with only a fraction of our resources.

  • Report this Comment On March 06, 2012, at 9:32 AM, Klarenbach wrote:

    One point overlooked is the fact that three of the top four oil producing states are Alaska, North Dakota and Texas. I would argue that this is the largest reason for the stability of these housing markets assuming lending practices in all states are the same. Without looking into the job numbers, I suspect that these states experience more stable employment numbers.

  • Report this Comment On March 06, 2012, at 10:25 AM, slpmn wrote:

    Good points by Steltek and Klarenbach.

    In hindsight the housing bubble was doomed to failure because it was fueled by monetary policy rather than real economic growth (i.e. people bought big houses because they could borrow more, not because there was a boom in high paying jobs). Classic self-reinforcing spiral on the way up with the inevitable collapse at the end.

    Now, policy makers continue to do everything they can to reignite the bubble believing it's the key to turning around the economy, but that misses the point. Economic growth has to be based on the creation of real industries that add value, and we haven't had that since the tech boom of the 1990's.

  • Report this Comment On March 06, 2012, at 2:03 PM, SunDevilDon wrote:

    The third largest oil producing state is .... California.

    Although, it is probably a smaller percentage of California's economy then for the others.

  • Report this Comment On March 06, 2012, at 2:10 PM, TMFMorgan wrote:

    Fair point about oil-producing states, but I'll add that oil wasn't much of a buffer during the recession. Oil prices fell nearly 80% from 2008 to 2009.

  • Report this Comment On March 06, 2012, at 2:50 PM, MartyTheCanuck wrote:

    I agree that a debt-induced recession takes more time to recover. And there is little that can be done, by fiscal or monetary policy, to make it much better.

    Republicans will blame Obama, Dems will blame Bush. The stimulus was mostly injecting money to shield some Dems constituencies from the hard times, and using the recession as an excuse to fund some pet projects, but did very little to help ( and increased the federal debt ). Scapegoating Wall Street is good politics but does nothing help.

    It should be about preventing the next bubble ( closing Fannie and Freddie would be a good start ), but very little was done in that area.

  • Report this Comment On March 09, 2012, at 1:40 PM, mbushman wrote:

    As usual, an outstanding piece by Mr Housel.

    Two issues to point out tho (one from the original piece, one from the comments):

    1) With regard to "local governments (influenced heavily by property taxes)"......."Local governments usually rebound 4%. Since 2009, they've declined over 5%.", I am not sure that I follow. Homes in foreclosure are still owned by 'somebody' (typically a bank) and continue to generate property taxes. There are probably some losses as owners refuse to (or can't) pay, but my guess is most of them eventually do - it's hard to run away from tax obligations for too long. So, while there is certainly some effect on local government property tax income, I think it is perhaps not so great as intimated here?

    2) With all due respect to steltek, to say "As of today, the tax code strongly favors foreign investment and long term capital gains, neither of which generates domestic opportunity, the precursor to strong consumer demand and domestic expansion." is, IMO, deeply flawed and short-sighted. Investment with a view to the long term is practically a mantra here, and hopefully I do not need to explain why that is in fact a strong motivator for consumer demand and domestic expansion (granted, in the long run). As for the tax code favoring foreign investment, I assume he is speaking of corporate taxes and the issue of repatriating funds earned overseas? While this may be an issue, it is debated what and how great the net effect is, so I am not sure too much of the current situation can be hung on that nail.

    Thanks all and keep up the great (foolish!) work.


  • Report this Comment On March 09, 2012, at 6:52 PM, TheKoz72 wrote:

    Now we should be able to see that simple supply/demand and price economics take over or they actually have always been in charge. California built a major excess of overpriced houses and they must now be sold off at less that cost (read as mortgage balance if you are a bank). In the meantime California is changing rules to discourage major employers with higher paid employees. That leaves service sector employees that cannot yet afford the cost to buy and/or upkeep the current excess supply of higher priced houses that are still available. This excess supply shows up as unresolved problem mortgages that have yet to get to the market. The solution to the housing problem is not jobs or housing but employees that can afford to buy the houses and pay the mortgages. The difference is that a job is a task(could be doing the dishes or mowing the lawn), an employee is someone who is paid for doing a job and that requires an employer. Exported employment is one of the reasons for the oversupply of houses in California. Want to fix the problem - ask GM and Toyota what changes to costs, rules and other conditions would be necessary to rehire the 4000 employees that were laid off when they closed their jointly operated plant in Fremont, California. Our political leaders have got to stop talking about housing and jobs and start talking about employment and employers to fix the demand sided of the housing issues.

  • Report this Comment On March 10, 2012, at 2:08 PM, WetTail wrote:

    A house is not an investment. It is where you live. Period.

    If housing prices remain "low" for a few more years more people will be able to afford them, so "low" housing prices are not a bad thing.

  • Report this Comment On March 11, 2012, at 1:57 AM, critter88 wrote:

    The comment that the country didn't have a housing bubble but an employment problem caused by the dot-com bubble bursting is incorrect. When I moved to San Diego in 2004, I wanted to find a comparable neighborhood so using census data, I found such a neighborhood where average household income was $100,000. The difference - people in San Diego making $100,000 were living in million dollar homes! The difference between those who lost their dot-com jobs and those who didn't? They both went into foreclosure, but the former just went into foreclosure sooner. The rest went into foreclosure once their teaser loans readjusted to market interest rates and, contrary to what their real estate agents told them, they could no longer take out equity loans to make the higher mortgage payments or flip their homes for a profit. Living beyond your means gets you in trouble regardless of whether you're getting a paycheck or an unemployment check.

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