Market Report: January 2008

The Year Ahead

Did you see the local paper last December 18th? The headline, above the fold, was "Home prices tumble". Above it was an ominous graph taking up most of the page that reminding me of some front page from 1932. If that wasn't enough, the sub-head proclaimed that the current price decline now exceeds the loss from the recession of the early 90s'.They might as well have run another tag line like, "Six Real Estate Agents Jump Off Bridge".

Residential re-sales next year are by some estimates going to be one-half of the number of transactions completed in 2005. There will be far fewer eager faces working open houses next year. It is good real estate shops only have offices on ground floors.

2007

The practice of looking ahead has become much more perilous craft. All of the traditional markers from past recessions are now less relevant in the global age of capital. Money moves around more rapidly and comes from myriad locations and institutions. Central banks in all First World countries have less influence in markets than they did fifteen years ago. Globalization is another way to say volatility and unpredictability. The Fed has lost a great deal of hand.

Houses, because of the flow of money, have been forced to become world commodities. Your local banker did not make and retain your house loan as was the practice in the past. The village has been lost and as a consequence it becomes much harder to predict the future. The only certainly is uncertainty.

Money and Oil

The cost of money and oil will be the biggest unknown this year. The fear of oil supply disruptions in the Middle East drives up the current price perhaps by as much as $20 a barrel. The price of money and oil will determine to a large extent the rate of inflation and perhaps usher in a period of stagflation. We last experienced stagflation in the early 70s', an unhappy brew of inflation and recession. If this occurs, consumer spending, which makes up seventy percent of the economy, will surely go in the tank and engender other unknown and horrible consequences.

The price of mortgage money is potentially more of an unknown. As noted above, central banks have less influence in this new era in influencing long-term interest rates. In an interview last month on NPR, Alan Greenspan was asked about his role in the creation of the housing bubble. The former chair allowed that he saw it coming but could not influence the flow of easy credit. By his own admission, which may be partly self-serving to preserve his historical legacy, the Fed could not influence long-term rates and therefore had no tools available to regulate the housing market.

Given this as mostly truth, this means future housing cycles are going to be just as extreme as today's. The past, as we have experienced, will do little to illuminate the future. The housing market, always a bastion of the free market, has become even more so.

2008

While money and oil remain the jokers in the pack, the gorilla in the room is really the government and how the entire sub-prime mortgage problem plays out. In this case, it is useful to take a glance at the last recession. There our government, through the Resolution Trust Corporation, took a mild recession and made it far worse. If banks, funds and other financial institutions can survive the impending flood of loan defaults, there will be little Federal intervention. This will mean the free market will sort out the housing market but that means blood in the streets. Since this is an election year, pols may find a way to re-regulate the market and minimize the collective pain.

Assuming the best-case scenario, the median price at the end of the year will be within two or three percentage points in either direction of the start of this year. I think conforming fixed rate 30-year mortgages will end the year at 6.25% plus or minus 20 basis points. The decline in prices has nearly run its course even though there is still plenty of ugly to go. 2009 seems a safe bet these days.

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