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Continued U.S. Housing Price Decline Won’t Derail the U.S. Economic Rebound

[Editor's Note: Former global merchant banker Martin Hutchinson warned investors about the dangers that subprime mortgages posed to the U.S. housing market -and to the U.S. economy. Read what he's predicting now.]

U.S. housing prices still have further to fall -perhaps a lot further.

In fact, depending upon the circumstances, the additional price declines could be quite steep.

But here's the shocker: That decline won't necessarily cause a "double-dip" recession.

In fact, it probably won't even derail the U.S. economic recovery.

Let me explain.

Anatomy of a Housing-Market Decline

Early in 2010, it appeared that U.S. house prices had bottomed out and were beginning to recover. In April, however, the $8,000 subsidy to first-time buyers ended.

Since that time, house prices have resumed what seems an inexorable decline, which seems likely to continue considerably further. However even in that event, it is unlikely that housing's new problems will do more than stem the overall U.S. economic recovery.

It is now clear that the George W. Bush economy of 2003-07 was a thoroughly unhealthy one. Artificially low interest rates courtesy of U.S. Federal Reserve chairmen Alan Greenspan and Ben S. Bernanke prevented the stock market from bottoming out properly after the 2000 bubble burst and inflated a huge housing bubble. That caused lots of "mal-investment" -to use the term beloved of Austrian School economists -in which houses were built far ahead of demand, and mortgage loans were created that should never have been allowed to exist.

As a result, investment in truly productive enterprise was suppressed, and the country was forced to undergo a huge and painful recession as the "mal-investment" worked itself out. According to Austrian economists, a similar surge in "mal-investment" was responsible for the Great Depression of 1929-41. Following our experiences of the last couple of years, the credibility of this theory has increased considerably.

When the bubble burst, policymakers were extremely worried about the effect that the U.S. housing "bust" would have on balance sheets of big U.S. banks. So they invented ways for this "mal-investment" to continue. For instance:

  • Interest rates, already far too low, were pushed down even further.
  • First-time buyers were given $8,000 subsidies.
  • And various schemes -all of them expensive -were devised to prevent foreclosures.

The result: The U.S. housing market -like the U.S. stock market of 2003 -bottomed out prematurely, allowing home prices to start to recover in late 2009.

Our story doesn't end there, however. Once the subsidies were removed in late April 2010, the market fell back.

Statistics bear this out. The Case-Shiller 20-city home price index dropped by 1% in September and by 1.3% in October. Indexes of mortgage applications fell to multi-year lows.

If you do the arithmetic, you can determine that U.S. house prices are still only at just about their average level in terms of incomes. In nominal terms, prices remain more than 40% above their January 2000 level, having almost kept up with consumer prices since that time.

But there's still a key point to consider. If you look at this from an economic standpoint, January 2000 was not a recessionary period, but the top of a crazy boom. And that means that we can expect housing prices to fall even more -perhaps an additional 10% to 15%, or even more if interest rates back up a long way.

That sounds like a dire prediction, but it isn't. Admittedly, you don't want to own stock in Bank of America Corp. (NYSE: BAC), which acquired a huge portfolio of dodgy home loans when it bought Countrywide Financial Corp. in January 2008. If U.S. home prices were to drop an additional 10% to 15%, it would admittedly create a whole new batch of homeowners who are "underwater" on their mortgages, and tempt even more borrowers to default on their Bank of America home loans.

However, there is no law compelling you to own Bank of America stock. In the long run, the additional home-loan losses the bank is virtually certain to incur will very likely end up as a taxpayer problem. In fact, that's equally true for any future loan losses that will be incurred by Fannie Mae and Freddie Mac, the home loan behemoths nationalized in 2008.

A Look Ahead

The important truth to remember is that -outside the housing market -the rest of the U.S. economy is now looking perkier. The Institute of Supply Management indices both rose more than expected in December, indicating that U.S. growth is picking up beyond its previously anemic pace in the 2% to 3% range. December job growth was robust -the first such report since the recession hit in 2007.

This is not a paradox. The heavy federal "stimulus" spending plans are winding down. Most were wasted, having been designed to provide subsidies for public-sector unions: Their demise frees up financial resources for the private sector -sort of a reversal of the so-called "crowding out" effect.

Now that the government has stopped trying to prop up housing, we can see that the less money that's "mal-invested" in housing, the more that is available for productive investment -particularly for small businesses, which are the main engines for job growth in this country.

If taxpayers and the new Republican Congress are suitably mean with bailouts of housing-related disasters, this trend will continue. In the long run, a U.S. economy that devotes fewer resources to housing and state spending is a U.S. economy that can devote more resources to productive, job-producing uses.

Unfortunately, not everything is this rosy.

The over-creation of money by Fed Chairman Bernanke and his international counterparts has inflated a commodity-price bubble, which will almost certainly bring about inflation. What's more, money spent on oil imports at more than $100 per barrel is also money that cannot be devoted to productive investment. Thus, further increases in the price of oil and other commodities could produce a second "dip" to the recession.

After that, the rising interest rates that are a virtual lock if inflation resurfaces will themselves depress home buying and other asset-heavy investments. However, the inflation itself will tend to support the prices of housing and reduce the real value of debt -both benign developments.

At the end of the day, what we find is that housing's renewed decline is mostly a positive development.

It will cause problems, to be sure. But in the long run, it will produce a healthier economy with more jobs. And hopefully the whole experience will teach us that houses are not a one-way bet (meaning that prices don't only increase -they can go down, as well). Thus, we should know better than to commit the bulk of our wealth to such an unproductive investment.

[Editor's Note: If you like the market insights and investment analysis that stories such as this one provide -but you want to receive stock recommendations, too, take a close look at our monthly affiliate newsletter, The Money Map Report.

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  1. Gary Wardell | January 12, 2011

    Lower home costs; more money to spend on other things. It becomes simple doesn't it.

  2. justin baldwin, London, England | January 12, 2011

    I've read that mortgages make up 70-80% of the US money supply. That being the case, falling house prices will have a very deleterious effect. Just as rising house prices encouraged people to take out mortgages and shove trillions into the money supply, then falling house prices will do the opposite. The old debts will not be able to be revolved into new ones if house prices aren't rising.

    Growth in a fractional reserve system is not so much the real growth of productivity but the nominal growth of more debt. Without people taking out more debt, and mortgages are the prime driver of that, then I can't see how the US economy, the UK economy, the EU, and soon China can expand. More stimulus will just go into the commodity boom, which is why I am loaded to the eyeballs with oil and coal companies.

    My view is that there will be no meaningful expansion until house prices have been allowed to hit rock bottom, but the Fed won't allow that because it will bankrupt his owners. So 'The Bernank' is printing to create fake growth to prop up house prices till people finally start buying again. Till, then the world is running on a banking system that has a 3% capital reserve based on nothing more than the myth of a price for those mortgage contracts. I believe we have entered a new age, as meaningful as the one that followed the Nixon Shock.

    It's all about house prices.

  3. Kevin Campbell | January 12, 2011

    The housing market is too big a part of the US Economy. As it goes, the economy goes. I see nothing but massive deflation as this deleveraging continues. Corporations sitting on cash and banks struggling to survive. The coming break up of the Euro Zone will spread to the US Banking sector sometime in 2011 and then all hell will break loose. It will take years in my opinion for a real recovery to begin. Real unemployment over 25%, no lending, and no spending does not bold well for the US economy.

  4. Owen K. | January 12, 2011

    What recovery? What are the signs that this economy is recovering? A drop in unemployment? Sorry, that one doesn't wash as Government figures are a joke. The stock market indexes? Those are manipulated by the Fed and the Plunge Protection Team. Energy costs rising, taxes increasing, states and municipalities in the red, etc. etc. etc. What recovery?

  5. Stephen Ganns | January 12, 2011

    Interesting theory. But, doesn't take into consideration the OTC derivatives liabilities that are appended to all of the the various asset classes, the potential failure of money center banks due to thin capitalization and accounting gimmicks causing firther capital markets freezing or loss of consumer spending power. In short, the markets haven't been allowed to clear. To quote Dr. Bob Eisenbeis" “With everyone at the Fed looking at the same simulations, there is the danger of group-think and believing that models are in fact the real world.”

  6. david | January 12, 2011

    i am a libertarian.Martin you must be kidding right,.Housing is a drag on the banks.There is 400 Billion dollars of second liens that are not being paid from res.housing.The majority of those leins are held by c.bof a.wells and chase.FASB states these losses or eventual losses have to be marked or accounted for on bank balance sheet unlike first leins which they can extend and pretend.The market cap of those banks is less than 400 billion.Just with this ,those major banks are insolvent without looking @ credit cards ,auto loans ,derivitives.These banks have comm.real estate exposure among other underperforming assets and ever increasing liabilities.They are not lending…..You cannot isolate housing ,jobs and taxes .The worlds largest economy is insolvent and greenspan and bernank policies of depreciating dollar and deficit spending with help of spineless politicians who want and need instant gratification like a 2 year old and you have a house of cards.I dont have time to get into all the phony gov. stats whether BLSor CPI whatev…Bottom line…The bankers run the gov./and Pres. and the fed is run by the global elite running the global banks.

  7. Craig | January 12, 2011

    Interesting comments by Wardell and Baldwin. They seem to be right abouth the housing crisis. I have a home that is valued at about 95K, if I'm lucky. I owe about 160K on it, and am planning on renting it (since I live somewhere else) to pay the mortgage. Even if I have good tenants there, it will take years to come back to a reasonable value….so I really don't know if I should hold on to it, or let it go to foreclosure. It is a Freddie Mac loan. Does anyone have advice as to which direction I should go?

  8. Ruth Hutching | January 12, 2011

    What is the ratio of gross income to house prices in the USA on an average?

  9. Bill Casper | January 12, 2011

    I would like to know the name of the author's recreational drug supplier. What school of economics did he attend? Is he kidding? Is he a Washington DC resident? How out of touch with reality can you get before two more signatures are garnered and this man gets placed in a sanitarium for his and our own good?! I would ask him one question…when total tax receipts at the federal level are less than half of what they need to be in order to pay the bills and there is no will on the part of our elected overlords to cut spending, how does that work when the Chinese decide not to purchase any more US debt?

  10. King Ralph | January 12, 2011

    I agree with your article. It appears that a lot of people have a ton of conspiracy theories as to why things will go wrong but the stock market keeps going up. There's one point these people seem to miss. If the stock market is being manipulated to go up, then buy stocks as you will make money. I don't believe in conspiracy theories however. The market is going up because the outlook for the U.S. economic environment has been improving since the March, 2009 market low.

  11. Pal | January 12, 2011

    Craig, it is not my place to tell you what to do but you should have a serious talk with an independent financial advisor. IMHO. Good luck Craig.

  12. Akos Nagy | January 12, 2011

    ASAP jobs materialize people will run in droves to buy homes. There is 4 year' worth of pent up demand for new homes. Today the biggest obstacle is over-caution by banks on granting mortgages. The banks now have 2 years of capital building behind them. Fed publicly screaming at banks to lendy, but telling them privately to hold off and instead build capital. PS This happens after every bank crisis over the last 30+ years. Fed keeps interest rate low so banks can make money on safe government bond and note investments and build up their capital base.

    1.2 to 1.4 million new homes per year for 300million people in the US is the norm. Do your math, how many new homes were built the last 5 years (versus the 6 to 7 million norm)? (Maybe 2.5 million). Immigration, illegal and legal, swelling, people are procreating. How many new families can live with their parents as the family grows.

    No real recovery ever in a growth country w/o decent housing,. Its a pipe dream to think US will have a meaningfull recovery w/o equally strong housing recovery.

  13. Robert Johnson | January 13, 2011

    Hutchinson sounds like he's straight out of an Obama economic 'snow job' team meeting! Cut the garbage! How about the new unemployment numbers huh? Anyone w/ half a brain knew they'd be going back up again.

    No matter how they 'spin it', this economy is ultimately going nowhere for a very long time.

    One major event, and all bets are off!

  14. Ivan A | January 14, 2011

    I couldn't agree more with this article. I always thought that the government "propping up" our economy is a bad idea because it prevents the economic cycles that must take place for it to grow long term. It maybe a short term pain but over the long haul. It has displayed itself time and time again that ultimately there is solid growth which is beneficial to all.

  15. Martin | January 16, 2011

    It seems almost all of us agree – Martin Hutchinson has got this one wrong. With house prices declining and fewer bank loans, where an growth come from? It's like saying a car can accelerate with the right pedal off. The economy can only shrink, with hugely deflationary risks.

  16. Michael Walters | January 16, 2011

    I think by now we would have figured out the self-fulfilling prophecy angle of these trying economic times, as well as the fact the media hype is hurting more than helping. So long as there are headlines hinting there may a double-dip recession, or the recovery will take a long time, that's exactly what's going to happen. Too many Americans are scared of thinking for themselves and they usually read only the headlines. Maybe the media could learn that better economic times means more circulation for their particular brand, as people would have disposable income again.

  17. Rey Rollpiller | January 16, 2011

    To most of the great comments above I just would like to add one point that has not been addressed by anybody.
    I am sure that it will take several years for the economy to turn around, if it will turn around at all.
    The continuous errosion of the US $ over the next 1 to 5 years by perhaps 20 to 50 % will increase all imported goods by the rate of the devaluation. The US imports much more than she exports. Can you see what this will do to the economic revovery.
    Once the US $ is no longer the reserve currency of the countries of the world, this will happen over the next 5 years, the US will be financially ruined, consequences of the present money creation.

  18. Michael | January 16, 2011

    At first I thought Chris Martenson wrote this drivel…whew(!), it's a guy it's a guy named Martin Hutchinson. In any event, to think that if housing goes down in a big way it can mean anything other than a double dip, one has to be pretty gullible (which is why I'm forwarding Martin a bunch of hot real estate recommendations as soon as I hit the Submit button). However, the most ominous sign of a double dip is when the stimulus of a $1.5T annual budget deficit and/or the Fed's QE program run out or decrease appreciably. Right now we're effectively an addict hooked up to a continuous drip of our favorite IV fluid (liquidity/dollars). When that drip stops or is sufficiently curtailed, the happy face of recovery will be turned upside down and the addict will begin withdrawal.

    If the deficits and QE continue into perpetuity – a distinct possibility, but by no means assured – the addict dies. That's why Mises said "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

  19. rolf meys | January 16, 2011

    Housing is conglomerate term. There are mansions and utility dwellings. Owner occupied modest housing is an essential for living a decent civilised life, where the next generation can be nurtured into a productive career. This educational process these days lasts up to their mid twenties. The cost of owner occupied houses must be discounted for the rent that otherwise has to be forked out. McMansions on the other hand are there as investment that needs a buyer's market to realise gains.
    Therefore utility housing is developing a shortage with low building rates ,as opposed to a glut of glamorous monstrosities. The market let free will find equilibrium, with McMasions suffering badly

  20. sharon ehrhardt | January 17, 2011

    This progressive Democrat has to agree with dave the libertarian's comment. To Craig: I bought 2 rental duplexes in IL. in 2003, 2004 for income. I have a lot of work, a lot of headache for a tiny income stream. You cannot imagine the expenses and vacancies. One of my beautiful and reasonable units has been vacant since August. I pay for ads and my realtor will get half a month's rent when she eventualy gets it rented. A longtime tenant is a month behind on rent. She had to take a big paycut and even with two jobs she is in trouble. If you don't live close by, you had better have a very good handyman and a good realtor. If your place is over 7 years old you will soon be buying new stoves etc. and then there's the airconditioning and basement flooding etc. Last year my properties yielded $3000 plus expenses, mortgage payments and depreciation, worry and headaches. If you live nearby, are handy, and the property is in really good condition you might go for it. The depreciation is a bonus to consider at tax time.

  21. graham anthony | January 19, 2011


    The USA has lived beyond it's means for a very long time, the last bubble was a product of extraordinarily loose financial policies and the results of that are still there in the form of a collapsed housing market, weak banks, municipals near collapse and an unemployment nightmare …….. it is very nearly bankrupt and saved only by the willingness of other nations to support its debt mountain which has little chance of being repaid or reduced to some sensible level

    The only way out for the USA is to devalue its debts away through a combination of a weak dollar and significant inflation, there is no other way, the last fix by way of stimulus packages was just like pumping more air into the ballon before if finally can't take any more and somebody realises the party is over !

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