Econ: Miraculous recovery or last gasp?

Miraculous recovery or last gasp?

The Economist
Dec 21st 2005
>From The Economist Global Agenda

After soaring for years, housing markets throughout the rich world
have been looking wobbly for some time. But surprisingly strong data
on mortgages and house-building released this week in America and
Britain seem to signal at least a temporary reprieve. How long can
this go on? And what will happen to the economy when it finally stops?


IN RECENT years, housing has been a peach of an investment in many
rich countries. The Economist's latest house-price index shows that
since 1997 prices have soared by more than 85% in America, 100% in
France, 112% in Australia, 150% in Spain, 166% in Britain and a
whopping 208% in Ireland. And hot urban markets, such as London and
New York, have far outstripped their national averages.

But recently anxious homeowners-and anxious central bankers-have
begun to wonder if the market isn't running out of steam. A decline
that started in Sydney has spread to other Australian cities, as a
result of which house prices rose by a measly 1% nationwide in the
year to the third quarter of 2005. Britain's market has also begun to
look sickly: the Nationwide building society's price index has risen
by only 2.4% in the year to November. Could Australia and Britain be
the canaries in the coal mine? Is America next?
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Well, not yet. On Tuesday December 20th, new data released by
America's Commerce Department showed that after a decline of 6.6% in
October compared with the month before, housing starts increased by
5.3% in November, a much stronger showing than expected. The number
of new housing permits, which had been expected to fall, also
increased, by 2.5%. John Snow, the treasury secretary, touted this as
proof of the American economy's strength.

Even the British canary seems to be waking from its coma. This week,
the Royal Institution of Chartered Surveyors reported that house
prices had risen in the three months to November, the first time this
has happened in 15 months. Mortgage activity is also on the mend,
according to the British Bankers' Association, which announced on
Tuesday that November had brought the biggest increase in mortgage
lending since July 2004.

But this may be less miraculous recovery than last gasp. A recent
report by the Organisation for Economic Co-operation and Development
(OECD) indicates that house prices in Britain remain overvalued by
more than 30% compared with rents. Britain's economy, which has grown
steadily for over a decade, has been flirting with recession in
recent months. In response, the central bank cut interest rates,
which may have sparked a temporary recovery in the housing market.
But without faster growth, consumers cannot pay ever-higher prices
for their homes.

Though the relationship between house prices and rents is less
outlandish in America, consumers there are seriously overstretched.
According to the Federal Reserve, the ratio of debt-service payments
to disposable income was 13.75% in the third quarter, an historical
high. Since 2000, the level of outstanding mortgage debt has
increased massively. While lower interest rates have helped consumers
to meet these obligations without much additional pain, those rates
are now creeping back up.

Not only is the Fed not done tightening, but the flood of cheap
capital flowing into America from abroad could reverse itself at any
time. This is bound to hurt consumers, especially since soaring house
prices have forced many of them into adjustable-rate loans to keep
their payments low. Indeed, a lot of desperate homebuyers have turned
to interest-only loans, or even negative amortisation loans (where
the payments don't even cover the accrued interest). As interest
rates rise, many of these marginal buyers will be forced out of their
homes, and the supply of new buyers will fall, which may result in a
sharp decline in house prices. The Federal Deposit Insurance
Corporation, which regulates America's banks, indicated on Tuesday
that it was considering stiffer guidance for banks that grant these
sorts of loans.

If the housing market does turn sour, it would be bad news for the
American economy, as it has been for the economy in Britain, where
the recent slowdown has been partially attributed to a weak housing
market. In both countries, consumers have become dangerously
dependent on strong house prices to keep them feeling wealthy enough
to spend. Housing markets may be the canaries that signal the fate of
the broader economy. And, as any miner will tell you, canaries don't
live all that long.