I’ll start off by saying that I don’t know exactly when the bottom for Southern California is, but that I’m confident 2009 is not it, not by a long shot. So, with that in mind, I am beginning a series of systematic exploration of previous bubbles and how we might relate this time around to give us a reference to what me might expect this time.
There seem to be some myths circulating both in the Financial Media as well as the blogosphere about exactly how long housing busts tend to last. To clarify some of these myths, I’ll borrow heavily from 2 of the best know (and contemporary) housing busts, the Southern California 1990′s housing bubble and bust and some from the Japanese housing bubble and bust.
These myths are some that have cropped up at reputable financial media sites and on television often (I believe) because the human attention span is very short. We find it difficult to believe that bad times can persist for a long period of time. We have a coping method that tends to follow a predefined path, often known as the Kübler-Ross Model or Stages of Grief. Over a period of time, we pass through Denial, Anger, Bargaining, Depression, and finally Acceptance. However, keep in mind that just because humans have gotten over the financial tragedy of the 2000′s (which we haven’t), there is no specific reason why that should translate into a financial or economic end to the problems. The real world operates outside of our internalized emotions.
Still, these myths are strong emotional pulls that if believed, will lead you astray. Over the coming week or 2 I will be taking a guided tour through some of the strongest myths that have gripped the housing market. Let’s start with the most pressing one right away:
Myth #1. As soon as the recession ends, housing will jump right back up.
This myth plays on the fear that was found to be prevalent during the housing bubble. It plays on the “buy now or be priced out forever” fear of being left behind. Indeed, one could argue that immediately after the 2000 recession, housing prices quickly vaulted to the stratosphere and left many high and dry. If this were to happen again, all those currently sitting on the sidelines would once again be left in the dust as many others partake in the new propserity of housing wealth.
However, keep in mind that the 2001 recession was not housing led like the July 1990 recession. While both were quite short, they were very different. In Southern California, the effects of the 1990 recession were felt long after it ended in March 1991. Indeed, housing prices had been inflated to bubblicious prices as early as 1989. As the economy strained under high housing prices, both consumption fell as well as pulled a number of financial institutions with it. Albeit much smaller than the present crisis, the Savings & Loan crisis still strikes fear into the hearts of many bankers. That was supposed to be “the big one”, and yet, it appears nothing was learned by that experience about residential prices risk taking. This crisis played out much like the previous crisis, where defaults led to restricted credit which in turn hurt businesses. Households strained under the increased debt load that had been created during the housing bubble in the previous 5 years, and that final crack shattered the weakest financial institutions. The effect snowballed into a full blown crisis, requiring the formation of the Resolution Trust Corporation, or RTC. The RTC did what the banks could not, liquidate assets in a timely manner. This quick liquidation set the stage for a much stronger rally later in the decade and avoided a Japan-style housing bust where banks hold bad assets for fear of becoming insolvent and being remanded into recievership unwillingly.
First off, let’s clearly define how long housing prices fell during the 1990′s following the late 80′s bubble. The following graph is inflation adjusted to 2008 prices, but the amount is not as important as the trip that was taken:
As the readers can easily see, the 1990′s bubble was retraced in nearly every single major SoCal county. Orange County, for example did not complete a full retrace as it developed from a sleepy surfing and vacation town into a pricey suburb of the LA area. However, for most counties, there was a full retracement to the pre-bubble inflation-indexed prices.
There are some notable trends that one can see in the numbers. First, that falls were fairly mild, so there was a transitory period for homeowners who had accumulated significant wealth through paying down mortgages and through inflation could still “get out” before the door closed. This is important to the swiftness and the after-effects of the housing bust because it differs significantly with the existing housing bust. Indeed, so slight was this housing bust, that many believed we would fare the same this time around (allowing inflation to eat away at the home prices makes them an economically bad decision, but not necessarily a bad financial decision if the price is right and the tax benefits are right as well). With prices clearly more than 20% off in all counties this time around, a recession that it likely to be almost 3X as long as the 1990′s and with reckless speculation not seen since the 1920′s, a “soft landing” was never in the cards. This the hardest landing we will have in our lifetimes. Make no mistake about it, this will not be easily forgotten like the last bubble.
The next notable trend that one finds is that even after the recession ends in March 1991, housing prices continue to fall for 5 additional years until 1996. This was primarily because several of the savings and loans tried to time the market, waiting for a rebound. Only to find that their hesitation caused them to miss higher prices, eventually dumping them later as regulators forced them to liquidate into a softer market. In a housing bust, there is no orderly decline, if we have learned one thing from prior busts, it is this: the longer you wait to foreclose and liquidate the property, the greater the economic loss and the more significant the effect to the financial institution. In fact, so ingrained in the minds of market participants that housing was a risky investment that the greater masses shunned it for some time afterwards, only beginning to buy again when the argument was much more compelling than renting. When buying was cheaper than renting, even accounting for potential losses. We have not yet reached that point, as any further declines wipes out significant equity since in most places in Southern California, renting is still a significantly cheaper option after factoring tax consequences for most locals.
To give you a breath of where we have come so far, the following is the Southern California Housing Prices inflation adjusted for 2008:
You can see that there has been no transition time for owners to jettison out the escape hatch. While this is primarily a problem to do with mix (very low priced properties selling vs a normal mix), I will explore this more in detail in a future myth review. Please note that even with the dramatic drop in prices, we have not seen a full retracement. With the magnitude of the present bubble in perspective, I find it unlikely that at present course and speed we will simply give up at a retracement to prior fundamentals. I fully expect an overshoot of epic proportions as the bubble that preceeded it was of epic proportions. Here’s a chart showing the 2 bubbles side by side, adjusted for inflation:
Finally, it is important to remember that when housing does bottom, it does not turn on a dime. It is much like a vast oil tanker that requires significant time and distance to change course. Ingrained social opinions are slow to change, but once they do, they don’t flip flop back. We saw this in the Wile E. Coyote moments of 2007-2008 in our present bubble. This recession is going to be significantly longer, and the recovery substantially slower than previous ones. Indeed, the “truth about jobs” is that there may be many fewer than before because we are no longer driven by a significant bubble in Southern California (at least in the forseeable future) while the late 1990′s recieved a shot in the arm.
Some thoughts about the current unemployment rate (which is over 10% in California at the present time) and future projections over the next 2 years.
Indeed, remember that in past recessions, unemployment peaked some time after the recession ended, hence the effects of the recession being felt much longer than the recession lasting. It is important to remember that the end of a recession only signals that the economy has stopped contracting. It does not mean that there will be a quick return to the heady days of the prosperous times that preceded it. This time might be much worse, as household balance sheets are still carrying considerable debt with litle savings. Until those are rectified, it is hard to see any meaningful reignition of economic activity that is not inflation-linked. And, with joblessness at record levels, any inflation we do see will not be the kind of inflation we saw in the 1970′s, constituting a wage-price spiral.
We’ll touch on that next time when we discuss Myth #2, Housing Prices will jump as soon as unemployment begins to come down.