Houston Democrats

In the past four years, the average price of a U.S. home resale has climbed by almost 38 percent, according to data compiled by the National Association of Realtors. The average price of a single-family U.S. home surged to a record $266,100 last month, the association said earlier this week

This finding is consistent with several other studies of the US housing market. The FDIC conducted one in February of this year, and National City Corp. released a second in mid-August. In addition, Fed Chairman Alan Greenspan announced his concern in his most recent policy statement.

The Right Wing Noise Machine (RWNM) has been stating there is no housing bubble, or there are a few markets that are experiencing a bubble, but people shouldn’t be concerned. The above information indicates otherwise.

So, what happens if the bubble does bust?

The US could experience a serious economic slowdown.

For the last five years, two macro-level economic events have conspired against the US consumer. The first is a lack of real wage growth. According to the Bureau of Labor Statistics, the average earnings increase from 2000-2004 was 3.86%, 3.22%, 3.12%, 1.71% and 2.39% respectively. However wages have to be compared to inflation to determine the real rate of wage growth. For the same years, annual inflation was 3.4%, 2.8%, 1.6%, 2.3% and 2.7% respectively. When inflation is subtracted from wages, overall wage growth becomes .46%, .42%, 1.52%, -.59% and-.31% respectively for 2000-2004.

So wages are not growing after inflation. However, the economy started to grow again in the first quarter of 2003, when GDP started to pick-up. If people aren’t making any more money after inflation, how do they afford new purchases? With a ton of debt. Look at these charts, courtesy of Prudent Bear. You will notice that mortgage debt, household debt as a percentage of assets, and household debt as a percentage of GDP have skyrocketed since 2000 and current stand at record levels. In other words, Americans have supplemented their stagnant wages by using debt to make their consumer products purchases.

And this is where the final piece to the puzzle falls into place. Consumer spending represents about 2/3 of US GDP. For the last 5 years, debt – not rising wages nor purchases from savings – has fueled consumer spending.

So, housing prices start to drop. People start to spend less because they are concerned about the overall health of the economy. As a result, 2/3 of the US economy starts to slow down because US consumers aren’t purchasing consumer goods.

Slumping property values can wreck an economy. ``Housing price busts in industrial countries were associated with substantial negative output gaps, as real gross domestic product growth decreases noticeably,'' Helbling wrote in his study. ``On average, the output level three years after the beginning of a housing price bust was about 8 percent below the level that would have prevailed with the average growth rate during the three years up to the bust.''

Several other problems will contribute to this problem. The first is the new bankruptcy laws, which make it harder to declare bankruptcy. Instead of having the opportunity to start again, people will be forced into indentured servitude to credit card companies, banks and mortgage companies. The use of exotic mortgage products such as ARMS and Interest only loans will increase the number of foreclosures. Finally, the US deficit will hamper the government’s ability to add fiscal stimulus into the US economy.

In short, the worst case scenario is, well, pretty damn scary.

LINK