Housing Recovery Begins, But…

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- Jim

In May, pending home sales posted their largest gain in 7 years, up 6.7% (and positive gains three months in a row). June was a little lower, but still positive. Of course, large percentage gains are easier when the denominator is small, but this is still good news, in part because these people are not “flippers”, speculators hoping to flip their agreement at a huge profit before settlement. With “flippees” non-existent, these are meaningful buyers.

Housing starts are still very low. In 2006, we built new houses and condos and rental units at a two million plus annual rate (well in excess of what demographics would support). Speculation on housing replaced the “dot com” insanity, even though it had to be very clear to even the casual observer that we were collectively building units far ahead of basic demand. The outcome was unavoidable and should have been clear to all, especially the big builders who collect market intelligence. When supply dramatically exceeds demand, prices must fall to reduce inventory and will fall until supply and demand are in balance, whatever it takes.

The problem is that even at a very low price, most people have no need for a second home (and don’t want the cash flow obligations attached). Perhaps a new breed of speculator is emerging, especially in the condo market–investors with cash and the patience to wait for demographics to catch up with supply. Blocks of condos in big projects are being sold off by initial financers and investors at bargain prices. Buyers with the best credit can’t get a mortgage to buy a new condo in a project that is only 20 percent sold out – the risk of project failure is too high.

Everybody is living somewhere, renter or owner. So motivating them to move may generate fee income, but doesn’t exhaust the stock of excess residences available. Only (1) throwing the kids out, (2) more demand for second homes, or (3) population growth and family formation will solve this problem. Many who would be OK home owners were sold a house that was too expensive with a mortgage with terms too good to be true (and they were). These “foreclosed” individuals will take years to become home owners again.

So, progress is being made. But residential construction, normally about 5 percent of GDP, is down to 2.8 percent. Expenditures are down almost $300 billion since 2005. The problem is being resolved, but slowly (since demographics improve slowly). In heavily overbuilt markets, prices aren’t done falling yet, but likely to slow as those who can’t “hang on” are mostly flushed out into the pool of foreclosures (and sales are growing in those heavily overbuilt markets).

Very Good News from the June PMI

On July 1 the Institute for Supply Management (ISM) reported that its PMI manufacturing index rose to 44.8 percent in June, up from 42.8 in May. While that is the 17th consecutive month of contraction in the manufacturing sector, it is the highest level since the 49.3 percent of August 2008. The index had sunk to a low of 32.9 percent in December 2008. A number below 50 indicates the manufacturing sector is declining. Click here to read the full post and comment (Insights subscribers) »

Shoppers Are Happier and Have More Money to Spend

On June 26 the BEA released their “Personal Income and Outlay Report: May 2009” and it had lots of good news. Total personal income leapt by 1.4 percent or $167.1 billion in May from April to a record SAAR of $12.3 trillion.

Disposable personal income shot up by 1.6 percent in May from April or $178.1 billion to a new record of $11.1 trillion. Personal savings shot up to 6.9 percent of disposable personal income, the highest ever recorded in the fifty-year history of the data series. Click here to read the full post and comment (Insights subscribers) »

Thoughts on Health Care Reform

The President’s Council of Economic Advisers released a 50-page report making the case for “health care reform.” It alleged that reform could, over twenty years, raise family income by $20,000 (assuming a reduction in health care cost growth by 1.5% a year) and covering the uninsured would increase “net economic well being” by $100 billion a year. But, just how is the reduction in the growth of medical care costs going to be accomplished? Great Britain and Canada control health care costs by deciding how much to spend and then rationing care to meet the target. Generally this means that older people get less care. Ask my students what “a dollar spent on Dr. Dunk’s health care” is and they will reply, “a bad investment,” recognizing my advanced age and a budget constraint – we can’t spend an infinite amount of money on anything, so a dollar spent on my health care is a dollar not spent on a young person who would be productive for a lifetime. Such thinking makes people uncomfortable, but such choices are a necessity. We tolerate 50,000 auto deaths a year so we can drive fast. These are choices we make.

In our last assault on health care costs, we were told that we had a “health care crisis” because we spent an amount equal to 12% of GDP on health care. But people choose to make these outlays, they are not compelled to. Part of this is due to a mispricing of health care services. You might pay $5 for a doctor visit with your insurance, but doctors won’t work for $5 a visit. When visits are cheap, we take more than we would if they were accurately priced. In short, we take too many visits because they are underpriced, just as we buy more apparel at a half price sale. Compounding this, states require many procedures be covered in basic insurance that most people wouldn’t use. This raises the price for everyone, and subsidizes the few that take those services. Case in point, Medicare covers penile implants. Quality of life and all that. Medicare costs are out of control. Most of this money is spent in the last few months of life.

Most medical and drug innovations originate in the U.S. Once available, everyone wants the “best.” Always expensive, but we all can’t drive a Cadillac to work. Yet our politicians claim to want access to the “best” for everyone, an impossibility.

How we finance medical care does need to be changed. Health care insurance is provided by employers because Congress made it a tax deductible cost decades ago. All other insurance we buy from competitive providers. Auto insurance doesn’t cover oil change and maintenance for the car, it only kicks in when there is a “disaster.” Health care insurance typically pays for everything, “tune ups” (check up), routine maintenance, etc. Necessary, but this should be the responsibility of the consumer, not the insurer. Catastrophic health care insurance that covers serious “accidents” is not expensive, but “prepaid medical care” (which most of us have) is very expensive!

What to do: (1) make health care benefits taxable (Obama would love this, companies would get out of the business of helping health care insurers manage their insured, workers would get the cash and shop for the health care package that fits their needs. At the moment, I have no health care choice, just what someone at my employer negotiated for me. One size fits all?); (2) price medical care appropriately, no “free visits”; (3) let providers compete for customers; (4) provide a catastrophic insurance that removes the risk of financial ruin (how about you pay up to 10% of your income, the rest is covered?).

The Private Sector Leads the Recovery

As is usually the case, the private sector is healing itself. The 90+ percent of the labor force that still has a job is re-grouping and starting to spend again. This is the force that will reverse employment trends and re-start the economy. Yes, the unemployment rate went up again as expected, but this time, a chunk of the gain came from more people looking for work, not from more people being thrown out of work. The unemployment rate is calculated as the number of those looking for a job divided by the number with a job plus the number looking for a job. When the number looking goes up, it pushes the unemployment rate up until they find a job. But more people actively seeking employment is a positive sign for the economy.

This squares with the rise in consumer optimism. As people become more optimistic about the economy, more seek employment. And those still employed spend more, which creates the employment opportunities for those looking for work. Business optimism is also on the rise. This will unleash spending to replenish inventories and buy new equipment and vehicles which has been postponed due to uncertainty about the economy, which is now fading. And trillions of dollars that have been sidelined in safe Treasury bonds or money market funds paying nothing are moving the stock market.

Oil, gold and commodities are hot again, but this is a bad sign, reflecting fears about inflation that could emerge in the future. Interest rates are rising in spite of Fed efforts. Historically low mortgage rates will fade away. The government needs to raise trillions of dollars to support its spending. Vice President Biden has admitted there will be much waste, but hey, one person’s waste is another person’s income. If I pay you to do nothing, you still have money to spend even though you didn’t create any output. Taxes must rise as must government borrowing. The government will be competing with the private sector to get funds and this will put upward pressure on interest rates, even with more consumer saving.

Housing of course will continue to be a drag in parts of the country. We built millions more housing units than people need. Even at very low prices, not many people want a second home to take care of. And the bad economy has slowed household formations, the major source of housing demand. The kids just won’t leave home. But, dramatic under-building (500,000 units vs the 1.4 million normally needed) will resolve the imbalance in most of the country this year. That will provide some boost, although two big economies, Florida and California, will take years to fix. Hurricanes might reduce supply in Florida, but not much hope for one in California or Phoenix or Vegas.

Bottom line, the economy is improving, and with little help from “stimulus” which, as predicted, takes a long time to impact the economy (unemployment benefits being the major exception). Let’s see how it plays from here.

The “Safety Net” Is Really an Awful Trap

The so called “safety net” now accounts for the largest share of consumer income since data were first collected in 1929. Sixteen percent of personal income now comes in the form of a government welfare check of some sort. With some 40 percent of tax filers paying no federal income tax, it is clear that the constituency for bigger government is growing. People who get benefits without having to pay anything will be inclined to vote for even larger government,

Of course the recession has contributed to the growth of benefit checks with more receiving unemployment benefits and for a longer period of time. Thirty-three million people get food stamps (5 million more than last year), the Medicare drug benefit is now in place (more people are retiring and make use of it), the 51 million Social Security checks cut each month are up 5.8% due to inflation in 2007 and this year all received a $250 bonus.

In total, these government checks add up to more than 2 trillion dollars, or a tax burden of about $17,000 for each man, woman and child in America, a burden that will continue to grow as the Baby Boomers retire and live longer. The entire weight of this burden is not felt on April 15 because the government borrows hundreds of billions of dollars to meet these obligations. If this sounds like insanity, it is. The hope in Congress, of course, is that it doesn’t all come apart before the next election. Once re-elected, at least our leaders will have two years to noodle a solution before 2012. The goal to insure re-election is to not raise taxes but to raise benefits further. One of these days, it won’t work.

Don’t Bet On Anyone’s Forecast

If you want to be thoroughly befuddled about where the US economy is going, just ask three or more forecasters. Any experienced professional who tells you that he or she is quite positive about the path of the US or global economy over the next two or three years should be looked at with a very jaundiced eye.

In a recent survey of 43 forecasters, only eight of us did not have negative numbers for real GDP this quarter and two of these people had a highly improbable (it’s only happened once in our 237 quarters of history) 0.0 as their prediction. For the thrid quarter, only 11 people had a negative number and only four people expected a negative number for the fourth quarter of 2009.

Over the year ending in March 2010, the range was from a drop of 1.9 percent to an increase of 3.2 percent. That’s my forecast and I’m sticking to it, but you should be aware it’s one of the most optimistic out there.

A similar split showed up in the survey released by the National Association for Business Economics (NABE). There were 45 of us in this panel. The median forecast was for a drop of 1.8 percent this quarter and increases of 0.7 percent and 1.8 percent for the third and fourth quarters respectively. The five lowest forecasts were for -4.2 percent, -1.8 percent and 0.0 percent for those three quarters. The five highest were 2.8 percent, 3.3 percent and 4.0 percent for the same three quarters. That’s a huge split. Click here to read the full post and comment (Insights subscribers) »

ISM, Construction & Savings Rate Provide Good News

On June 1, the Institute of Supply Management (ISM) reported its manufacturing index rose to 42.8 percent in May from 40.1 in April. That’s the highest level since the 43.4 of September 2008.

This is very good news because the ISM states that an index above 41.2 is consistent with growth in real GDP. This is despite the fact that the index has to be above 50.0 to indicate that the manufacturing sector is growing. Click here to read the full post and comment (Insights subscribers) »

HamburCare: A Fable for Our Times

Twenty years ago I wrote a commentary entitled “HamburCare”, about a Senator Kennerly who found himself without the financial means to acquire a hamburger at a moment of intense hunger. He introduced a bill to remedy the situation that allowed consumers to get hamburgers by simply providing their social security number. Burger establishments were to be reimbursed by the government at the prevailing cost of a burger plus an allowable profit. With the price of a burger to a consumer reduced to $0, people ate many more (substituting burgers for healthier food and spending less on groceries), creating a boom in the construction of burger joints and an increase in obesity and related health issues. At a price of $0, consumers bought extras to keep in the car in case they got hungry later. Burgers were used for pet food since they were cheaper. And the “prevailing price” of burgers rose since there was not an immediate increase in the supply of burgers, increasing the cost of the program.

To pay for this program, everyone was required to pay a burger insurance premium designed to cover the cost of the program at inception (equal to expenditures on burgers in the U.S. divided by the population, which immediately resulted in subsidies from those who don’t eat burgers to those who do). Of course because the price actually paid for a burger was $0, many, many more were purchased and the program was immediately in a deficit. Congress raised the burger insurance premium, reducing the income available to spend on other food. More burgers were consumed, the deficit grew and obesity worsened.

As Congress wrung its hands over the deficit caused by the burger program, someone suggested “privatizing” the provision of burgers, but that idea was roundly booed. Another suggested raising the price from $0 to some positive “co-pay” charge. This was done, but the program continued to generate deficits as the “co-pay” charge was very low compared to the actual cost of producing the burgers. Raising the “burger insurance premium” (aka “the burger tax”) was rejected as an election was approaching. So Congress borrowed enough to cover the deficit, promising to add the interest cost to the burger insurance premium after the next election. Yup.

Be Afraid, Be Very Afraid

In a front page story in USA Today, on May 29, Dennis Cauchon laid out the stark picture of how deep a hole Congress has dug for all citizens of the US. The net present value (NPV) of all the commitments that Congress has made added up to $546,668 for every household in the country in 2008. That was an increase of $55,000 or 12.0 percent per household.

The total NPV was $63.8 trillion at the end of last year. That dwarfs our $14.3 trillion in GDP in 2008 and is 23.9 percent larger than the $51.5 trillion in net worth held by consumers on December 31, 2008.

By far the biggest problem is Medicare. It accounts for $284,288 or 52.0 percent of the obligation per household. Social Security is second at $160,126 or 29.3 percent. The two entitlement programs combined account for $444,414 or 81.3 percent of the total.

There are no simple and obvious solutions or Congress would have used them by now. One possibility is a flat tax on consumption with a cap on total spending for Medicare. Social Security can be solved by raising the retirement age in the future (ten years or so from the change) and indexing the annual increase in benefits to wages rather than prices.

The national debt accounts for only $54,537 per household. That part is manageable.

The debate on how to resolve this huge gap between commitments and reserves to pay for them will consume increasing amounts of time until the situation is resolved. That is unlikely to be soon. Sadly.