Economist Downplays Housing Bubble, But Sees Other Problems

Register now

The United States economy has issues, but according to one economist, CU leaders should not worry about a sudden, sharp fall in housing prices.

Christopher Thornberg, senior economist with the closely watched UCLA Anderson Forecast, delivered a cautiously upbeat outlook to attendees of the California and Nevada Credit Union Leagues here. He noted there have been nine consecutive quarters of economic growth, and he expects to see more growth in 2006.

"But, there are problems, most rooted in the last doldrum period of 2000-01," Thornberg said.

The last downturn was mild, odd and short, Thornberg said, to the point it barely qualified to be called a recession. While slow job growth during the recovery became a major presidential election issue in 2004, he said outsourcing was not a major blow to U.S. manufacturing jobs-"employment was the victim of productivity gains."

More recently, fears that Hurricane Katrina could shake the national economy have proven to be unfounded. Thornberg said Katrina was not a big problem for California, other than the impact on gasoline prices due to oil refineries on the Gulf Coast being taken offline.

"Disasters do not cause recessions," he asserted. "The disrupted area is 6% of the U.S. economy."

Gas and oil prices continue to be issues, but still not as significant as in 1980, he continued. "They won't have an impact on the economy. Inflation shows some signs of heating up, but rates are still low."

So what is wrong with the economy? A few things, Thornberg explained.

First, while GDP growth is good, employment and industrial production growth rates are low, and capacity utilization remains relatively low. The main issue, however, is consumer spending.

"Consumer spending continues to drive the economy. Consumers are on a binge, to the point it is bad news," he stated. "Consumer spending as a percentage of disposable income is over 100%, which means it can't last."

Reflecting The Problem

The U.S. trade deficit reflects the problem. Thornberg said the United States is consuming 5.5% more than it is producing. While some have blamed low interest rates, he believes the "real reason" is the dramatic appreciation of housing prices in recent years. "Real estate has been rising at record rates in the U.S. Even if people are not taking money from their house, it is influencing their decisions. People are spending more."

"The housing market is the thing we are worried about," he continued. "Housing prices tend to move closely with employment. But in 2001, housing prices accelerated past employment. We are spending more on houses and prices are rising faster than ever before. It feels like a solid economy, but it is not. It is a real estate-driven economy."

The ratio of median home price to per-capita income is 12:1, an all-time high, Thornberg said. Which means: "We have a big, big problem on our hands."

Still, the finish of the much-discussed "real estate bubble" might not be as catastrophic as many fear. When most people hear bubble, they assume it ends with a "pop," he said. For example, Amazon.com stock was selling for $200 per share in 1999, and was one of many securities to take a dramatic drop in 2000 because the price was not indicative of its value.

Real estate is an asset, and it, too, has a fundamental value, Thornberg said. Low mortgage rates do not cause housing prices to rise, but falling mortgage rates do. Once mortgage rates stop declining, there is no more effect.

Therefore, he said, rising mortgage prices will not bring an end to the housing bubble. It will end when it stops "feeding" at the bottom end. "Watch unit sales," he advised. "When the number of people entering the market declines, the pyramid will collapse on itself."

Home sales have been flat for one year, which Thornberg said is a sign housing is at its peak: "It is running out of people to keep the cycle going."

Other signals have been mixed. Some local markets are cooling, while others still are strong. He said consumers have been "running wild" for 14 years, from the Internet and the "New Economy" to the high-flying real estate market. "What will be the next driver?" he wondered.

Many people are concerned about "crazy credit" in the market, including interest-only, adjustable-rate and no-documentation loans, Thornberg said. The problem lies in people using these loans to buy something they cannot afford, then relying on 10% appreciation to bail them out.

The risk is not as bad as feared, he said, because housing prices do not "pop" the way stock market bubbles do.

"Home prices will not plummet. They will go flat for years. The wealth effect will be gone, which means consumer spending will pull back and savings will rise. Add it all up and-at best -we will have slow growth. Or, a possible downturn. There is little chance of a recession in the next 12 months."

Thornberg predicted the Federal Reserve Board will continue to tighten credit by raising the Federal Funds rate for four or five more months until signs of growth cool off.

He said he does not believe the "new guy"- Ben Bernanke, who was nominated by President Bush to take over for retiring Fed Chief Alan Greenspan the day before Thornberg spoke at the convention-will "severely alter" the path Greenspan has set.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER