Updated Predictions

My prior predictions are all more or less coming to fruition. QE2 has inflated asset prices over the past few months, but inflation appears to be on the rise so further easing may be impossible. The Fed won't raise rates until inflation forces them to, and I don't anticipate that happening for another year or so. Real GDP growth will run around 3% on average for the foreseeable future, which shouldn't do much for unemployment. I see unemployment staying at 9 and change for 2011 and around 8.5-9% for 2012. Exits from the labor force will primarily drive this drop in unemployment rate.

House prices have continued their descent and are nearing a new low on a national level. I expect them to bottom out approximately 10-15% below their prior low as expectations about house price appreciation continue to drop and the household formation rate continues to be low. The shadow inventory is still there and foreclosure sales are picking up (20% increase over 2010 according to RealtyTrac). Far too many people are still looking at houses as investments, and I expect this sentiment to recede over the next half-decade, as house prices sputter.

Predictions

House prices are dropping once again. The homebuyer tax credit is expiring, the stimulus package effects will start dropping next quarter, and mortgage rates can only rise from here. All of this means that, on a national level, we can expect house prices to fall a significant amount (20-25% is reasonable in my view, although this will most likely occur over a few years). A key variable is whether the Fed will raise rates in the next two years. I no longer think will happen. There will be no solid recovery until the excess housing inventory is churned through the market, and this won't happen except at a significantly lower price and will take 3-5 years. When the stimulus effect on GDP recedes starting next quarter, GDP will start falling and the pressure against raising rates will be enormous. The U.S. will continue to run massive deficits, keep rates below 2%, and see unemployment above 9.5% for the remainder of 2010, as well as 2011. If the stock market returns to resembling economic reality, there should be a sizable downward adjustment within the next 6 months. On the bright side, the weather is getting nice here in New York.

Via Calculated Risk.

Get Embarrassed

California has foolishly extended its Homebuyer Tax Credit. You would expect a state in the middle of a budget crisis not to waste money like this, but then again this is California.

More on Greece

The former chief economist at the IMF just eviscerated the IMF and EU for kicking the Greek can down the road. The more things change, the more they stay the same.

The Bear Case

This is the best argument for a double-dip recession: Declining tax revenues for states and municipalities will lead to downsizing at both levels. Coupled with another fall in house prices and corresponding dip in PCE, we could easily lose another few % points of GDP. I certainly hope this isn't the case, but I wouldn't be surprised to see it.

Great piece by Zero Hedge. The swaps that Greece has come under fire for were more widely used than I realized.

Full disclosure: I'm long the dollar. This piece is yet another reason to be. I call that my "in the land of the blind, the one eyed man is king" strategy.

Manhattan Rents 2002 to January 2010

I have been keeping tabs on the Manhattan rental market with the help of data culled from Citi-Habitats's market reports. I excluded the 3+ bedroom series because most of the volume is in the smaller sizes and the graph is just easier to read without it.

Some notes about the data:

1. It doesn't include the effect of incentives unless they are factored in the base rent. Adding this effect in would add an additional decline when those incentives started appearing en masse.

2. The data comes from actual rented apartments. This is why data from CH is vastly preferable to data from TREGNY, which (inexplicably) uses asking prices.

3. The series was annual from 2002-2006, has data for Q3 and Q4 2007 (none for Q1 and Q2), and monthly thereafter.

4. The data that goes into this average changed slightly between 2006 and 2007. The LES, Harlem, Washington Heights, and Morningside Heights were added into the index. This might account for the decreases between 2006 and 2007. I will post some neighborhood-specific graphs (they are much more volatile) later on, which won't have this issue.

My read is that we are around 2003 prices.

Average 2002 Jan2010

On Japan's Sovereign Debt Nightmare

I previously mentioned that Japan's sovereign debt situation scares the crap out of me. This is why.

Yikes

Brutal new home sales numbers and MBA purchase application numbers. The price indices (Case-Shiller, Corelogic) are going to get smoked in the January-May timeframe. I hope Congress doesn't take this as a reason to throw more money at the housing market, but they probably will. The way I see it, this is just more evidence of the futility of the government's attempts prop up house prices. If house prices drop, we will get out of this mess faster.

This data now gives us reason to believe that residential investment as a percentage of GDP might not have bottomed out yet, which would indicate that unemployment hasn't peaked.

The First Step to Recovery..

On the topic of GSE reform, Rep. Scott Garrett has proposed a change to the policy of leaving GSE costs out of the budget. The President's budget didn't include the cost of the GSEs even though the government has explicitly guaranteed their debt. This guarantee means that the costs are going to be paid by the taxpayers; they need to be included in the budget. It's a simple change, the CBO has advocated for this since before the guarantee was made explicit, and there isn't any reasonable justification for the current treatment. Somehow the Democrats aren't on board with this yet, which is just embarrassing. I see no reason for the existence of the GSEs, and the first step to getting rid of them is coming to terms with their real costs to taxpayers.

Over the course of the next few years, the US is going to have to come to terms with the true costs of the life it is living. The federal budget will shrink eventually; state and municipal budgets are already in disrepair. Unfunded liabilities like Social Security and Medicare as well as trillions in private pensions will be forced to reduce entitlements. It's not going to be easy, but the earlier we get off this unsustainable path the better off we will be in the long run.

Fighting the Good Fight

Great piece on Sheila Bair by the New Yorker. To this day I am shocked that Bush appointed her to head the FDIC. It's proving to be one of his best moves.

Residential Investment and Unemployment

I thought it might be worth taking a look at residential investment and unemployment over a longer period. I'm surprised at how tight the (inverse, lagged) relationship turned out to be. Every time residential investment took a nosedive, unemployment shot up quickly thereafter. Every time residential investment increased rapidly, unemployment dropped precipitously.

Here's the chart:

RI % GDP and Unemployment 1970-2009

Here are the peaks and valleys and the lag between them:

Peaks Valleys

I should note that prior to 1970, the relationship wasn't quite the mirror image you are seeing here. However, I think 40 years worth of data of this quality is sufficient to make the conclusions I am making. We shouldn't expect a dramatic drop in unemployment until we see a dramatic rise in residential investment.

Some Housing Numbers

10% of prime loans and 15% of all mortgage loans are delinquent or in foreclosure. Stunning.
via Calculated Risk

Recommended

From Bond Girl, a quick note on contagion, debt crises, and the Fed.

One of the best writers on issues finance-related is the Epicurean Dealmaker. Here's his take on Goldman's PR strategy.

Chicken/Egg Cont.

More on residential investment. This has been a great leading indicator of the current recession, and doesn't portend any recovery in the near future. Once we see improvement in this metric, which won't happen until we have worked through the excess inventory on the market, we can finally expect job numbers to improve. Below is residential investment as a percentage of GDP over the past decade.

RI % GDP

It appears that the typical percentage was around 4.5% before the bubble, rose to 6.2% at the peak, and has dropped to around 2.5%. We have lost around 2% of GDP directly and perhaps significantly more assuming a reasonable multiplier effect.

For more on the impact of residential investment on the economy, see Edward Leamer's 2008 paper Housing IS the Business Cycle, which expanded upon RK Green's 1997 paper on the same topic entitled Follow the Leader. This work should be far more popular given its clear evidence of residential investment's enormous impact on the American economy. Considering what I was taught in undergrad macroeconomics a few years ago, it seems that the field hasn't fully assimilated this work.