Thursday, March 27, 2014

What Came First: The Decline In Housing Or The Mortgage Crisis?

We're awash in a great sea of complicated answers to the question of what caused the Lesser Depression. Why? The story's rather simple.

A graph of what started the Lesser Depression: Housing Starts, Institutional Failures, and Mortgage Delinquencies in the Lesser Depression or Great Recession or whatever it is we'll call it in the long run

For those who would say it all comes down to deregulation, the repeal of Glass-Steagall, and sub-prime loans, please answer this: How could a collapse in loans that comes well after the sharp drop in housing starts supposedly reach back in time and cause that preceding sharp drop in housing starts? Or how could failures of financial institutions travel time to kick off the decline in housing starts before they started failing?

The delinquency rate on single family residential mortgages averaged 2.2% between 1991 and 2007. Let's presume that wasn't a time of extraordinary caution and thus that 2.2% represents a reasonably ordinary rate of delinquencies. That rate dipped below 2 in 2003 and didn't get back up to 2 until the fourth quarter of 2006. Delinquencies didn't climb past 2.2% until the 2nd quarter of 2007, over a year after housing starts began plummeting. It seems quite clear that since there was no rash of delinquencies until well after housing starts crashed, we can't reasonably blame the decline in starts on the delinquencies. In other words, failing sub-prime loans simply don't work as an explanation without time travel.

Chart of Delinquency Rate On Single Family Residential Mortgages from 1991 through Lesser Depression

Bank failures run a similar course. None in 2006 while housing starts drop sharply. Three in 2007. But 25 in 2008. Housing starts fell off the cliff long before banks started failing.

But then, what did go along with the housing starts decline? Why did they stop starting so many? Could it be that folks stopped being willing to pay ever higher prices?

Chart of S&P Case-Shiller 20-City Home Price Index and Housing Starts: Total: New Privately Owned Housing Units Started from 2000 through Lesser Depression / Great Recession

Yep. In early 2006, housing prices tapered, peaked, and then started dropping a bit. And then they went flat for a while. Sellers resisted selling for less than they'd hoped a few months earlier. It's easy to understand reluctance to drop prices when it had so recently been a sellers market. But before long, prices joined in at the same angle of descent they'd set up in housing starts. Of course those two declines would feed into each other. With prices no longer rising and worse declining, it just doesn't make sense to build as much.

And what happens when we don't build as many houses? There's a bit of lag in effect. After all, once a start happens there's usually a few months of building. But as some months go by with a continuing sharp drop in house component orders and furniture sales, we get a decline in employment.

Chart of Employment Rate: Aged 25-54: All Persons for the United States and Housing Starts: Total: New Privately Owned Housing Units Started during the Great Recession / Lesser Depression

And once we have a decline in employment, fewer people can afford houses and fewer people can hold off on selling houses ... at any price.

Chart of Employment Rate: Aged 25-54: All Persons for the United States and S&P Case-Shiller 20-City Home Price Index during the Great Recession / Lesser Depression

In short order, not long after employment started down from the October 2006 peak, the bottom fell out from under house prices after March 2007.

Which brings us to the 2nd quarter of 2007. Remember that? That was when delinquencies started up past the norm for the preceding decades. So here's the question: did all this happen because collapsing sub-prime loans hopped a ride on Dr. Emmett Brown's DeLorean back to before the home prices, housing starts, and unemployment all started down? Or should we perhaps consider that maybe reality actually went in chronological order?

What came first? Home prices stopped rising and housing starts fell. Then unemployment. And we don't get into issues with mortgage-backed securities and complex derivatives until after those three got together. Can someone show us a working time machine or reference to all of this in Nostradamus? If not, no matter how much sub-prime loans and Glass-Steagall's repeal might have made the aftermath worse, it might make sense to presume they didn't have a thing to do with causing the whole mess.

No comments:

Post a Comment