From a small northwestern observatory…

Finance and economics generally focused on real estate

3/22/09 — Newsletter this week

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The past two weeks have been busier than usual due to a pair of expert-witness trial testimonies in Kansas City. (Congrats to our clients, by the way, who prevailed with flying colors!). This coming week is slightly relaxed, then I’m off to the races again for a couple of weeks, including a trip to Louisiana and some other projects here in Seattle.

In the meantime, our monthly newsletter, The Greenfield Advisor, is slated to come out this month. We had planned to unveil our new trophy property index this month, but now I believe we’ll defer that for a couple of months. This month, our newsletter will summarize our economic forecast for the 1st quarter, with emphasis (of course) on the implications for real estate. I’ll unveil this forecast at a luncheon presentation to Seattle’s “Belden Club” at the Seattle Yacht Club on Tuesday.

The crux of the forecast depends on which of two economic theories you buy into — is this recession “normal” (albeit far deeper and longer than usual) or are we looking at a real structural shift in the economy?

It’s hard to point to specific phenomenon and say, “Aha! We have a structural shift on our hands!” because these events are so rare and ideosyncratic. Recessions are easy to spot, at least in the rear-view mirror. String together a couple of quarters of negative GDP growth, and you have, definitionally, a recession. However, once a recession is over, people go back to their jobs, asset markets make-up for lost time, and generally all of the trend lines are back where they were before the recession began.

There’s a lot to suggest that this time will be different. The obvious one is the housing price bubble — Moody’s in a report released last month predicts that the Case-Shiller Index will retreat a total of 36% before it bottoms-out in the 4th quarter of 2009. That’s not only unprecidented, it also implies a massive loss in household wealth which will take many years to re-coup. Unfortunately for many families, time is not on their side, since the crest of the baby-boom — currently in their 50’s — were looking at this accumulated equity as a major source of retirement cushion. Coupled this with the declines in the stock market — household wealth buried in the equity market (either directly or indirectly) was another significant source of retirement cushion.

Some economists think the real clincher is the pay-down in household debt, which began last year and will probably accelerate this year. There’s a double-whammy there — much (most?) of the pay-down is being done by the most credit-worth households, leaving credit card companies seeing a real shift in the aggregate credit-worthiness of their borrowers. This is happeneing at the very time when the credit card companies themselves are seeing significant retrenchment in their lines of credit. Credit card companies are left with no choice but to curtail credit limits, thus forcing less credit-worth households to either pay-down or default. Since many households were already running permanent balances, and using the monthly pay-down as their revolving purchase line, the impact on household consumption is obviously severely negative.

If we ARE in a structural shift, then the impacts will be felt differently in the U.S. and abroad. Domestically, we’ll look a lot more like the 1970’s but without the inflation. The stock market will trade in a narrow band, and without inflation, bonds will look better than equities. Younger workers coming into the job market will see stagnating expectations, with older workers deferring retirement and an economy that won’t sustain significant job growth.

Abroad — Asia and Europe will be basket cases. The more conservative oil countries (Saudi Arabia comes to mind) will fare well enough, but the economies that bet the whole farm on $100 oil (Venezuela comes to mind) will quickly go into downward spirals. Don’t even start talking about sub-Sahara Africa. Japan — already suffering — from an aging population and a stagnant economy, will face political turmoil. China may be the worst hit — they’re more than happy today to loan us whatever money it takes to get the U.S. economy rolling again, since we are the engine that pulls their 8+% GDP growth. The U.S. could face two choices — either fund our domestic recovery with severe devaluation of the dollar (a distinct possibility) or hunker-down with protectionist legislation (anyone read what a good idea this was in the 1930’s?). Either case leaves China headed back to subsistence rice farming. A significant structural shift in the U.S. away from a consumption-driven economy basically puts us and China in the same position anyway, albeit indirectly rather than directly.

I’m personally leaning 60-40 in favor of a believing in a structural shift. The Obama Administration, at its core, believes in stronger domestic-spending by the U.S. government on things like education, health care, and domestic infrastructure. All of this shifts money away from consumption and toward government expenditures. GDP grows, but the mix of components that gets us there is lower consumption (or at least lower growth in consumption), higher growth in government spending, and a dampening of the import/export red ink.

What are the implications for real estate? More on that in my next post.

Written by johnkilpatrick

March 22, 2009 at 8:17 am

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