Before looking at the household sector, a client asked me this week what the US needs to do to get out of this slump. My response sounded eerily similar to Ronald Reagan. I googled some memorable quotes from our former President and selected a handful that resonated with me. It is amazing how universal they are and how true they ring still today.
We’ve tried spending our way to prosperity for more than four decades and it hasn’t worked. . . . Twice in this century, in the 1920’s and in the early 60’s we cut taxes substantially and the stimulant to the economy was substantial and immediate.
The nine most terrifying words in the English language are, ‘I’m from the government and I’m here to help.’
The government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.
Well, back in 1980, when I was running for president, it was all so different. Some pundits said our programs would result in catastrophe. Our views on foreign affairs would cause war. Our plans for the economy would cause inflation to soar and bring about economic collapse. I even remember one highly respected economist saying, back in 1982, that “the engines of economic growth have shut down here, and they’re likely to stay that way for years to come.” Well, he and the other opinion leaders were wrong. The fact is, what they called “radical” was really “right.” What they called “dangerous” was just “desperately needed.
The way I see it, there were two great triumphs, two things that I’m proudest of. One is the economic recovery, in which the people of America created–and filled–19 million new jobs. The other is the recovery of our morale. America is respected again in the world and looked to for leadership.
The economy isn’t stalling because of a lack of ingenuity, a lack of capital resources or anything of the sort. It is failing for philosophical reasons. Our country was founded on 2 concepts, equality and freedom. If one embraces equality and neglects freedom, he is prone to endorse socialism. Reagan embraced freedom in conjunction with equality of opportunity. We are closing in on 25 years since the fall of the Berlin wall, proof that it is freedom and equality of opportunity that produce invention and growth. Winning the Cold War isn’t game, set, and match. We have won the argument that freedom is the correlated factor, but now the playing field is more competitive and we must move away from current policy in order grow. Social Security contributions in our country are 57% higher than the OECD average. If you want to know why companies aren’t hiring, look no further than legislation passed in the past 2 years; the health care reform bill comes to mind.
It seems apparent that current levels of government spending and the mandated benefit costs passed on to employers lower the competitiveness of our companies and move economic activity elsewhere. Europe has the same issues. Banks are leveraged and suffering from a lack of economic activity. So my answer is to restore competitiveness, take the burden off of corporate America, and stop protecting citizens from themselves; embrace freedom.
What questions might we ask to infer the ability of the households to purchase real estate? How are households doing on income v. expenses? The National Association of Realtors puts out an affordability index that equates current median income, median house price and current lending rates which we will see at the end of the narrative. But let’s see what insights we may draw by going through a more thorough exercise.
Below we see real personal income rising at an annual rate of 2.5%, while real personal consumption expenditures are rising at 2.3%. But real disposable income is not keeping pace, rising a mere 1.2%. The trend here is not positive.
Are potential purchasers feeling hesitant because they are not able to save as much as they want? Might there be a debt burden on households that is eating away at their purchasing power? Purchasers of homes are forward looking and current monetary policy and job market indicators would likely make potential purchasers nervous. The 2 biggest reasons for saving are retirement and liquidity. Looking at the savings rate of households there are 3 conclusions I can draw.
First households are nervous about the likelihood of future cost increases and are saving more today than 5 years ago. Second, households do not want a repeat of the recent experience and are saving to give themselves a bigger buffer against recession. Third, lenders are requiring larger down payments on real estate and households must save in order to qualify.
Let’s look at their balance sheet, starting with consumer credit.
Consumer credit began contracting in September of 2008. Consumers mainly paid down revolving lines of credit, forgoing discretionary purchases as interest rates on unpaid credit card balances became onerous. Non-revolving LOC’s such as auto and student loans suffered less as the ability to get to work and fund your education are higher priority investments than a new pair of shoes. Consumer credit growth returned positive in October of last year, a good sign for the health of households and the economy overall.
A brief look at where households have their savings and investment. The 3 primary areas of investment for households are financial assets, stocks, bonds, mutual funds; real estate holdings; and non-corporate assets, private family businesses, LLC’s and partnerships. The graph below shows the relative value of these investments.
The more liquid assets – financial assets – have been sold by households trying to stave off foreclosure and pay down debt. Financial assets have recovered where real estate holdings have not. As seen below, 75% of the wealth in this nation is stored in legacy investments with imbedded capital gains. How much money new purchasers have will depend much on incomes and the ability to get a mortgage. The remaining 25% of financial assets on household balance sheets are unencumbered by tax liabilities and thus become fungible assets more likely to be exchanged for real estate.
The fact that such a large portion of wealth in this country is legacy assets leads to some interesting dynamics. The government has a potential windfall embedded on household balance sheets, as the majority of wealth is in the 65+ age demographic.
What will they do with inheritance taxes? There are 2 scenarios. They may take/use this money to pay for current spending and past debt; or they can free the capital, leaving it in the private sector for more prudent investment in our future.
These insights lead us to look at current income and employment measures as preferable factors related to new real estate purchases. Debt levels look contained in the personal sector.
So, the ability of consumers of housing to purchase real estate seems dependent on current income v. household expense. As seen above, the trend of the 2 series is not favorable. Future purchasers need a down payment; disposable income and savings will need to outpace consumption expenditures; or Susie and Ron, newly married at 30, need a gift or loan from mom and dad.
So how is future employment looking for these young Americans seeking the American Dream?
Economic Growth and Unemployment
GDP growth is declining and job creation follows. The main take away from the entire exercise is that the potential buyer of houses is doing ok today; houses are affordable and households appear to have the wherewithal to buy. Whether they have the confidence to take that step is another story.
Participants in markets are forward looking and families are wary of their future prospects. Monetary policy is such that inflation is a concern. House buyers are delaying purchase in favor of saving and feeding their families. Job prospects are dim and fiscal policy is scary. Our leaders are not instilling the confidence families need to make the most major purchase of their lives, a new or first home. Rhetoric is worth nothing. Our leaders need to take action to provide confidence to the citizenry. The actions of our leaders over the past decade leave households mistrusting and uncomfortable with current and future economic prospects. A big step in the right direction would be to resolve the fiscal standoff and normalize monetary policy.
Next week we will take a closer look at supply and demand for real estate. We will look at rentals and sales. Is there growing demand? Are households delaying purchase in favor of renting? What is the current vacant inventory situation? Is there potential upside in the real estate sector?
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