UW economist: Strong housing prices might not return for five to 10 years
Morris Davis is known as an astute economist, especially in his area of specialty, housing, but he acknowledged that he’s been “horribly wrong” about the staying power of this recession and the national housing slump that helped cause it.
“This one looks like it’s going nowhere fast,” Morris stated in a recent In Business radio interview. “I have no reason to believe we’ll have a particularly strong recovery.”
As a result, Morris, the one-time advisor to former Federal Reserve Chairman Alan Greenspan who now serves as director of the James Grasskamp Center for Real Estate at UW-Madison, does not expect what he called “honest” housing prices to rise back to 2006 levels for another five to 10 years.
In Wisconsin, where sales of existing homes rose 10.8% in January over the same month in 2011, the picture is somewhat brighter than it is nationally. However, the impacts of the housing slump still are being felt, as demonstrated by the closing of Soref’s Carpet City in Milwaukee after 49 years in business. News of Soref’s closing followed the demise of Appliance World, another longstanding Milwaukee business that recently closed due to the struggling housing market.
The housing situation, which impacts small businesses, will turn around “when we start seeing real employment gains and real income growth,” Morris said. “If incomes rise and interest rates stay under control, we should expect a modest rise to house prices over time.”
Morris noted the housing market has been coasting along at a relatively low level for house prices, and it’s actually much harder to get a mortgage loan now than it was two years ago. The lack of availability of mortgage credit to people who would have otherwise qualified a few years ago continues to depress the market, and many people have stopped looking for work – 1.2 million in January alone – due to what Morris called “tremendous labor market distress.”
Morris said it’s somewhat odd that in previous recessions, when the downturns were sharp, the upturns were equally sharp just a few years later. This time, the recovery is more sluggish. Democrats attribute that to not understanding the full severity of the downturn they inherited, while Republicans lay it at the feet of President Obama’s tax and regulatory policies.
Learning from Japan
Whatever the explanation, Morris said the best comparison for what the United States is going through is Japan in the 1990s, when that nation experienced what has become known as a lost decade.
“We could be in for another three years of tepid growth overall,” he warned. “The overall economy and housing are linked.”
Morris believes there are lessons to be learned from Japan’s experience with prolonged economic doldrums. In the 1990s, Ben Bernanke was critical of Japanese policy, which emphasized stimulative infrastructure spending – most of it not as useful as advertised – over expanding the money supply. Now that Bernanke is Federal Reserve Board chair, the U.S. is trying to do what the Japanese did not do, Morris said, including more aggressive monetary policy with quantitative easing.
Critics blast “QE” as an inflationary risk, but the Federal Reserve is determined to avoid the mistakes made by the Japanese Central Bank, Morris said. “The United States has been more aggressive. It was quite painful but we made sure that banks are well capitalized.”
Banks not only have more capital on the books, they also have tighter lending standards, which is the reason that it’s harder to get a mortgage loan. The lack of a unified federal policy hasn’t helped, nor has the government’s decision to sue the banks, and nor has a lack of leadership at the Treasury Department, Morris said.
“I just find it odd,” he continued. “Bank balance sheets are the healthiest they have been in awhile. Why have tough lending standards for mortgages right now, when housing prices are at the bottom?”
Morris said banks should have had tough lending standards in 2005, when people were starting to raise concerns about a real estate bubble. “If we had tighter standards then, we’d have less of an issue than we do now,” he stated. “We don’t need them now. Banks were forced to have more capital. They were forced to pass stress tests, so our banks are in better position than Japan’s banks.”
On the flip side, banks face losses on their commercial real estate loans, and Europe is “in deep trouble,” Morris noted. “We don’t know how large an exposure U.S. banks have to the sovereign debt problem in Europe, or whether our banks are holding a sizable portion of European sovereign debt.”
Davis said the opposing responses to economic contractions, what he called “salt water” versus “fresh water,” date back to the Great Depression. Salt-water advocates prefer robust government spending programs to stimulate demand, the so-called Keynesian approach. New York Times columnist Paul Krugman, who argues that the 2009 stimulus program did not go far enough in terms of ramping up spending, is one of its devotees.
Fresh-water evangelists counter that government policies during the Great Depression, which featured unprecedented government intervention in the economy, actually added uncertainty and made it more difficult for employers to hire and for capital to find its most productive use. They say something similar is occurring today, given the regulatory thrust being unleashed by the Affordable Care Act and by the Dodd-Frank legislation.
“We are having exactly the same debate now,” Morris said, “and I don’t see it being settled anytime soon.”
Morris also commented on the delicate two-step that will be needed to keep inflation in check. “In Europe, they will inject hundreds of billions of euros into their banking system to prevent a collapse, but you can’t just print money and not expect things to happen,” he explained. “We’ve done similar things with quantitative easing. The Fed has bought long-term treasuries from banks and replaced it with cash. The banks have put the cash under their mattress and called it reserves. The trick is, will the Fed be able to withdraw the cash they call ‘reserves’ before banks start lending it out with such force as to cause inflation? Does it have foresight to do that?”
He believes the Fed will take the necessary action if unemployment remains about 8.5% and the inflation rate creeps up to 4% or 5%. “I know a number of the presidents of the Federal Reserve Banks,” he said. “They are inflation hawks.”
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