Will the US Downgrade Sink the Housing Market?
It won't help consumer confidence, which doesn't bode well. But if inflation is coming, more people will want income-producing properties.
And here we are.
Miraculously, however, the sun still rose in the east. Alarms blared, coffee brewed and traffic, as it's apt to do, ground to a halt. The world has not yet ended, but it is surely not the same place it was 72 short hours ago. Over the weekend, political leaders and banking chieftains huddled, preparing for calamity. They sent out soothing words, aiming to calm jittery investors. Markets didn't crash, but they are indeed teetering.
Meanwhile, the pundit class rushed to make its typical sage forecasts and deft assessments of S&P's downgrade. Predictions for bonds, equities, commodities, and pretty much every other asset class are opaque, at best. Consensus remains unsurprisingly elusive.
So what about housing? Commentators are now busily rehashing S&P's blunders in the years leading up to the collapse in property values, a shrill reminder that there once were firms called Washington Mutual (JPM), Wachovia (WFC), Bear Stearns, and Merrill Lynch (BAC). Residential real estate, like the rating agency's credibility, remains fragile.
Chief among housing market concerns is the degree to which the downgrade will damage consumers' already dour outlook for the economy. Today's housing market continues to be highly-sentiment driven, with conditions fluctuating week-to-week, even within individual markets. On the morning after the debt-ceiling agreement last Monday, the phones at my real estate firm were busier than they had been in weeks, with everyone from hedge fund managers to contractors expressing relief that with a deal struck, we could all get back to work.
Focus has now shifted to figuring out what this downgrade actually means. A dreary task for an already pessimistic group. Last month, the University of Michigan's widely watched consumer sentiment index slipped to its lowest level in two years. And employment, which is inextricably linked to housing, is really just a reflection of confidence. Given the vast uncertainty already stemming from Friday's historic downgrade, American consumers are not likely to be overly eager to embark on large-scale purchases. Like homes.
Second, persistently low interest rates have gone a long way to buoy home prices, enabling would-be buyers to either buy more house or at the very least keep housing costs under control. If US debt holders begin demanding higher interest rates for owning Treasuries, home financing costs would rise. And while this would bode poorly for home prices, the Federal Reserve, working closely with the Treasury Department, has given every indication that it will bankrupt the country before allowing market forces to push up interest rates in any material way.
The wild card in the interest rate equation is of course inflation. If prices, as measured by the Fed, move higher, policymakers may decide that raising rates is worth the economic (and political) risk. But in an inflationary world cash flows into assets, and housing is an asset. Specifically, income-producing property should fare well in a world of rising prices and rising rates.
Third, many housing commentators stubbornly cling to the notion that the backlog of foreclosed homes is due to flood the market at any time. I have discussed at length why this is a flawed assumption, that as long as not a single actor has an incentive to dump shadow inventory onto the market, it won't happen. If the S&P downgrade does in fact push the US economy back into recession, banks will be even less eager to take losses on (read: sell) repossessed homes.
Ultimately, the extent to which the downgrade impacts housing all boils down to confidence. And it can go one of two ways. If the past three years is our guide, S&P's downgrade will be seen as the latest in a string of defeats for a country that was once, economically and in many ways socially, held up as a model for first-world democracy. The loss of our AAA credit status, piled on top a deplorable political climate and real economic problems stemming from massive overleveraging, will plunge us deeper into our self-created financial chasm.
The other option, however unlikely it may appear, is certainly possible. And hopeful. The S&P downgrade could, after a period of volatile debate, be viewed in hindsight as a grand galvanizing event. That point at which the country was doused with ice water after a truly wicked hangover, shocked into the realization that there are consequences for our divisiveness and inability to face our long-term fiscal demons. And more importantly, as long as we blame someone else for our ills, we will be doomed to wallow in them.
The race is a bit too early to call. And while the smart money may be betting on the former, I'm silently placing chips on the latter. Call me a stubborn optimist.
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