Recovery vs Rebound

We all are aware that the economy has had a massive correction in which we had tremendous asset revaluations in housing and the stock market. There are sign that the bottoms have been reached and that we are looking at the end of the recession and the start of the recovery. However, some who hear this act as if the economy was about to rebound back to its former levels. This is extremely unlikely to happen and what we should expect is fairly slow growth.

The primary reason for this is that housing values have shrunk so much. I read a number of economic papers this weekend arguing over whether housing wealth impacted consumer spending. One study said it did not, but briefly acknowledged that while wealth in housing was somewhat locked, it was possible that there was a secondary effect related to borrowing against that wealth. With all due respect to the authors of that study, no one goes out and spends their houses. Spending has been directly related to growth in apparent wealth related to either refinancing, HELOCs or trading up. This money has fueled the consumer driven economy and unless housing prices were to rebound, it is not coming back.

There is another impact, but possibly one that will settle itself down. Some of the areas heavily impacted by the housing crisis were areas in Florida and Arizona, as well as California and Nevada. Now, as far as Florida and Arizona go, there has been a long range trend where retirees sold homes in the north and purchased homes and/or condos in those areas. This has slowed down tremendously because retirement rates are down and people feel that the prices for their northern homes are too low for them to sell. However, clearly the relative value of homes in much of the North has actually increased in comparison to homes in Florida and Arizona and when this gets marketed properly, assuming there are buyers for the Northern homes, we may see a resumption of that trend (retirees fueling home buying in Florida and Arizona).

Let me return to the main point I was making. Real estate values are widely depressed, but as always it has to do with location. However, the wealth lost is simply not coming back quickly. Now, for those who didn't actually lose their homes, this may be worse than it is for those who did.

Suppose you have a house that has been finance at the 80% level in an area that has seen prices drop by about 20%. Well at this point you have no equity but you are not underwater. Even if you go slightly underwater or maintain a small amount of equity, you cannot refinance and it will probably take a rebound in prices to a level above previous ones to be able to "mine" your home for spending or retirement money. Since this is probably unlikely for a number of years, the only available spending is discretionary earnings and other forms of credit. I could develop a mathematical formula for this, but trust me, it is a lot less available for spending.

Now suppose you lost a house or never had one. You, assuming you can get credit and a down payment have the opportunity to buy the same or similar house for a lot less and start off with say 20% in equity. Even a modest increase in price may provide you with a source for home equity loans or refinancing. However, it is not going to match prior spending levels when you consider the slow increase in housing prices and those who have lost their equity positions.

So, if we have lost x amount of housing wealth (equity) and therefore have lost the spending from loans associated with that amount the only way to replace it is by restoring that wealth. Well, I can find no scenario where that is going to happen quickly.

So, our consumer driven economy has no potential to "rebound". It will start to recover meaning that having reached a level of GDP significantly lower than it was, we will see it increase slightly. This growth will require adjustments to a reduced level of economic activity until we fix the energy sector and grow our renewable energy industry.