Happy days are here again?

Economic indicators are perky now, but the day of reckoning still awaits.


Andrew Leonard
February 23, 2006 1:00AM (UTC)

Scanning the business press headlines this morning, you'd think everything was just peachy keen in the U.S. economy. The index of leading economic indicators, a grab bag of monthly statistics designed to give a snapshot of the current state of affairs, significantly outperformed economists' expectations. Claims for unemployment benefits fell, building permits rose and factories ran full tilt. Never mind that blip on the radar that suggested growth during the last quarter of 2005 was a piddling 1.1 percent. The economy is back in action. Good times are here again.

But hey, what about that looming housing crisis we keep hearing about? How's that going? While doing some research on household debt this morning, I ran across a paper published by the Levy Economics Institute of Bard College that provides one of the better in-depth analyses of why the housing boom is poised for a major retrenchment. That, in turn, encouraged to me to head to the Web site for the National Association of Realtors and review the last few months of housing market statistics.

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It's not a pretty picture. Since September 2005, sales of existing homes have dropped each month, and sales of new homes are also down from earlier highs. Meanwhile, mortgage rates have been on a steady upward rise for a year. The one bright spot for the housing market has been a huge burst of new housing starts, but a) that can be largely attributed to one of the warmest Januarys in history, and b) if anything, a plethora of new homes on the market may end up making the inevitable downturn even worse.

Now it's true, if you go back to the third quarter of 2005, the housing market in the United States set all-time records in virtually every category, so even though some indicators are on their way down, the overall housing market is still quite healthy. But there are plentiful reasons to be wary. As noted here before, since 2000, home buyers have increasingly turned to adjustable-rate, interest-only mortgages and other "innovative" financial instruments to finance their purchases of new homes, or to engage in cash-out refinancing of homes they already own.

In 2000, wrote David Streitfeld in the Los Angeles Times, only 2 percent of California homeowners relied on interest-only loans to purchase their homes; in 2004, 48 percent did.

As noted in detail in the Levy paper, interest-only mortgages usually defer any payment on principal for a period of years, but when the reckoning finally comes, if interest rates have risen in the meantime, mortgage payments can and likely will take a big jump upward. Since rates are climbing and are predicted to climb further, that means that in the very near future, a whole lot of new homeowners, many of whom had pretty bad credit to begin with, are going to be faced with substantial new financial obligations.

But Americans are already more in debt than ever before, as measured by virtually every indicator. There is no margin for error. And on that slim thread, the weight of the global economy hangs. Which is why central bankers and economists all over the world are watching every monthly release of U.S. housing market data like hawks. The indefatigable American consumer has long been willing to go that extra mile of debt to just keep on buying. But some day the music is going to stop.

There is one silver lining: Should the bubble pop, you won't hear much complaining about the trade deficit anymore. Because all of a sudden, it won't be there for anybody to kick around.

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Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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