As soon as I saw that housing starts had plummeted in January, to their lowest level in 10 years, wiping out the modest gains from November and December, I wondered what economist Dean Baker would say. Some analysts have been quick to cite recent upticks in housing economic indicators as signs that the bust has finally bottomed out, but Baker had been cautioning against getting carried away.
Sure enough, while warning, as he usually does, not to make too much of any single month's statistics, there he was, pointing out in his blog why the new numbers should perhaps be taken more seriously than the mildly good news from December. When reviewing housing start numbers, always check the weather! Baker had previously observed that the good numbers for starts in December were primarily in the East and Midwest, which experienced an unusually warm month. But there was little corresponding bad weather in January to explain the January figures.
But Baker's post, titled "Housing starts plunge: What will the 'experts' say?" also included a somewhat plaintive plea:
The reporters who write up this release will no doubt speak with many analysts who will express their surprise at this sharp downturn. It would be helpful if they also sought out the views of analysts who were not surprised. Presumably being right does not disqualify someone from being cited in news reporting.
To hear is to obey! How the World Works reached for the phone.
Baker first reiterated his points about the weather. But then we cut to the chase: What could the numbers mean for the health of the U.S. economy in general? I asked him about the news this week that both Florida and California were reporting significant under-budget revenue numbers in January that they were attributing to the housing bust. Wouldn't the bad housing start numbers portend that more bad budget news was to come?
Baker agreed. "You might see some serious shortfalls," he said. One problem, he noted, was that at the state level, budget predictions are hardly an exact science. According to Baker, in many states, budget planners just did "straight line projections" from the revenue collected the previous year: In other words, they didn't just assume that they would get the same amount of tax revenue, but that it would grow at the same rate as it did in previous years. For any revenue associated with housing (sales taxes, housing transfer taxes, income taxes related to the construction industry), that just wouldn't be true.
But why are so many analysts willing to declare the bottom has been reached?
"The long and short of it is: You have a lot of people who are anxious to see the turnaround, and looking desperately at single-month data. But I have a hard time seeing the conditions for that. There is still this huge overhang of unsold homes, along with a huge inventory of vacant homes, which is also an indication of possible financial stress. Foreclosures are rising very rapidly."
Baker's reference to foreclosures brought up the second big question about the ultimate ramifications of the housing bust. The collapse of the sub-prime lending sector has led some financial analysts to wonder whether there will be a cascade effect on Wall Street that hurts the investors who have been buying and selling complicated financial instruments -- credit derivatives and other exotic fare -- that are directly or indirectly tied to the health of the housing sector. Has risk been spread around enough that Wall Street can ride out any storm? Or has the moment of truth for a largely unregulated and opaque system finally arrived?
First Baker speculated that the trouble currently being experienced by sub-prime mortgage lenders will spread into standard loans. If prices continue to fall, many homeowners will be holding mortgages whose value is greater than what they can sell their home for, he said.
"The problem will go well beyond sub-prime. We are going to see higher default rates on standard loans."
That in turn will increase the pressure on institutions and investors who have been speculating on such things as mortgage-backed securities. It won't just be the riskiest bets that blow up in hedge fund investor faces, but even some that were considered "safe."
"But we really don't have any idea how exposed the hedge funds are. No one knows how much they are leveraged. But there must be a lot of people exposed to far more risk than we understand, because you don't get the really high returns [enjoyed by hedge funds] without exposing yourself to a lot of risk."
So what's going to happen?
Dean Baker doesn't know. No one knows!
"We are just shooting in the dark," he conceded.
It's always refreshing to hear an economist tell you that he doesn't know what's around the corner, and not to make too much of the startling numbers of the day. But it's also a little nerve-wracking to ponder how much it is that we are ignorant about.