You don’t have to know who Larry Summers is and you don’t need to care about macroeconomics to be interested in this story. If you are curious about the fate of the California real estate market, read on.
A sobering truth
There is a lot of buzz right now surrounding the technical economics term, “secular stagnation.” Larry Summers, President Emeritus of Harvard University and Secretary of the Treasury under President Clinton, recently used it at the International Monetary Fund (IMF) research conference. The ears of elite economists and businesspersons perked all over the world when one of the most well respected voices in economic policy finally mentioned the dreaded phrase.
Secular stagnation is a lengthy period of stagnant (read: slow) economic growth. For example, think the lethargic wake of the Great Depression. Further, think Japan’s two lost decades from the 1990s to today.
Now “secular stagnation” is being used to describe economic realities closer to home: the dire economic situation playing out in the U.S. right now.
Referring to dashed recovery expectations, Summers said:
“The share of men, or women, or adults in the United States who are working today is essentially the same as it was four years ago. [. . .] GDP has fallen further behind potential as we would have defined it in the Fall of 2009 [and] it does seem to me that four years after the successful combating of the crisis, there is really no evidence of growth that is restoring equilibrium.”
In other words, there has been no recovery in terms of real purchasing power. Nada. None, dear reader. We’ve been treading water.
Predictions come to fruition
Larry Summers is just now sharing what we at first tuesday have seen since the fall of 2009. Back then we called it the abortive checkmark recovery, and discussed it at length.
Editor’s note — See the first tuesday forecast timeline below.
In 2011, as pundits and real estate professionals discussed the inevitable double-dip, we introduced another term of art to describe our economic situation. Paul Krugman was, by this time, calling it the Lesser Depression — a term we embraced and employed where fitting. But we named the protracted period of post-recession false starts the bumpy plateau. Think of a washboard, riddled with a series of peaks and valleys.
By mid-2012, when the prevailing wisdom optimistically held the real estate market was in full recovery and resurgence, first tuesday made clear that speculators were temporarily driving a mini-bubble. Instead of increased prices from organic demand stemming from a jobs recovery, it was clear to us that we were merely in a peak of the bumpy plateau — an illusion of recovery generated by cash-in-hand speculators looking for a place to park their funds.
Call it a “liquidity trap”
Typically, in the wake of financial crises and economic downturns, we first look to the Federal Reserve (the Fed) to restore balance. One of the Fed’s two mandates is to maximize employment. The Fed accomplishes this is by acting to lower short-term interest rates to encourage private business expansion, stimulating hiring.
Currently, interest rates are at zero, known as the zero lower bound. Thus, rates cannot go any lower without going negative (see here for the possible but unlikely exception to this rule).
So what Summers is saying, and what we at first tuesday have been arguing since about a year after the bubble burst, is that, absent aggressive fiscal stimulus from the employer of last resort (the federal government), the economy simply cannot and will not “fully recover.”
As the mainstream, elite economists increasingly become conscious of the data signifying this reality, the notion of what has recently been referred to as a “recovery” is being entirely thrown into question.
Let’s put this all in the context of California real estate. Then perhaps it will be clear how your practice is dramatically affected by what otherwise might be considered economic noise.
Appearances are deceiving
At the distant dawn of 2012, first tuesday observed an unreasonable spike in California real estate sales volume. A corresponding, unreasonable spike in prices followed. We use the term “unreasonable” since we knew then the world was in the midst of a global credit crunch, which is still the case today. The fact is, historically, the middle class has never been able to purchase a home outright and thus has always relied on lender-provided purchase-assist financing to make the American Dream a reality.
This means the vast majority of post-WWII real estate purchases were largely accomplished through leveraging. As credit was simply unavailable to the average household in 2012-2013, it was clear that this anomalous spike in prices was coming from elsewhere, not end users of the property.
As it turns out, and as many are now beginning to agree, the ensuing 2013 mini-bubble was purely the result of real estate speculation. Private investors, both institutional and small, have been buying up properties with large sums of cash reserves amassed during the recession and earning those not-so-stimulating, zero lower bound interest yields.
It is a well-documented fact that corporations amassed huge cash reserves during the Great Recession, spending nothing on hiring and equipment needed in a recovery. After widespread downsizing and increased “efficiency” measures, corporate profits skyrocketed in the years following the recession.
Rather than invest in growth, big businesses saved and sat on their cash. To wit, in 2011, non-financial companies saved over $2.1 trillion in cash and liquid assets. To put this into perspective, this amount of corporate cash reserves had not been seen since records set in the 1960s.
The fundamentals of this recent trend in real estate speculation require real demand to occur in order for investors to realize a return.
Speculators cannot day-trade properties into perpetuity and expect a quick, tidy profit. Someone needs to eventually buy the home at an increased price and keep it.
As it becomes clear that this is still not a possibility as credit availability and mortgage rates remain insufficient to stimulate real end user demand, the speculative activity will die down. Further, many investors who were late to the party and ignorant of what price to pay for property will realize a significant loss.
Here’s the basic equation that ought to bring you, as a practicing real estate agent in California today, some alarm.
California real estate was entirely propped-up by an unsustainable credit bubble from roughly 2000 to 2006. This is undisputable and now a matter of history. Less clear to some — but crystal clear to the well informed — our real estate market has since been propped up by an unsustainable speculation bubble from very early 2012 until today.
May we also remind you of the fleeting support provided by the 2009 tax credit stimulus that saw sales volume, and then prices, drop during 2010 and into early 2012.
Thus, the cash reserves amassed during the recession due to savings have largely been sunk into the non-performing black hole asset of California single-family residences (SFRs) by speculators rather than end-users. What’s left is being romanced away by record-breaking stock market gambles. Both are highly volatile in reaction to any increase in short term interest rates, and those rates can only go up. Thus, prices of assets go down as capitalization and price to earning (P/E) ratios go up, like the opposing sides of a teeter-totter.
Austerity is the poison, spending is the antidote
A population boom of historic proportion, followed by the aggressive fiscal stimulus of the New Deal, arrested the secular stagnation of the Great Depression. Japan’s economy continues to suffer from a 20-year period of secular stagnation, though they are finally working hard today on assertive fiscal stimulus, known as abenomics.
The U.S., on the other hand, has confronted our current predicament with growth-stifling austerity from a do-nothing Congress.
Mr. Summers was quick to point out in his speech that our immediate response to the 2008 financial crisis was quick and effective. The potential global market meltdown was stopped in its tracks. But the following years of what ought to have been sustained fiscal stimulation have instead been five years of counterproductive brinksmanship.
As Fed Chairman Bernanke has repeatedly said, and as Fed Chairperson-elect Janet Yellen has echoed: we need fiscal stimulus now to reverse course, which only Congress can provide. Otherwise, California real estate is just now settling into a very long lost decade — maybe two.
first tuesday forecast timeline
- Fall, 2009
first tuesday coins the “aborted checkmark” term to describe the shape of the slow recovery.
- Winter, 2009
first tuesday refers to the problem of the sticky price phenomenon. As a result, the recovery would never fully take off as sellers were unwilling to price their home low enough, in consistence with the realities of the new real estate paradigm, to stimulate demand from an underemployed population.
- Fall, 2011
first tuesday discusses the bumpy plateau pattern of recovery we continue to ride.
- Fall, 2012
first tuesday recognizes the speculator-driven mini-bubble well before other media outlets and economists.
- Summer, 2013
first tuesday foresees when the mini-bubble will burst, six months before the mainstream catches on.