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Jim Scott
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Hold the Champagne

Metro area housing statistics show the residential real estate market is much improved from a year ago. When compared to the fall of 2011 or the fall of 2010, nearly every metric indicates the Great Recession in real estate is passing. The Federal Reserve Board, fearing a deadly deflationary cycle in house prices, aggressively intervened in the mortgage market and halted the free fall of prices. The numbers show the results of those efforts. For example, the number of distress sales and foreclosures has dramatically dropped and traditional equity sales have substantially increased. Owners have recovered about half of their losses they suffered so quickly in 2008 and 2009.  

This does not mean it is time to break out the champagne. What you read in the papers is old news, and as they say in the financial world, past performance is no guarantee of future performance. The Fed is keeping the house market on life support and must continue to do so for at least the next twenty-four months. Mr. Bernanke’s printing presses will be kept busy until unemployment approaches six percent. Can you imagine what this market would look like if mortgage rates were six or seven percent?

Mr. Bernanke was quick to recognize that keeping short term rates effectively at zero did little to boost housing. Although controversial, he moved aggressively with his quantitative easing and ‘operation twist’. Just last month for example, the Fed injected another forty billion dollars, the first phase of QE3, into the financial system, using freshly printed greenbacks to buy up mortgage-backed bonds, forcing 30-year fixed mortgage rates to historic lows. Conventional economic wisdom holds that housing always leads the national economy out of recession. Low long term rates, the thinking goes, will spur housing starts and resales, which will in turn create more growth in other parts of the economy. An ancillary benefit, saving struggling homeowners with historically cheap refinance money, will also benefit the financial system and provide a floor under home prices. A little inflation is usually not be bad for real estate and the economic effects of a robust recovery in housing will have a multiplier effect on the rest of the economy.

Unlike his obtuse predecessor, The Chair is being transparent as possible and has repeatedly stated that cheap money will be available until mid-2015. This strategy, however, does not completely insulate residential real estate markets from potential problems that could arise from global markets, the political environment, or from potential structural budget changes now being discussed in Washington.

First, the economies in Europe and China have been underperforming and could easily derail America’s fragile recovery. San Diego’s job base will shrink if those economies cannot reverse their respective declines in growth rates. Local economies have become players on the world stage and poor growth in countries that are major trading partners with America will have negative employment consequences in San Diego.  

Next and perhaps more importantly, the political drama being played out in Washington is of more concern. I believe we will not see the automatic defense spending cuts that would come from sequestration. Cooler heads inside the Beltway will work out a budget deal after the heat of the Presidential campaign fades away. There will be some grand compromise this time around and it is likely there may be less Federal swag in these parts.  We can only hope the advantages of San Diego’s geography and military infrastructure will carry the day. Second, Mr. Romney has said if elected he would replace Mr. Bernanke in early 2014 when his term expires. Presumably he would replace The Chair with an inflation hawk and fiscal conservative who would be expected to rein in Mr. Bernanke’s accommodative policies. This could have little or no effect on the market if the patient is off life support, a possibility by 2014.

Finally, our regional income has always been based on defense spending, tourism and real estate development. We are inexorably moving into an era of shrinking government resources and I think the Department of Defense will not be spared. No matter which party gains power, the future of how this country decides to defend itself and project power abroad will impact local home prices.

True, the region’s economy is more diversified today but I have seen this movie before. It was in 1961 that the Secretary of Defense, Robert McNamara, attempted to revamp and streamline the Department of Defense. The re-prioritizing of defense and government spending sent San Diego’s economy into a bust nearly as bad as the Depression. A more recent example was the bloodbath in rental housing following the deployments resulting from Desert Storm in 1991. Vacancy rates in some cities were well over twenty percent, leading to a cycle of declining asset prices and foreclosures. It is hard to believe the military will not be in for a makeover.

In spite of these risks, the Fed under Mr. Bernanke will not throw housing under the bus. I believe the market is close to the beginning stage of the next long-term cycle. Moderate inflation in housing will be the goal and ensuring that, in the face of globalization and myriad other risks, will be the Federal Reserve Board. The future market will resemble the old one; the postwar period before the first oil shock of 1973.  Homes were not a commodity to speculate on but a utility and moderately increased in value. All of us will be better off when this occurs. The hard part is getting through the next two or three years without a relapse.

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