Aug 30 2006 12:30PM | Permalink | Email this | Comments (0) |
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The 2006 housing slowdown was largely set off by the loss of speculative demand at the top of the market rather than the more typical loss of entry level demand at the bottom of the market. The current slowdown comes more from a problem unique to the housing market than from deterioration in the overall economy. So this slowdown will progress differently and the impact on different segments of the construction market will be different than what you may remember from the last extended housing slowdown in 1990.

Indeed the current housing slowdown has more in common with the 2000 Internet bust than with the housing market crash in 1990.

Here is what happened 16 years ago. Housing starts fell near 50% from January 1990 to January 1991. During that period, 30-year fixed mortgage rates were over 10%, employment declined, the unemployment rate rose one percentage point, the CPI increased 5.6%, the Consumer Confidence Index fell 50 point from 105 to 55 and GDP declined 1%.

While economic growth has clearly slowed this year, the slowing is minimal compared to 1990. Later this year, and especially next year, housing demand will be weakened by the weakening economy but so far most of the damage in the market is from the decline in speculative demand.

Recall how the Internet bust developed. Telcom companies believed that they could sell all of the network capacity that they could build. Speculators joined in and soon more network capacity than the world would need for many decades was under construction. The last sentence is also an apt description of the 2005 Miami condo market. Then the surplus capacity caused network user fees to plunge and construction came to a halt. This is also an apt description of many resort condo markets in spring 2006.

The adjustment to a realistic demand level for network capacity caused the bankruptcy of many with a financial commitment to capacity than no longer needed to be built. Some manufacturers specializing in network equipment experienced several months of more cancellations and returns than new orders. This may be happening now at some condo projects in the southeast and southwest.

A market slowdown set off by the collapse of speculation causes a loss in sales and profits for the speculative developers not able to built what they had planned to build and the speculative investors caught owning surplus capacity whose asset value plunges. However, the loss to contractors and their suppliers is much less because they did not year have the orders for the projects in the planning phase when the bubble began to leak.

Contractors and their suppliers in the interior of the country — away from the rapid speculation on both coasts — will suffer no direct loss from the end of speculation but eventually will be hit by a modest decline in housing demand that comes indirectly from the end of speculation via less spending and confidence in the aggregate economy.