|Housing History: Is it 1986 or 1929?|
Housing stocks got a nice pop this week, as both Barron’s and the Wall Street Journal called luxury homebuilder Toll Brothers a buy. Interesting timing, this. Why would such usually-sensible papers talk up a cyclical industry at the peak of its cycle? Well, it seems that the big home builders have diversified into lots of different regions, and used their financial muscle to buy up all the good home sites. This makes them immune from a mild slump, which is what their fans expect. As the Wall Street Journal put it:
“That's why the bulls need this housing slowdown. They are expecting that the companies will be able to have some earnings growth, grab more market share, and throw off enough cash to buy back stock to shore up their share prices.”
So the idea that the homebuilders—and by extension, I guess, the mortgage lenders and big consumer banks—are a buy hinges on the severity of the housing slowdown. If it’s modest, as the past few have been, then the homebuilders, trading at, like, 6 times earnings, will push their weaker local competitors off the field and emerge even stronger and more valuable. And based on the behavior of housing starts since the 1980s, that doesn’t seem too farfetched. Starts have fluctuated, sure, but they haven’t fallen by very much for very long. A few years of modest decline is the worst recent history says to expect. The leading homebuilders would breeze through another 1990 or 2001 without a scratch.
Unfortunately for the homebuilders and their investors, the history on which they base their optimism has another component: Leverage. While housing has been doing its onward-and-upward thing, Americans have been borrowing like crazy, mostly to buy, you guessed it, houses. And once inside, they’ve been sucking out the remaining equity via cash-out refis and home equity loans. It’s the perfect self-reinforcing cycle: Home prices go up because we can borrow, and we can borrow because our homes are going up.
In 1985, total U.S. debt came to a not-inconsiderable $55,000 per person, or $220,000 per family of four. Two decades and 25 million new houses later, those totals have risen to $140,000 and $560,000, respectively. Our debt burden is now three times the size of the economy.
For the brief-slowdown-followed-by-another-building-spree thesis to work out, you have to assume that Americans will spend the rest of the decade borrowing two trillion more dollars each year. And for that to be possible you have to assume that America’s trading partners will buy another $700 billion of new Treasury bonds each year without demanding a higher interest rate. Who knows, maybe they will, and the housing bubble will inflate for another decade. As an economist said to me on a radio show a while back, “People have been complaining about American debt for thirty years and it hasn’t slowed us down. This economy can handle whatever amount of debt we care to take on.”
But what if this time a different bit of history is about to repeat? Since we’re borrowing like it’s 1929, maybe the housing market will start behaving that way too. Here’s what happened after that debt binge: