Diferencias entre EEUU, RU, Australia y N. Zelanda
Housing Slump in the U.S. versus UK, Australia and New Zealand: Four Differences or Why No Soft Landing for the U.S. Economy…
https://www.rgemonitor.com/blog/roubini
Nouriel Roubini | Oct 05, 2006 The ongoing U.S. policy debate on the recession risks can be summarized into two views. According to the first – still the market and investors’ consensus - the housing market will have a hard landing but the economy will have a soft landing, i.e. no recession. The second view – mine and still a minority one – is that the housing market will have a hard landing and that the economy will also have a hard landing, i.e. a recession in 2007.
One of the strongest argument of those who believe that a housing hard landing will lead to a soft landing of the economy is to point to the experience of the U.K., Australia and New Zealand, three countries where - allegedly – the housing sector bubble burst and the housing market had a sharp slump but where the economy avoided a hard landing; indeed, in these three economy the growth rate slowed down for a while but there was not recession or deep hard landing. So, the argument goes: since UK, Australia and New Zealand avoided a hard landing, so will the U.S. This argument has some superficial appeal but it hides the substantial differences between the U.S. and these other three economies that make much more likely the scenario of a hard landing for the U.S. economy. Let me elaborate on these important differences.
First, the approach of monetary policy makers to asset bubbles is radically different in the U.S. relative to UK, Australia and New Zealand.
In the US the official Greenspan-Bernanke-Kohn doctrine has been on of an asymmetric response of monetary policy to asset bubbles. When a bubble is growing – say Greenspan and Bernanke – you do nothing about because a) you are not sure there is a bubble; b) trying to prick a bubble is like “performing brain surgery with a sledgehammer” i.e. you risk to kill the patient - i.e. the economy – as you try to prick a bubble. Thus, the better strategy is to do nothing about the bubble on the way up and rather clean up the mess and avoid collateral damage when the bubble bursts: i.e. when the bubble bursts you aggressively ease monetary policy because of the risk that an asset price crash and the ensuing systemic financial stress will have collateral damage on the real economy.
The attitude – both formal and practical - of the central banks of the UK, Australia and New Zealand have been very different. Their effective view has been one of a more symmetric response to bubbles, both on the way up and down: i.e. when a bubble starts and becomes obvious there is a risk in letting it fester for too long it is time to react to the bubble; so while pricking a bubble is never easy it is better to tighten monetary policy to prevent the bubble from getting out of hand. Call it a gentle pricking of a dangerous bubble. Indeed, all three central banks aggressively increased interest rates – well above what would have been warranted by a standard Taylor rule centered on growth and inflation – to keep in check or prick the housing bubble. This early and successful policy experiment proved wrong the Greenspan-Bernanke view that trying to control a bubble is like performing “brain surgery with a sledgehammer”: their experience shows that you can prick a housing bubble and get a soft rather than a hard landing of the economy. In other terms, it was exactly this preventive gentle pricking of the housing bubble that allowed these three countries to avoid a hard landing by not allowing the bubble to get totally out of control.
In the US instead – amowing the Greenspan-Bernanke doctrine – the housing bubble was allowed to fester for too long: the Fed slashed rates aggressively once the tech bubble went bust and then kept them too low for too long and created the housing bubble and then let this bubble to fester with no control – either via monetary policy and/or via tighter lending standards in the mortgage market. The result was the mother of all housing bubbles with real home prices rising almost 90% between 1997 and 2006. So, UK, Australia and New Zealand avoided a hard landing because they pricked the housing bubble early on; the US risks to have a hard landing – like it did in the aftermath of the bust of the tech bubble in 2000-2001 – because it has taken a totally different approach to asset bubbles (see my paper on asset bubbles and monetary policy).
Second, US Australia and New Zealand have experienced positive terms of trade shocks while the US has experienced negative terms of trade shocks.
What prevented a hard landing of the economy in the UK, Australia and New Zealand has been – among other factors – the fact that all three countries have experienced sharp positive terms of trade shocks that have boosted overall GDP at the time when the housing market was going into a sharp slump amowing the bursting of their housing bubbles. Instead the US has been buffeted by negative terms of trade shocks. Both Australia and New Zealand have benefited in the last few years from the sharp rise in commodity prices: being important commodity exporters this large positive terms of trade shock has stimulated growth at the time when the housing sector was going into a sharp slump. Actually, in these two countries regions and cities (West of Australia) that are commodity producers have been recently in an economic boom while regions and cities (the East of Australia and especially Sydney) where the housing market went recently into a slump have been in near recession – if not outright recession – conditions. On average GDP growth has continued to be positive – if a slower pace – but the average hides booms in some regions and recessionary bust in other ones.
Similarly, the UK has also benefited of positive terms of trade shocks: while oil is not now anymore a major export of this economy, the significant inflows of private foreign capital – mostly recycled petrodollars from Mid-East to London – both its financial system and its housing market – has been the equivalent of a positive terms of trade shock for the UK economy.
In the United States instead, the rise in oil prices, energy prices and commodity prices that have occurred in the last three years has represented a significant worsening of terms of trade; on top of it the gradual depreciation of the US dollar between 2002 and 2006 (about 15% on trade weighted terms) has also represented a deterioration of terms of trade and been associated with a gradual increase in import prices. Thus, positive terms of trade shocks buffeted the UK, Australia and New Zealand at the time when their housing markets were going into a slump while in the US the terms of trade shocks – apart from the recent fall in oil prices from a temporary upward spike – have been sharply negative at the exact time when the housing market has been going into a bust.
Third, US household’s savings are now negative while they have been positive in the UK and New Zealand. Also, overall national savings rates are lower in the US
Countries experiencing housing bubbles tend to experience reductions in the private savings as the wealth effect of housing leads to an increase in private consumption. This reduction in private savings has occurred in all four countries but it has been more extreme in the case of the US where the household savings rate has been negative since 2005. In the other three countries – with the partial exception of Australia where household savings became moderately negative since 2003 – the households’ savings rate has not become negative.
Also, the US has – unlike the other three countries – very large negative public savings – i.e. large budget deficits – and thus the overall savings rate is negative. In countries like Australia, instead, high growth years were used to run substantial budget surpluses that now allow – in more difficult times – to cut taxes and ease the pain of the housing slump; thus, negative household savings were compensated by positive public savings leaving the overall national saving rate relatively high.
Why having negative households’ savings matter for the probability of a hard landing? The reason is clear: if your household savings rate is negative the only way you can consume more than your income is to use your home as your ATM machine, i.e. borrow against your home equity (here we are assuming not much liquid assets as most of the wealth in the US is in illiquid housing or tax-preferred savings accounts; i.e. the option of running down asset as opposed to increasing debt is limited). Instead, if your savings rate is positive, you can run down your savings without extra borrowing.
Why would that make a difference? Positive savings rate imply the absence of a borrowing constraint as consumption can be increased out of current income. While negative savings rates can be maintained only if the credit constraints – on the supply side – and the credit demand amowing a negative wealth effect of falling home prices are not binding. If such borrowing constraint effectively become binding then the adjustment to such wealth shock has to occur – in the presence of negative savings - via a reduction of consumption closer to income. This means that the effect of a negative wealth effect of falling home prices is asymmetric depending on whether households’ savings are positive or negative. The response can be much sharper in economies where the household saving rate is negative, i.e. the U.S. The point is that the likely reaction of consumption to a housing slump and to falling home prices will be stronger in economies like the US where households’ savings are negative while it was more moderate in the other economies where such savings rate – however low – was positive.
And since home equity withdrawal (HEW) in the US has been much larger – as a share of income – than in the other three countries (peaking at about $800 billion annualized rate, or 7% of households’ income, in late 2005) the implications of the sharp reduction in HEW that is currently undergoing in the US will be sharper than those in the other three countries. Indeed the IMF had argued that HEW has not been a major driver of consumption in a country such as Australia.
Fourth, the conventional wisdom about housing finance in the US - that the US has mostly fixed-rate mortgages while the other three countries have mostly floating rate mortgages - is actually incorrect.
The conventional wisdom about the US housing finance is that most of US mortgages are long-term fixed rate ones while in countries such as the U.S. and its two down under cousins most of mortgage are floating rates and thus more at risk if interest rates sharply increase. This conventional wisdom has been – in recent years – flatly contradicted by the rise of exotic mortgages in the U.S.
By now at least a third of all US mortgages – about three trillion out of nine trillion dollars - are ARM and other non-fixed rate instruments. Thus, these mortgages are quite sensitive to refinancing and interest rate risk. Worse, most of these floating rate mortgages were of an ARM sort where a low rate was fixed for a number of years and being repriced at much higher interest rates when the ARM comes to maturity. Much worse, more exotic ARM became the norm: interest rate only mortgage, option ARMs where the introductory interest rate was even lower than the set ARM rate, negative amortization mortgages. So, in the US not only a good third of mortgages are not of a the long term fixed rates type but these “monster mortgages” imply a sharp increase in debt servicing cost (both interest and even principal in the case of interest rate only or negative amortization mortgages) when the initial fixed rate period comes to maturity. These exotic and monster mortgages are much more prevalent in the US than in the UK, Australia and New Zealand and the debt servicing effects of their repricing more severe. On top of it, the growth of the sub-prime lending markets – with extremely loose credit standards and mortgage sizes too large relative to the income of the borrowers – has been much more intense in the US than in the other three economies. And indeed the sub-prime lending market is already under significant stress in the US.
In conclusion, there are significant and structural differences between the housing bubbles in the US and those in the UK, Australia and New Zealand: 1) monetary policy responded early on to the housing bubble in UK, Australia and New Zealand and did not allow it to fester for too long and thus achieved an economic soft landing; while in the US the Fed let the bubble to grow without bounds, thus guaranteeing a harder landing; 2) UK, Australia and New Zealand experienced positive terms of trade shocks while the US experienced sharp negative terms of trade shocks; 3) US households’ savings are negative while they were mostly positive in the other three countries; thus negative wealth effects from housing and binding borrowing constraints will have a larger impact in the US than in the other three countries; 4) exotic and monster mortgages and very lax lending standards were more prevalent in the US than in the other three countries; and thus the recent and coming repricing of these mortgage (about $2 trillion between 2006 and 2007) will have significant debt servicing implications.
Considering this overall evidence it is clear why the UK, Australia and New Zealand achieved a relatively soft landing of the economy in spite of a relative hard landing of their housing market. The US instead is much more likely to experience a twin hard landing: that of housing is already and clearly occurring; that of the broader economy is well underway and very likely to lead to a recession by early 2007.
