A likely recession?

From the Daily Reckoning:

Will the US housing bubble mean a recession?

The US housing bubble is in the midst of deflating. There is no doubt now that the halcyon days of this housing boom are over.

New home construction in the US tumbled in October – hitting six-year lows. Sales are slowing. inventory continues to build. Based on September’s rates of sales, it would take more than six months to sell off the existing new homes on the market. That’s just new homes. Never mind the existing stock of older homes. Existing home inventories are up 70% from the beginning of 2005, with nearly 4 million unsold units.

So predictably, prices are falling. The median price of a new home in the US fell nearly 10% in September from a year ago. That’s the steepest drop on record, which goes back about 40 years. It was also the second consecutive month of price declines. Anecdotal evidence suggests things are much worse in certain pockets of the country. At this point, most Americans have heard horror stories from neighbours and friends trying to sell in this market.
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Now, it’s just a matter of debate as to how bad things will get. This is a nice illustration of Hyman Minsky’s view on financial stability. The late Minsky coined his thesis the Financial Instability Hypothesis, which, despite its grand name, offered up a relatively simple insight. “Over periods of prolonged prosperity,” Minsky wrote, “the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.”

In simpler terms, long stretches of good times lead people to take more chances. In Minsky’s terms, we find more “speculative units” and “Ponzi units” – entities financed increasingly with debt in a manner less than prudent. In the US housing arena, we certainly saw a vast increase in creative financing.
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A wise individual once observed that innovation in finance usually amounts to buying more and more with less and less. Again, we saw that in US housing, with a surge in unconventional house payments: more adjustable-rate loans, more interest-only loans, “low docs,” “no docs” and much more. In this new era of creative financing, the old 30-year house loan with 20% down became a quaint vestige of a bygone era – like a vinyl record or a fully-funded pension plan.

So now the pendulum has begun to swing the other way. What does this mean? It means a rollback of the speculative and Ponzi finance units, as Minsky would say. It means a withdrawal of EZ credit to the US housing market. Which means a consumer-spending retrenchment…and a very likely recession.