Big Economic Contraction on the Way?‏

So, is the economy improving? Is the credit crisis over? Are markets on the mend?

Below offers a differing viewpoint from what you'll hear on the mainstream media.

Big Economic Contraction on the Way?
"When Housing Starts Stop, the Economy Does the Same"

By Robert Jay Thu, 26 May 2011 17:00:00 ET

Bad news about the housing market these days is almost too common to be called "news."

The sad irony is, a single family home is the one asset we were told "always goes up"...

...Yet housing is the one major sector that's remained worse off than virtually any other.

Here's the latest round of government data: U.S. home prices fell by 5.5 percent in Q1 vs. a year ago, and lost 2.5 percent vs. the previous quarter; monthly housing starts fell 10.6 percent in April alone. 

Housing starts reports do more than provide information about home construction. They also serve as an indicator about the health of the economy (see chart below):

The economy is slowing. Growth now stands at 1.8 percent, vs. 2.6 percent last summer.

There was another time in our history when the economy slowed and went into a severe contraction. With that period in mind, EWI's Robert Prechter explains his forecast for housing:

"I am sometimes asked why I have such a 'crazy' outlook for real estate, calling for prices to fall as much as 90 percent. I will let a subscriber answer that question. He recently sent this email:

'For what it’s worth, I will recount what my father told me when real estate values were falling in the sun belt in the late 1980s. He was born in 1919 and never stopped talking about the Depression as it made such an impression on him. I asked him one day how far the price of farmland fell in the 1930s. He answered, 'Your Grandfather and I went to the auctions held on the county courthouse steps...and watched auctions for the best farms in this county that had been repossessed, and there were no bidders. You couldn’t borrow a dime to finance a purchase, and if you had money you wouldn’t part with it under any circumstances.'"

Conquer the Crash, 2nd edition, pp. 338-339

Does the trend in today's real estate market portend what's ahead in the general economy?

We can say this: many of the same deteriorating economic indicators that we saw in mid-2007 are flashing the same signals now.

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Unending Foreclosure Story: What Does It Mean for U.S. Economy?

By Susan C. Walker Fri, 27 May 2011 14:00:00 ET

People in the market to buy a house but who don't need to buy one soon have it good. They can sit back and watch housing prices head down -- all thanks to the vast number of foreclosed properties that clog the market and continue to drag down prices. Here's the latest news about the effect of foreclosures on the U.S. economy:

• The Associated Press reported on May 26 that "RealtyTrac [a company based in Los Angeles that tracks U.S. foreclosures] estimates there are 872,000 homes that have been repossessed by lenders but have yet to be sold. At the first-quarter's sales pace, it will take three years to clear the inventory of 1.9 million properties already in some stage of foreclosure." 

•  The company also reported that foreclosures made up 28% of all home sales, an "astronomically high figure, ' according to a senior VP at RealtyTrac. He told AP that foreclosed properties normally make up less than 5% of the market.

• Meanwhile, the latest housing news on May 27 shows that sales of existing homes were donw 12% in April 2011, according to the National Association of Realtors. (Reuters)

Robert Prechter and other analysts at Elliott Wave International began warning about the housing market debacle as early as 2002. That was when most people still believed that house prices went only in one direction -- to the sky. Here's what Prechter wrote then in his book, Conquer the Crash:

"What screams 'bubble' -- giant, historic bubble -- in real estate today is the system-wide extension of massive amounts of credit to finance property purchases. As a result, a record percentage of Americans today are nominal 'homeowners' via $7.6 trillion in mortgage debt…."

That mortgage debt number grew to more than $11 trillion by 2008, according to Federal Reserve data. In the current May 2011 issue of The Elliott Wave Theorist, Prechter writes about the recent effects of the government's effort to clean up the housing market mess: 

"There is no free lunch. The Fed is making new dollars, but it is backing many of them with bad debt. The government has decreed that taxpayers shall be liable for the errors of speculators, 'guaranteeing' that many bad debts will be repaid. But these are short-lived schemes. No one can thwart the economic ecology forever.

 "Remember the government’s program last year to prop up the real estate market with free money via tax deductions? Well, that program is over, and real estate prices have just plunged to where they would have been anyway. Innocent taxpayers had their money given to others, so they were cheated. But the buyers of homes were screwed even worse, because they got stuck with high-priced albatrosses.

"Every government plan is short term, and each one makes things worse in the long run. When the markets start deleveraging again and the government begins to stare ruin in the face, the programs that temporarily buoyed the markets will fail, and the markets will make up for lost time on the downside." [Excerpted from the May 2011 Theorist]

As if to make Prechter's point, the AP article also said that "[h]omebuyers who purchased a bank-owned home in the first quarter saved an average of 35 percent versus the average price of other types of homes," according to RealtyTrac.

Overall, housing prices have dropped dramatically. The S&P/Case-Shiller index of property values in 20 cities is "down 33 percent from its July 2006 peak," reports Reuters.

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