Housing market key to avoid a double dip

Oversupply of housing has been so huge that some economists are advocating demolishing whole neighbourhoods to take supply off the market
 

The question being asked is will America experience a double dip recession. As the largest economy in the world, what happens in the US will have a bearing on the world economy. As far as the GCC countries are concerned, US is the largest consumer of oil and a weak American economy will mean weak demand for oil and hence lower prices.

In most of the post-war recessions in the US, housing led the economy out of recession with the housing market improving a few months before the recession ended. This has not been the case in the latest recession of 2008/2009. Eminent economists including former Fed chairman Alan Greenspan say that the housing market is key to the US avoiding a double dip recession.

It is important to understand what happened in the last decade or so to foresee what is likely to happen. Home ownership increased dramatically in the US and in other developed countries as mortgages were made available to all and sundry without any respect to the borrower’s capacity to repay. Home prices kept rising and mortgage brokers convinced lenders and borrowers that the rising values alone would enable the borrower to repay.

This looks a fantasy world now but looked plausible at that time. This was aided by easy money policies followed by central banks in many countries with interest rates kept artificially low for extended periods. (Interest rates are even lower now, and near zero in the US, but the difference is that credit is scarce unlike in the past). Investment banks on Wall Street acted recklessly by parceling these mortgages (called subprime) and selling them to innocent investors who were unaware of the underlying risks.

Length of bubble

In the long run, demand and supply determine real estate prices and prices are related to nominal income growth. However, during the long period of rising prices, supply increased dramatically in many countries as lenders poured in money into mortgages. The length of time that a real estate asset bubble lasts determines how much oversupply there will be. In the US, the property bubble lasted a decade or more during which a large amount of oversupply was created and in real estate once supply comes on it cannot be withdrawn. The oversupply is so huge that it will take many years for it to be worked off. In fact, some economists are advocating demolishing whole neighbourhoods to take supply off the market.

The bubble lasted a few years in Dubai but the increase in supply was very rapid and considerable excess supply got built up in a short period. It will take many years for Dubai to work off the excess.

In Oman, the bubble was too brief and supply did not get built up. Many large projects that were announced could be shelved before they got off the ground. Therefore, in Oman while prices have receded from their peak in mid 2008, there is very little excess supply and hence far less pain to property developers.
 

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