Correctly Interpreting Recent Increase in Housing Starts

The recent increase in housing starts shows us how data can either inform or mislead. If we want to use our reason and common sense more effectively, it's important that we also understand the reported facts (data) we are considering. For example, when we read or hear reports in the media about economic activity, we usually find points of data presented to us that are used to draw some sort of conclusion about what's really going on. Are the conclusions valid? This week, economist John Hussman discusses how data is best used to understand what's going on in the economy right now. He begins with recent data presented regarding the housing market.

Regarding last week's housing data, for example, we read  at the beginning of last week that new home construction jumped higher. Then, later in the week, we read that existing home sales fell. How do we now understand these two facts, the one seemingly indicating "recovery" for the housing market, the second indicating a continuing slump? The media focused on the first and mostly ignored the second, leaving the impression that a) housing is increasingly recovering; b) a housing recovery will help spur an economic revival. But a careful reading of the data indicates otherwise.

Hussman explains that we need to understand the "data-generating process," which provides the "structure" of the data we are considering:

One part of the process is purely statistical. The housing data that is reported each month actually uses monthly data at an annual rate, so the jump from 758,000 to 852,000 housing starts at an annual rate actually works out to a statement that “During September, in an economy of about 130 million homes, about 100 million which are single detached units, a total of 9,500 more homes were started than in August – a fluctuation that is actually in the range of month-to-month statistical noise, but does bring recent activity to a recovery high.” Now, in prior recessions, the absolute low was about 900,000 starts on an annual basis, rising toward 2 million annual starts over the course of the recovery. The historical peak occurred in 1972 near 2.5 million starts, but the period leading up to 2006 was the longest sustained increase without a major drop. In the recent recovery, housing starts bottomed at 478,000 in early 2009, so we’ve clearly seen a recovery in starts. But the present level is still so low that it has previously been observed only briefly at the troughs of prior recessions.

Having understood the structure of the data we read, which shows recovery in starts, we move to the important question of whether it's sustainable.

Here the question to ask is how and why does a decision to “start” a house occur?...buyers who are able to secure financing (or pay cash) often find it more desirable to build to their preference instead of buying an existing home.

The reason buyers might prefer building a new home is that the existing home supply is constrained. First of all, 22% of mortgages are underwater (more owed on the home than the home is worth) and many people are reluctant to sell a house at a loss. Second, banks have taken over millions of homes in the foreclosure process (known as REO, or "real estate owned" by a lending institution). They have only slowly released these homes for sale. These two factors reduce the availability of existing homes. The price of existing homes might have fallen farther had the market been allowed to clear. But government, working with the banks, does not want house prices to fall farther, so they "encourage" banks to hold onto foreclosed homes instead of dumping them on the market.

The net result of all this manipulation has been artificially propping up the price of existing homes, leading to new buyers opting to simply build a new home. These new homes increase the total number of homes. This sort of government meddling has led to what economists call a "misallocation" of capital. People are spending money to build new houses, in a market where there is already a glut of homes, whose prices are artificially kept high.

In the end, the data-generating process features millions of underwater homes, huge REO inventories, and yet constrained supply. The result is more stable home prices, but a misallocation of capital into new homes despite a glut of existing homes that cannot or will not be brought to market. So starts are up even though existing home sales are down. 

I found this analysis helpful in understanding this data. So thanks to Hussman. He then expands his analysis to comment on today's financial markets. It's worth a read. He concludes his neat little lesson with this:

In short, it is not enough to examine data, even large volumes of it. In order to extract information and draw conclusions, it is crucial to think about the process that is involved in generating that data.

Notice how he exhorts us to think.

You can find the whole article by clicking HERE...