News that U.S. home prices fell 3.2 percent in the second quarter of 2007 - the steepest rate of decline in the nationwide housing index since 1987 - could not have arrived at a worse time for the American economy. Coupled with record foreclosures, a tightening of the credit market, and worries over the continued viability of major credit lenders, the plummeting housing market could be the bellwether of even worse economic conditions to unfold in the U.S.
Add to this the report just out showing that consumer confidence fell in July to its lowest level in a year, and you have all the markings of a recession in the making. Even worse, July 2007 home sales were down 9% from July 2006, suggesting that the fallout from the credit crunch is starting to take a deep toll.
Historically a decline in new home sales has been associated with a coming recession. This was the case in the 12 months prior to the start of the 1991 recession, and it does not take an Ivy League economist to figure out that people will cut back on their largest purchases - especially a new home - when they sense that economic conditions are deteriorating. While July 2007 showed a slight increase in new home sales, the trend over the past year has been sharply downward.
Left: New home sales, 1989-1991
My wife and I are fortunate in that we refinanced our mortgage at a favorable fixed rate last year, and that we should have enough of a cushion in equity should prices continue to fall. Many over-leveraged borrowers are getting in trouble when the value of their house drops, which triggers lenders to call in mortgages that exceed established debt ratios.
Other borrowers, of course, have used attractive rates and low-fee offers to refinance their homes while continuing to spend beyond their means. These folks will likely contribute to escalating rates of bankruptcy filings in the coming years. Business and consumer bankruptcy filings are up almost 50 percent over comparable periods in 2006, and show no signs of lessening.
For those of you with high debt loads: this is the time to get a second (or third) job, start paying down debt, and cutting your expenses. I see too many friends and acquaintances running up credit card debt, buying flashy new cars, and pursuing the acquisition of expensive consumer goods like Skagen watches through variable rate charge accounts.
Despite the fact that my income has dropped in the last few years after I took the graduate student vow of poverty several years ago, our efforts to eliminate consumer debt have paid off. We now have little debt beyond our mortgage and some student loans - no car loans, no credit card balances, and no outstanding balances. Life is much easier when you can miss a few paychecks and not have to worry about the imminent collapse of a financial house of cards.