The Next Housing Crisis - Relying on Echo Boomers

A 2012 paper entitled "Demographic Challenges and Opportunities for U.S. Housing Markets" by the Bipartisan Policy Centre examines how growth in the number of seniors in the United States (and, for that matter, any developed nation with a large cohort of Baby Boomers) and how it will impact housing particularly as these Americans retire and dissolve their households.

Let's open with a couple of definitions.  Baby Boomers are generally considered to have been born between the years of 1946 and 1964 and it is estimated that in that time period, approximately 76.4 million Baby Boomers were born, making up nearly 40 percent of the total population.  Echo Boomers are the children born to Baby Boomers between the years of 1981 and 1995; there are an estimated 65 million children in this age group.  Since fertility rates dropped over the 50 year period between 1946 and 1995, Baby Boomers generally had fewer children than their parents as shown here:

During the period of the baby boom, women were having between 3 and 3.7 children each; this fell to between 1.7 and 2.1 during the period between 1981 and 1995.  Please note that while the 76.4 million number is commonly used as the total number of Baby Boomers born in the United States, the census in 2000 counted 79.6 million United States residents born between 1946 and 1964 with the larger number accounting for the inflow of immigrants.

Between 2000 and 2010, the number of Americans over the age of 65 increased by about 5 million.  Over the next 20 years, it is estimated that the population of Americans over the age of 65 will increase by over 30 million with an increase of 14.2 million by 2020 and an additional increase of 16.5 million by 2030.  This means that senior Americans will make up 20 percent of the total population, up from 13 percent today.

How will these tens of millions of older Americans impact the housing market?  As adults enter their sixties, the level of household dissolution exceeds the level of household creation, releasing more housing units into the market, particularly over the next forty years.  While many senior Americans currently prefer to remain in owner-occupied housing, a trend that is likely to continue into the future, many of the houses that they occupied while they were raising families are unsuitable simply because they are:

1.) too large (over-housing)

2.) too expensive to adapt for impaired mobility or 

3.) too isolating as they need increased support from family members.

It is estimated that between 2000 and 2010 (before the influx of Baby Boomers into their senior years) that people over the age of 55 released over 10.5 million net mainly owner-occupied housing units to the housing market.  During that same time period, 14.7 million new dwelling were built and the number of new households headed by Americans under the age of 55 grew by 21.8 million.  That means, on net, there was a growth of 11.2 million new households (the difference between the number of households dissolved and the number of new ones formed).

Looking to the future, economists estimate that seniors will release between 10.6 and 11.3 million housing units between 2010 and 2020 and will release an additional 14.4 to 15.0 million units between 2020 and 2030 with 80 percent of these being owner-occupied housing.

The American housing market will increasingly rely on Echo Boomers for its salvation; before the year 2020, it is estimated that Echo Boomers will account for the absorption of between 75 and 80 percent of owner-occupied housing.  Unfortunately, it is this very generation that has suffered from a series of recessions in the new millennium which has resulted in lowered income and an inability to form new households and purchase residential real estate.  As shown on this chart and keeping in mind that today's 24 year olds will have the potential to form new households within the next decade, the number of unemployed younger Americans was still at elevated levels in 2012:

On top of that, it is estimated that only 21 percent of Echo Boomers were married in 2009 with 75 percent being single and never married.  Only 20 percent have children in their homes compared to 30 percent of Baby Boomers when they were at the same stage of life.  As noted, the economy has been particularly hard on Echo Boomers; the median income of 15 to 24 year olds dropped by nine percent between 2009 and 2010 with nearly half of 25 to 34 year olds who moved in with family and friends to save money living below the poverty line.  Another issue facing Echo Boomers is very high debt loads associated with student loan and credit card debt. 

With all of this in mind, the authors of the study generated three scenarios that predict the demand that Echo Boomers will bring to the housing market.  Note that these scenarios each include a constant net immigration rate of 975,000 people per year.  Here are the scenarios:

1.) Low Case: Between 2010 and 2020, 9.7 million new households are generated because of a weak economic recovery and an inability to attain homeownership.  Including people between 15 and 34 years of age plus five years in 2010 brings the total to 15.6 million new households.

2.) Medium Case: Between 2010 and 2020, 12.3 million new households are generated because of a moderate economy recovery.  This scenario assumes that there are moderate reductions in the requirements for down payments and that the rate of household formation is similar to what was seen between 1990 and 2010.  Including people between 15 and 34 years plus five years in 2010 brings the total to 18.8 million new households.

3.) High Case: Between 2010 and 2020, 14.9 million new households are generated because of a strong economic recovery similar to what was seen in the 1990s.  Including people between 15 and 34 years plus five years in 2010 brings the total to 17.1 million new households over the decade.

Under the same economic assumptions, the decline in the number of older households over the decade ranges from 11.6 million to 10.6 million, a factor that is less impacted by economic growth rates.

Here is a graph summarizing the data:

While the number of housing released by America's newly minted seniors is absorbed by the growing number of newly minted households in all three cases over the period from 2010 to 2020, the situation worsens in the decade beyond 2020.  Under the low case scenario (weak economic growth), the number of owner-occupied dwellings released by Baby Boomers will increase and new owners will only be able to absorb 300,000 more units that seniors will release on a national scale.  This near national parity means that many local markets will be oversupplied, meaning that existing Baby Boomer homeowners after 2020 will face some difficult decisions; lowering prices, conversion to rental housing, leaving them vacant or abandoning them.  Sadly, metropolitan areas with a large future supply of dwellings released by an aging population are not necessarily those areas which will have a high future housing demand.  Most states now have a relatively even distribution of Baby Boomers, however, the population distribution of Echo Boomers (and post 1980 immigrants) is much more uneven.  For example, in Michigan, West Virginia, Ohio, Pennsylvania, Rhode Island, Mississippi and Louisiana, the number of seniors exiting homeownership is nearly the same as the number of new households being formed largely because these states had difficulty retaining and attracting Echo Boomers and immigrants.  As Boomers age, the number of dissolving households in these states is likely to outstrip the number of new households being formed, putting downward pressure on the housing market.  In contrast, Nevada, Arizona, Utah, Idaho and Texas have all experienced high birth rates and added a great number of jobs since the beginning of the new millennium.  In these states, the release of owner-occupied housing added up to less than 35 percent of the increase in housing supply required to meet the demands of newly formed households.

Obviously, this analysis shows that the formation of new households by the Echo Boomers is key to the future of the United States housing market.  If the rather lukewarm economic growth experienced by today's young men and women in combination with an elevated number of working "retirees" prevents them from being able to afford homeownership, as the next two decades pass, we could see the housing market, particularly for some types of housing, suffer from further stress.

America's Indebted Consumers - An Explanation for Poor Economic Growth

Consumer spending is the driver behind economic growth in today's economy.  Since consumer spending in the U.S. makes up roughly 70 percent of GDP (including spending on health care), rises and falls in spending by Main Street has a significant impact on overall economic growth.  

According to the Bureau of Economic Analysis, real personal consumption expenditures (PCE) increased by 3.2 percent in the first quarter of 2013 compared to 1.8 percent in the fourth quarter of 2012.  The biggest increase was seen in the purchase of durable goods, up 8.1 percent in Q1, down from an increase of 13.6 percent in Q4 2012.  It's buy, buy, buy time as you'll see on the next graph.

Here's a graph from FRED showing how real PCE has performed since just before the beginning of the Great Recession:

Here is a graphic from the Federal Reserve Bank of New York showing how household debt levels have changed over the past eight years:

While household debt has decreased from its peak of $12.64 trillion in the third quarter of 2009, it still stands at a whopping $11.34 trillion when both housing and non-housing debt is included.  Note that while housing debt levels have dropped, non-housing debt levels have remained consistently high and , for the first time since 2008, have grown by $31 billion in the last quarter of 2012.  This explains the growth in personal consumption expenditures noted above.  

Here is an even more detailed breakdown of what American consumers are using credit for:

Now for the bad news.  Here is a graph showing which types of loans are delinquent:

Lastly, here is a graph showing the percentage of loans based on their delinquency status:

While the percentage of loans that are 120 plus days or more overdue has dropped since the depths of the Great Recession, over 6 percent of borrowers still find themselves in credit hell, only slightly better than the 7.5 percent at the depths of the consumer credit crisis and well above historical norms.

With an elevated number of American consumers still finding themselves with credit difficulties, perhaps we have an explanation for the rather lukewarm GDP growth numbers four years into the "recovery".  What is particularly concerning is that once interest rates begin their march back to historical levels, American consumers will find that they simply cannot afford to buy, buy, buy.

The Federal Reserve - Balance Sheet Woes

Updated September 16, 2013

In researching another posting, I stumbled on some interesting data that I wanted to pass along.

Since the Great Recession, the Fed has been very busy intervening in the free market in a series of desperate attempts to stimulate the American economy.  Through the use of quantitative easing and "The Twist", the Fed has ended up with a very bloated balance sheet, containing nearly two trillion   dollars worth of U.S. Treasuries as shown on this graphic:

In the two years before the crisis in 2008, the Fed's balance sheet stood at between $860 billion and $920 billion.  On September 3, 2008, the Fed had $905 billion in assets; by October 1, 2008, that number had risen to $1.504 trillion, a 66 percent increase.  It now stands at $3.701 trillion, an overall increase of 411 percent over its pre-Great Recession level!

In mid-September 2013, the Fed owned $2.038 trillion worth of U.S. Treasury securities as shown on this chart:

The data shows that 55.1 percent of the Fed's total asset base is made up of United States Treasuries.

Now, let's get to the key point of this posting.  From the President's Fiscal Year 2014 Budget, comes the following data showing the history of the Federal Reserve's holdings of U.S. Federal debt since 1940:

Here is a bar graph showing how the percentage of the Federal debt held by the Federal Reserve has changed over the 7 decade period, showing how it has more than doubled since 2008:

As I've said before, Mr. Bernanke and his merry band of bankers are trapped in interest rate purgatory.  If they raise rates, the value of the Fed's balance sheet could plummet as the market value of the majority of the Fed's assets drop since the trading price of bonds varies inversely with interest rates.  A recent study shows that a mere 2 percentage point increase in interest rates on a 30 year bond with a 4 percent coupon would see the bond price drop by 27.7 percent.  The same 2 percentage point rise would push the price of a 20 year bond down by 23.1 percent and a 10 year bond by 14.9 percent.

In any case, the Federal Reserve is now at the mercy of its own policies and, since interest rates are just above zero, it is highly unlikely that they will see the market value of their Treasury portfolio rise with a drop in interest rates, unless they are willing to experiment with a negative interest rate policy. 

The 2014 Presidential Budget - The Revenue Side of the Equation

Analysts at the Tax Policy Center have now released their analysis of President Obama's Fiscal Year 2014 Budget.  Here are the salient points in chart form:

Notice that the deficit reduction proposals are over a 10 year period from 2014 to 2023.

Let's look at more detailed highlights and their impact on overall revenues.

a.) Increasing taxes to reduce the deficit: 

Implementing the Buffett Rule which will raise taxes for those making $1 million or more will reduce the deficit by $53 billion

Reducing the value of tax expenditures for high-income taxpayers will reduce the deficit by $529 billion.

Restoring the 2009 parameters for estate and gift taxes will reduce the deficit by $72 billion.

Increasing and indexing tobacco taxes will reduce the deficit by $78 billion.

Expanding the unemployment insurance tax base will reduce the deficit by $51 billion.

b.) Reducing taxes to increase the deficit:

Permanently extending certain provisions in the American Taxpayer Relief Act will increase the deficit by a net $161 billion.

Providing small businesses with a 10 percent tax credit for new jobs and wage increases will increase the deficit by a net $26 billion.

Increasing the tax enforcement program integrity cap will reduce the deficit by $47 billion.

Reducing the tax gap, simplifying the system and strengthening compliance will reduce the deficit by $28 billion.

The net result of the 32 key revenue measures in the budget is a net decrease in the deficit of $881 billion over the 10 year period.

Here is a chart showing how changes to individual federal taxes in the Obama 2014 Budget will impact  different cash income levels in 2015:

Americans earning cash income of less than $100,000 annually will see their average Federal taxes increase by between $18 and $74 in 2015.  Those earning cash incomes of over $1,000,000 will see their average Federal taxes rise by $82,604.  On average, these individuals will see their average Federal tax rate rise by 2.3 percentage points to 41.1 percent.  Those making just under $1,000,000 will see their Federal tax rate rise by 1.3 percentage points to 33.6 percent.  The remainder of Americans will see their average Federal tax rate rise by between 0.1 and 0.8 percentage points, ranging between 2.1 percent and 27.2 percent.

The 2014 President's Budget claims that it will achieve additional deficit reduction of $1.8 trillion over 10 years through reductions in spending and increases in revenue as noted above, bringing total deficit reduction to $4.3 trillion and reducing the deficit to 2.8 percent of GDP by 2016 and 1.7 percent by 2023.  

How likely is it that these deficit goals will be achieved?  Here is a graph from FRED showing a history of the deficit as a percentage of GDP since the Great Depression:

In 2009, the deficit hit 10.1 percent of GDP, the fifth worst on record.  Between 2010 and 2012, the deficit ranged from 6.9 percent to 8.9 percent of GDP, the sixth, seventh, eighth and ninth worst years on record.  The only years with greater deficits as a percentage of GDP were from 1942 to 1945 when America was ramping up spending for the war effort.

To put things into perspective, here's a bar graph showing the unceasing climb in the Federal debt since 1940:

Now, with these two graphs in mind, what do you think the odds are that historical trends will suddenly reverse and that the rather meagre spending cuts and revenue increases in the President's budget for fiscal 2014 will do anything to improve America's indebtedness over the next decade?