(Roughly) Daily

Adam Tooze on the biggest vulnerability in the global economy…

In this precarious moment – in the fourth quarter of 2022, two years into the recovery from COVID – of all the forces driving towards an abrupt and disruptive global slowdown, by far the largest is the threat of a global housing shock…

In the global economy there are three really large asset classes: the equities issued by corporations ($109 trillion); the debt securities issued by corporations and governments ($123 trillion); and real estate, which is dominated by residential real estate, valued worldwide at $258 trillion. Commercial real estate ($32.6 trillion) and agricultural land add another $68 trillion. If economic news were reported more sensibly, indices of global real estate would figure every day alongside the S&P500 and the Nasdaq. The surge in global house prices in 2019-2021 added tens of trillions to measured global wealth. If that unwinds it will deliver a huge recessionary shock.

In regional terms, as a first approximation, think of global real estate assets as split four ways, with the US, China and the EU each accounting for c. 20-22 percent and 35 percent or so belonging to the rest of the world.

The housing complex is at the heart of the capitalist economy. Construction is a major industry worldwide. It is one of the classic drivers of the business-cycle. But beyond the constructive industry itself, the influence of housing as an asset class is pervasive. Compared to equities or debt securities, residential real estate is owned in a relatively decentralized way. Homeownership defines the middle class. And for the majority of households in that class, those with any measurable net worth, the home is the main marketable asset.

Middle-class households are for the most part undiversified and unhedged speculators in one asset, their home. Furthermore, since homes are the only asset that most households can use as collateral, they pile on leverage. For households, as for firms, leverage promises outsized gains, but also brings with it serious risks in the event of a downturn. Mortgage and rental payments are generally the largest single item in household budgets. And household spending, which accounts for 60 percent of GDP in a typical OECD member, is also responsive to perceived household wealth and thus to home equity – the balance between home prices and the mortgages secured on it. For all of these reasons, a surge in mortgage rates and/or a slump in house prices is a very big deal for the world economy and for society more generally…

More background and an assessment of the outlook: “The global housing downturn,” from @adam_tooze.

For Tooze’s follow-up piece on the risk inherent in the $23 trillion US Treasury market, see here.

* Harold Samuel

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As we mortgage our futures, we might recall that it was on this date in 1914 that the Federal Reserve Bank of the U.S. was opened. In actuality a network of 12 regional banks, joined in the Federal Reserve System, they oversee federally-chartered banks in their regions and are jointly responsible for implementing the monetary policy set forth by the Federal Open Market Committee.

In that latter role, they are central to the housing market in that they set interest rates and purchase mortgage securities from Fannie Mae and Freddie Mac (Government-Sponsored Enterprises in the mortgage market). At this point the Fed owns about a quarter of the mortgage-backed securities issued by Fannie Mae and Freddie Mac.

The Federal Reserve Banks in 1936 (source)