US housing was the prime cause of the current financial crisis. US banks spent most of the 2000-7 period lending at low 'teaser' rates to borrowers who had no prospect of repaying the loan. And by syndicating the loans to gullible European banks, they ensured that losses were shared equally, when credit standards finally began to tighten.
This lending binge also led to a Boom period for the global chemical industry. US housing starts rose to 2.2 million in 2006, worth $35bn in chemical sales (in 2010 values), with each house worth $16k according to American Chemical Council analysis. In addition, China's export-based manufacturing economy prospered (requiring ever-increasing volumes of chemical imports), as US demand rose for the goods required to furnish all these new homes.
The result is shown in the above chart, based on the authoritative S&P Case-Shiller Index for the 10 major US cities. From a base of $100k in January 2000, US house prices more than doubled to $226k by July 2006. Since then, they have fallen 29%. Housing starts have tumbled to just 600k, worth only $10bn in chemical sales. Now, the question is what happens next?
• Massive Federal support, including $8k tax breaks for purchases, has only led to a very modest price recovery. The index bottomed at $150k in April 2009, then peaked in July this year at $162k, just 8% higher.
• Unsold housing inventory (including foreclosures) already totals 6.3m homes, equal to 2 year's sales at current rates, versus 6 - 7 months in the Boom.
• The index's originators are cautious in their outlook. Karl Case says his Base Case is for prices to remain flat. But with "2 - 1 odds, I'd bet they go down".
• Yale's Prof Shiller refuses to forecast price changes, instead focusing on what he believes is a "catastrophic drop in confidence". He also seems to share the blog's view that we could be entering a New Normal, noting that "there's been a cultural change which goes beyond any short-run forecasts".
Chemical companies finalising their budgets for 2011 cannot afford to ignore this uncertainty. A Scenario approach seems the best way forward, as described in the blog's own Budget Outlook:
• In a Base Case, housing starts and prices might remain broadly stable
• An Upside Case could hope for some improvement
• The Downside Case of lower starts and prices also implies greater uncertainty in the global financial system, as it increases the risk that more banks will fail.
As always, the blog will be happy to discuss these critical issues in more detail, if this would be helpful for your management team.